Key Points
With the S&P 500 hovering near all-time highs and its valuation at its highest level since the 2021 tech stock boom, investors need to be prepared for a correction.
Corrections, when the market drops at least 10%, are not necessarily a bad thing for long-term investors; they are just temporary drops that occur regularly and for a variety of reasons. They could be related to economic forces, like slow growth or high inflation, but they could also be a pullback due to an overheated market.
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If you invest for the long term, you don’t panic-sell when the market corrects, because over time, the S&P 500 has consistently produced double-digit returns. Over the past 10 years, for example, it has had an average annualized total return of 15%, and over the past 20 years, it has averaged 11%.
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Additionally, corrections are a fantastic time to buy great stocks and exchange-traded funds (ETFs) at a discount. Warren Buffett, the former CEO of Berkshire Hathaway, famously advised investors to be “fearful when others are greedy, and greedy when others are fearful.”
Is it time to get greedy?
Given the meteoric run the market has been on over the past two months, this is definitely not the time to be greedy.
The S&P 500 has risen 16.4% since March 30 and reached an all-time high in early June of 7,620. It has dropped about 3% over the past few days, but the index was still sitting at around 7,385 as of June 5.
Certainly, every portfolio should have an S&P 500 ETF as a core holding, because of its track record and the exposure it provides to the largest stocks in the U.S. across sectors. All of the major shops have their own S&P 500 index funds, including the State Street SPDR Portfolio S&P 500 ETF (NYSEMKT: SPYM), which is essentially the retail version of the oldest ETF, the SPDR S&P 500 ETF (NYSEMKT: SPY).
The SPYM ETF has the lowest expense ratio of the major S&P 500 ETFs at 0.02%. That means investors pay just $0.20 in fees for every $1,000 invested in the fund.
Look for a time to buy
Currently, the P/E of the S&P 500 is around 27, which is above the historical average but down from 29 in January.
However, the Shiller cyclically adjusted P/E (CAPE) ratio, which looks at earnings over the past 10 years on an inflation-adjusted basis, is at 42. That is the highest since the dot-com boom in 1999. Many experts believe the Shiller CAPE ratio is the most accurate valuation metric because it takes a longer view and accounts for inflation. So, a Shiller CAPE of 42 should be concerning.
Should investors pile into S&P 500 index ETFs like SPYM now? Probably not. Certainly hold your allocations, but there might be a better time to get greedy when valuations fall a bit more. At that point, adding shares of SPYM will be a no-brainer.
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Dave Kovaleski has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Berkshire Hathaway. The Motley Fool has a disclosure policy.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
