Has investing in the S&P 500 been worthwhile given a specific level of risk? To address this, we utilized the Sharpe Ratio (SR).
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In today’s research piece, we set out to examine the relationship between risk and return for the S&P 500 over time, aiming to answer one key question: Has investing in the S&P 500 been worthwhile given a specific level of risk? To address this, we utilized the Sharpe Ratio (SR). This metric is calculated by subtracting the risk-free rate (proxied by the 10-year Treasury yield) from the market’s average return over a given period, then dividing by the standard deviation of excess returns. For our analysis, we used six months of daily data (126 trading days) and applied a 30-day moving average to smooth fluctuations and highlight underlying trends. Conceptually, a higher SR indicates better compensation for risk taken, while a lower SR suggests more risk for less reward.
Our study focused on how the SR has evolved since 2000. As shown below, the Dot-Com Bubble marked the lowest reading, with an SR near -2. The Great Financial Crisis (GFC) also produced a depressed SR, hovering around -1.8 in early 2009. Fast forward to 2025, and the SR is near record highs, underscoring exceptionally strong risk-adjusted returns this year.
Zooming in on recent months, the trend becomes clearer. During Liberation Day in April, the SR dipped to roughly -0.65. However, starting in July, the SR climbed steadily, peaking at around 3.0 in the month of November. In the past few weeks, the ratio has begun to decline from its highs, signaling a moderation in risk-adjusted performance. The natural question at this point is, should we consider lowering our allocation into large-cap domestic equities? The answer to that question is still a strong no! For starters, the Sharpe Ratio is still above 2.0, meaning that it is still in exceptionally strong levels right now. Additionally, large-cap growth is still the strongest group in DALI when looking at the different style factors.
Lastly, when looking at the SPDR S&P 500 ETF Trust (SPY), the fund still maintains a strong fund score of 5.19 and has been on a positive trend since 2022. When looking at the 5-point scale for the fund’s chart, you can see that the fund completed 4 consecutive buy signals after coming off the April bottom. Although the fund completed a double bottom break last month, SPY did reverse back into a buy signal last week after completing a double top break at $685. Long exposure can be considered here. Initial strong support is at $655, with additional support at $620. Maintain your current exposure to large-cap domestic equities, but monitor closely for signs of sustained weakness and be ready to adjust if conditions deteriorate.
