Why is the S&P 500 near a record while most shares are falling?

Five minutes a week that makes you smarter and calmer about your own money — plus a look at what I’m actually doing with mine…

A few of you told me last week’s letter was a bit dry. You were right. A lesson on P/E ratios is useful, but it’s not exactly riveting.

So from this week the letter has a new shape: what’s going on out there, what I make of it, what’s coming next, and what I’m doing with my own money. The teaching comes after the story, not instead of it. Reply and tell me if it works.

The S&P 500 closed September at 7,652, about 2% below the record it set in August, and up 2% over the quarter. Inside the index it was a different month: four out of five shares went down in September, which is the story of this letter.

What happened

There are two stock markets at the moment, and they’re going in opposite directions.

The first is the S&P 500 you see on the news: nearly at a record high ten days ago, up about 12% this year.

The second is most of the companies inside it.

Six in ten of them are down 20% or more from their all-time highs, which is the textbook definition of a bear market. On the day the index came within half a percent of its record, only six of the 500 made a new high of their own.

Half the index is below its own 200-day average, the line that tells you whether a share has been going up or down for most of the past year. An index at a record with half its members falling has happened once before: March 2000, a few weeks before the dot-com crash…

A handful of AI companies are holding the whole thing up. Everyone else has been sold.

Three things happened this week that bear on which way this resolves.

Iran. Tehran offered to reopen the Strait of Hormuz within seven days if America lifted its blockade and sanctions. Trump turned it down on Saturday, posted “I offered them NOTHING!” on Monday night, and told reporters on Wednesday: “We blow them up or make a deal.” A counter-offer went back through Qatar this morning. Meanwhile three ships were hit by unknown projectiles in the strait on Tuesday, oil is just under $100 a barrel, and America has released another 40 million barrels from its reserve, now at its lowest level since 1982.

Xi. The Chinese president spent three days in Washington last week. The result was a $30 billion cut in tariffs on goods including fish hooks, artificial flowers and microwave ovens, ten million tons of American coal, an AI hotline, and two pandas for Atlanta Zoo. Nothing on chips, nothing on Taiwan. The market rallied into it and has drifted since.

The election. Five weeks to the American midterms, and the betting has swung hard. Before the Iran war the markets had Republicans keeping both houses of Congress at about 80%. Now they have Democrats taking the House at over 90%, and the Senate as a coin toss leaning their way.

What I think it means

Here’s how I see it, and I’ll say up front that I’m echoing Tom Hayes of Great Hill Capital, whose work I follow and whose view I share.

A split like this can only end two ways. Either the handful of AI names come down to meet the rest of the market, or the rest of the market goes up to meet them. Hayes describes the 490 unloved companies as a beach ball being held underwater. You can only hold it under for so long before it explodes upwards. I think that’s the more likely outcome, and my money is positioned for it. I’ll explain why in a minute.

What decides it is oil. Government borrowing costs are moving in lock-step with the oil price right now, more closely than at any time since the first Gulf War in 1990. Any real de-escalation with Iran drops oil, which drops borrowing costs, which lifts every business that’s been sold because money got dear. That’s most of the 490.

The election is the other lever. October has been the best month of a midterm year, and the pattern is a low somewhere between now and mid-October, then a rally into polling day.

Nobody knows the future, and anyone who tells you the AI names will definitely catch down, or definitely won’t, is guessing. Wednesday’s inflation numbers came in softer than expected and the odds of a rate rise this month fell by half in an afternoon, which is a reminder of how fast this can turn.

I’d rather own the beach ball than the hand trying to hold it down.

You can see every position I hold, and what each has done, on the portfolio pages, refreshed with last night’s prices.

This is why I hold the S&P 500 the way I do. Most people own it weighted by size, so the biggest companies dominate and the AI names are a huge slice. I own the equal-weighted version as well, where all 500 companies count the same. It has lagged this year while the giants ran. If the catch-up comes, it’s the version that catches it and we are already positioned for it.

Free readers get the thinking. Full members get the specifics.

The S&P 500 isn’t 500 companies counted equally. Each one counts in proportion to its size, so a company worth $4 trillion moves the index about a hundred times more than one worth $40 billion. Ten giants make up nearly 40% of the whole thing, and the biggest, Nvidia, is about 8% on its own.

So a handful of enormous AI companies going up can drag the index to a record while the other 490 go down. The index tells you what the giants are doing, and very little about the average business in it.

It also means that when you buy an ordinary S&P 500 index fund, nearly 40p of every pound goes into ten companies. That has been very good for three years. It’s just worth knowing which market you actually own.

The run-up is often rough: midterm years have averaged a 19% fall from peak to trough since the 1960s. This year’s was 9%, back in March.

The year after is a different story.

Since 1950, the S&P 500 has never been lower twelve months after a midterm election. Not once, in nineteen goes. The average gain is about 14%.

The uncertainty gets resolved, whoever wins, and the market goes back to pricing businesses instead of guessing at politics.

Book of the week: Same as Ever, by Morgan Housel. Essential lessons on risk, opportunity and living a good life. Some things never change: people panic the same way in 1929, 2000 and 2008; the crowd is always sure; nobody sees the big one coming. If this week’s letter left you thinking “surely this time is different”, Housel’s answer is that everyone always thinks that.
Get it on Amazon.

You might be thinking you’ve woken up in the wrong country — we’re UK investors, so why is everything here about America? Simple: it’s all about performance. The American stock market offers much better investment returns than the UK, so we mostly invest there. You don’t have to invest in UK companies just because you live here!

If you joined in the last few weeks, welcome. Start at timswealthletter.com/start-here. It’s where I’d send a friend who asked me where to begin, and it’ll make the rest of these letters make sense.

Reply to this email and tell me the one thing about the market that’s bothering you right now. I read every reply, and the best questions become next week’s letter.

See you next week.

Tim

P.S. If you reply, I’ll answer. Even if it’s about P/E ratios.

I am not a financial adviser. Nothing here is personal financial advice. Please do your own research before making any investment decisions.