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What’s to stop the S&P 500 hitting 5,000? I see 3 problems

Closeup ruffled American flag representing US stocks and shares
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In his latest yearly letter to shareholders, billionaire Warren Buffett said, “In its brief 232 years of existence…there has been no incubator for unleashing human potential like America.” The Oracle of Omaha added, “Our unwavering conclusion: Never bet against America.” When I look at the awesome performance of the S&P 500 index, I have to agree with the world’s most acclaimed investor.

The S&P 500 seems unstoppable

The US is the world’s richest country and the biggest economy. It has the largest, deepest capital markets and the most powerful companies (notably in technology). Hence, when America booms, its stock markets usually follow suit. During the global financial crisis of 2007–09, I vividly recall the S&P 500 plunging to 666 points. (For the record, it hit the ‘Number of the Beast’ during the tumultuous afternoon of Friday, 6 March 2009.)

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As I write, the index hovers around 4,521.34 points. Therefore, since 2009’s low, the S&P 500 has risen by almost 579%. In other words, $1,000 invested in the index at that time would be worth roughly $6,790. That’s a wonderful return over 12.5 years, equivalent to 16.6% a year compounded. But that’s not all. Here’s how the index has performed over: One month: +3.1% | Six months: +15.9% | One year: +29.2% | Five years: +107.4%.

In short, despite the Covid-19 pandemic of 2020–21, the S&P 500 index keeps steamrollering on. Next stop 5,000 points, surely? But I recall the old City saying that “markets climb a wall of worry.” Here are three problems that could restrain the main US market index from further advances:

1. The S&P 500 is highly valued

Currently, the S&P 500 trades on a forward price-to-earnings ratio of 22.3 and an earnings yield of 4.5%. Also, it offers a forward dividend yield of 1.3% a year. In historical terms, this suggests that US stocks are trading at the top end of their valuation range. Indeed, based on several key measures, US stocks are strongly overvalued. And history shows that markets tend to revert to their mean, which might indicate that the S&P 500 is riding too high right now. Then again, with interest rates so low, what alternative do investors have but to keep buying stocks?

2. China’s economic growth may be slowing

China is the world’s workshop, its second-largest economy, and a major contributor to global growth and trade. However, after roaring ahead earlier this year, there are early signs that Chinese growth may be easing back. In addition, the Chinese Communist Party has started cracking down on giant tech firms, education providers, and over-leveraged property developers. Thus, if China’s economy sneezes hard, then the rest of the world might well catch a bad cold.

3. The delta variant keeps spreading

The delta variant of Covid-19 also makes many investors nervous. That’s because it’s more transmissible and deadlier than previous coronavirus strains. Indeed, it’s estimated that delta is twice as likely to hospitalise sufferers as the original strain. After 18 months of a global pandemic, the last thing markets (and the S&P 500) need is more lockdowns later this year. Therefore, let’s hope that the world gets delta under control before the Northern hemisphere winter arrives.

By the way, I worry about rising US inflation, monetary policy, and interest rates, too. But I have a simple approach to these worries. I just keep buying cheap shares for their future returns. And few markets are as cheap as the UK’s FTSE 100, where is where my money is going for now!

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Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services, such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool, we believe that considering a diverse range of insights makes us better investors.

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