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These days, it’s rare for me to go a full day without running into an article about a stock market crash. Leaving aside the irony that I am in the midst of penning my own such article, it’s fair to say there’s some substance to all the panic.
Want evidence? Take your pick. Jerome Powell made headlines when he warned that stocks were “highly valued”. The S&P 500 average price-to-earnings ratio nudged north of 30. That’s an average of all 500 companies on the index!
The Warren Buffett indicator, a measure of stock valuation compared to the underlying economy, is at record levels too. According to this metric, American stocks, relative to the size of gross domestic product, are valued around four times higher than in the 1990s.
There might be a modern phenomenon that explains what’s happening here, though. It’s to do with the behaviour of many modern investors and may mean the fears of a stock market crash are a touch overblown. Let me explain.
Likelihood
The phenomenon, in short, is index funds. These broad market investments originated in the 1970s and have become very popular since. Some reports have the S&P 500 at 33% ownership by such passively managed funds.
Why is this a problem? Well, the mantra of these investors is ‘S&P 500 and chill’. Essentially, buy index funds and don’t sell them until retirement. This could be creating a lot of upward pressure on share prices. It may indeed be the reason why valuations are at record levels.
Most importantly, it may be a reason that a stock market crash is less likely. After all, if a third of shareholders will hold onto their investments come hell or high water, then that’s fewer people who might panic sell.
A buy?
Leaving aside what happens when the bulk of these investors reach retirement age – that’s a story for another decade – the popularity of index funds has consequences for individual stocks too.
Take iPhone manufacturer Apple (NASDAQ: AAPL). As the third-largest member of the S&P 500, the prevalence of passive investors might indicate an inflated valuation. The forward price-to-earnings ratio now stands at around 32. That’s pretty expensive, yes, but nothing crazy.
Warren Buffett thinks so. Apple makes up Berkshire Hathaway‘s largest holding and by some distance. The firm produces the best electronics on the planet, in my view. Its best in class laptops and smartphones mean sales and earnings have a lot of protection.
With so much of the Cupertino-based firm’s manufacturing outsourced abroad, the firm is threatened by the ongoing tariffs issue. The ‘Trump Tariffs’ debacle indeed caused a brief stock market crash earlier this year. Apple shares plunged 33% in the brouhaha, although they have recovered to an all-time high now.
Can they continue climbing from here? I wouldn’t bet against it. Apple shares are one to consider, if you ask me.
This story originally appeared on Motley Fool
