Is the S&P 500 Just a Giant Bubble?

You know that saying in investment ads: past performance is not a reliable indicator of future returns. It's an interesting one and it got me thinking, because for passive investors that are literally buying the whole market, the very thesis of that strategy revolves around hopefully getting a similar return from the S&P 500 in the future to what's happened in the past.

Now, since 1957, when the index first adopted the 500 stock structure, the S&P 500 has returned an average of 10.15% per year. But here's the thing: in order to maintain that same average annual return out into the future in 50 years, the S&P 500 will have to go from where it is now—around 4,500 points—to a whopping 5,648.78 points. That's 125 times higher than where it is today! How on Earth is it going to be able to do that?

Because we have to remember, the stock market doesn't just go up. Despite what the forums will tell you, you don't just sprinkle some magic fairy dust on these businesses and all of a sudden, the stock market rises. Over the ultra long term, the performance of the stock market is a direct reflection of the collective performance of the underlying businesses that make it up. So, that begs the question: How likely is it that the S&P 500 will actually keep going up as it has done in the past? What's going to cause that, and how likely is it that a passive investor today would actually make 10% per year on average?

The S&P 500 is a stock market index that tracks the 500 largest companies in America over time. These days, it is now the predominant index that's used to judge the performance of the American stock market. When someone talks about the market returns over in America, the metric that they're referencing is the S&P 500.

And yes, since 1957, this group of companies has returned an average of 10.15% per year. Why? Well, because over that time, America's economy has flourished. If America's economy is flourishing, this means productivity is rising, people are making more, they're spending more, and thus American businesses are getting increasingly profitable. Increasing profits across the board makes American businesses more valuable, and thus, stock prices rise. And when the stock prices of American businesses rise, you guessed it, the S&P 500 does too.

So, there's no doubt the success of the stock market over the ultra long term is closely linked with the success of a country's economy. But could that be precisely the problem for investors? When you boil down an economy, the most fundamental driver of economic growth is what Ray Dalio calls productivity. Productivity is basically total work getting done. Think about a landscaping business: their productivity is measured by how many landscaping jobs they can get done in a week.

Now, let's say they currently get three jobs done every week, but they want to increase their productivity to four. What are the two ways they could achieve this? Well, they could bring in the heavy machinery, AKA they can use tools to increase their efficiency so they can get the jobs done faster. And/or, they could bring in more workers—more manpower to pick up the pace.

Now, that exact same principle can be applied to an economy. Productivity broadly increases with more manpower and with greater efficiency. And over an ultra-long time period, that's what's fundamentally needed to power businesses and the stock market forward. But this is where things start to get a bit iffy, especially when it comes to manpower.

Now, we all know the human race faces a big fertility problem, with the average births per woman dropping to just 2.3 in 2021. But even if we look at population growth in the U.S., which also factors in immigration, the stats don't look any more promising. Conveniently for us, in this chart we can see that from 1950 up until today—so roughly the entry point we were talking about for the S&P 500—the U.S. has seen really good population growth, more than doubling from 150 million to 340 million. Now, this is a phenomenal driver of growth obviously.

Now, versus 1950, the U.S. has more than doubled the people contributing to economic growth: double the workers, double the spenders, just double the people. What this means is that more stuff gets made, more stuff gets sold, and more revenue is generated. But have a look at what the U.N. is projecting over the next 50 years: extremely low growth from 340 million people to just 388 million. Have a look at the annual population growth expectations plotted on this chart—it's just a constant decline.

So, while this doesn't lock it in that the stock market is going to suffer heavily over the next 50 years, that extremely low population growth in the U.S. removes a massive part of the tailwind that has powered ahead in the last 50 years. So that's the first consideration. But on the flip side, we also have a very interesting argument going the other way.

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So we've spoken about population slowing down, but then we also have the alternate viewpoint. And this is where things get really interesting. Because as we discussed before, there are two factors that drive productivity. Yes, having more manpower helps, but another factor is developing tools to increase efficiency. If you have the same number of humans, but you give them tools that help them do double the work, well, your productivity still doubles.

And right now, many would argue that humanity is on the cusp of developing two technologies that could increase our efficiency in a profound way: robotics and artificial intelligence. Now, we've already seen the power of large language models like ChatGPT, and that's very quickly opened up a new technology race in the realm of AI, which is now being rapidly adapted for use across multiple industries—from construction or agriculture to coding, driving, writing, travel, utilities, banking, chemical engineering, and so on. AI is very quickly being adapted and integrated across the board, and what this enables is a massive increase in efficiency.

Companies don't need as many staff; the tasks are performed faster and more accurately. Business models and supply chains are being optimized through AI—it's proving very beneficial. Now, we don't yet know where all of this leads, but many innovators and engineers are now predicting that the rise of AI will more than compensate for the slow decline in manpower.

The Nielsen Norman Group recently analyzed three studies on the ability of AI to enhance business efficiency. In one study, it was found that customer support agents who used AI could handle 13.8 more customer inquiries per hour. Another study showed that business professionals who used AI could write 59% more business documents per hour. A third study showed that programmers who used AI could code 126% more projects per week. Now, granted, these AI platforms haven't been around for long enough to really get solid data with randomized control trials and systematic reviews, etc.

But I think these three studies show a definite trend, particularly when you consider that AI is really only in its first inning. So, no doubt AI is impressive, but there is another technology that, when paired with machine learning, could be a game changer—at least that's what Elon Musk says. Over the past year or so, we've seen his company Tesla work very quickly on iterating designs of this autonomous humanoid robot called Optimus.

In fact, Elon is so bullish on the pairing of robotics and AI, he's even gone so far as to saying things like this: "Given that economic output is number of people times productivity, if you no longer have a constraint on people effectively, you've got a humanoid robot that can do as much as you'd like. Your economy is limitless—the infinite."

So, from Elon's point of view, if down the line we can pair strong machine learning with capable robotics, then he thinks that's really going to be all that matters. He thinks at that point we will have solved the productivity problem. It won't matter that there aren't enough babies being born; it won't matter if the population declines, because the tools we will have access to to increase the amount of work that we can get done will be so strong that it'll essentially be ten steps forward and one step back.

So despite the American economy losing one tailwind over the next 50 years, if the other tailwind that influences productivity gets far stronger, then there could be a case where economic growth could be faster than ever before. The amount of work done per capita will vastly increase, and if Corporate America is able to get a lot more efficient—i.e., get more work done in the same time period—then that force should increase profitability across the board, which will drive stock prices and thus the S&P 500.

So, will the S&P 500 keep going up at 10% over the long run? It's an interesting question. On one hand, you can say that the headwind of a population slump could have major impacts on the future growth of corporate America, which will massively drag on the stock market. But then you could also argue that America might see a future of abundance, and technology like artificial intelligence and robotics will power a completely revolutionized economy of the future.

It's a super interesting topic, but there is one more point I wanted to touch on when we're discussing whether the S&P 500 will continue rising as it has done over the past 66 years. And this point revolves around entry and exit points. So, a lot of passive investors get hung up on this 10.15% number, which is the average annual return of the S&P 500 from 1957 through December 21st, 2022.

But we have to acknowledge that that's the return between those very specific points in time—two convenient points in time, actually. On one end, you've got the start of a multi-decade bull run, and at the end of 2022, despite the stock market declining across that year, you're still sitting amidst the highest period that the S&P 500 has ever seen.

Now, we have to remember that if you change around those entry and exit points, you can get different results. We looked at 1957 through 2022, right? But what about 1961 to 2020? It's reasonably close to the same time period—just a few years different on either end—but if we use that time period, the average annual return of the S&P 500 isn't 10.15%; it's only 6.23%.

Here's an even more extreme example: if you bought the S&P 500 at the turn of the century, you would have had to wait 13 years until you started making any money at all. Or even worse, imagine if your entry point was 1929. If you sunk a whole heap of money into the market then, you would have had to wait until 1954 before you made any money—25 years in the market, and you've gone nowhere!

So, while the average annual return of the S&P from 1957 through 2022 has been 10.15%, to say that in another 50 years it will have also returned about 10% per year is a tough sell. But really, this just highlights the importance of being in it for the ultra long term and having the patience to wait for a good exit. Because hey, so far in human history, after every major market crash, the stock market has recovered to a new all-time high. It might take a while, but so far, the S&P 500 has always recovered eventually and has offered long-term investors really solid returns.

But with that said, let me know what you think in the comments. Also, something I just wanted to tell you guys about: something big is coming on Black Friday, everyone, so get excited! Make sure you've got notifications turned on; it's something that a lot of you guys have been asking for, so I'm very excited for you guys to see what we've been working on.

But apart from that, thanks very much for watching this video. Leave a like if you enjoyed, and I'll see you on Friday.