As its name suggests, the Vanguard S&P 500 ETF (VOO +0.66%) gives investors exposure to the S&P 500 (^GSPC +0.73%). Owning this exchange-traded fund (ETF) basically means you'd be betting on the growth of the U.S. economy, with a stake in 500 or so large and profitable companies. It's a hassle-free approach.
In the last 12 months, this popular ETF ended up producing a total return of 17% (as of Jan. 16). Where will the Vanguard S&P 500 ETF be in one year?
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Hoping for the best
Investors have no complaints about the performance of the Vanguard S&P 500 ETF. In the past decade, it generated a total return of 337%, translating to an annualized gain of 15.9%. This above-average performance is the result of three major themes, in my opinion.
The first factor is a generally favorable macroeconomic backdrop. Over the past decade, interest rates have spent a lot of time below 2%, a historically low level that reduces borrowing costs, supports business investment, and drives consumer spending. Furthermore, this can lift companies' revenue and earnings power. The Federal Reserve is once again lowering interest rates and embarking on quantitative easing.
Stock market gains have benefited from the emergence of the tech sector overall. Companies within the "Magnificent Seven" offer globally adopted products and services and have strong growth, network effects, and huge free cash flows. And they have come to dominate various industries, benefiting shareholders and representing a bigger share of the overall stock market.
I believe passive investing might be the most underrated factor of these three. At the end of 2023, money in passive funds exceeded money in active funds for the first time ever.
This massive trend introduces a lot of capital to the stock market that might not have had access to it before. Thanks to the proliferation of fee-free brokerage accounts, having exposure to the stock market is frictionless. That adds buying power to equities.
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Key Data Points
Preparing for the worst
After the Vanguard S&P 500 ETF's impressive winning streak, market participants are concerned that the valuation is stretched. According to the CAPE ratio, a closely watched metric that looks at the current S&P 500 level relative to trailing-10-year inflation-adjusted earnings, the S&P 500 is extremely expensive today. The CAPE ratio is currently 40.8. It has never been this expensive throughout its entire history, except for the period of the dot-com bubble in 1999 and 2000.
Data is very clear about what returns could look like going forward. According to research from Invesco, whenever the CAPE ratio is around 40, as it is today, it usually means annualized S&P 500 returns over the next decade will be in the negative low-single-digit range.
Howard Marks, a successful credit fund manager who founded Oaktree Capital Management and has a net worth of $2.2 billion, adopts this more critical view of the market's valuation. He suggests that credit opportunities could provide more value and better risk profiles today than equities. This is something investors have to think about.
Ending up somewhere in the middle
It's impossible to accurately predict where the Vanguard S&P 500 ETF will be one year from now, in January 2027. There are too many variables at play, most notably changing market sentiment. I'm not predicting the nearly 16% trailing decade pace to continue. And I don't necessarily expect the index to produce a negative yearly return as the high CAPE valuation might suggest.
Instead, it's probably best to sit somewhere in the middle. Over the very long term, the S&P 500 has generated an average annualized return of 10%. This seems like a reasonable view of what will happen over the coming 12 months, although it could be much better or much worse.
