The S&P 500 Is Historically Expensive Now. Investing in This ETF Could Help You Hedge Against a Potential Crash.

Key Points

• The S&P 500's Shiller P/E ratio is the highest it has been since October 2000.

• Investing in international stocks could hedge your portfolio against a decline in overvalued U.S. stocks.

• The Vanguard Total International Stock ETF contains companies from both developed and emerging markets.

• 10 stocks we like better than Vanguard Total International Stock ETF ›

Since the end of 2022, the S&P 500 (SNPINDEX: ^GSPC) -- an index tracking 500 of the largest public U.S. companies -- has been on a good run. Much of its rise in value during that period was fueled by investors' huge optimism about the artificial intelligence (AI) trend, with the tech-focused "Magnificent Seven" stocks accounting for the majority of the index's gains.

The S&P 500's recovery from the 2022 downturn has been great for investors, but it's also a double-edged sword. The index now sits at historically high valuation levels -- in particular, its Shiller price-to-earnings (P/E) ratio, which measures stock prices against inflation-adjusted average earnings during the past 10 years. As of the time of this writing, the S&P 500's Shiller P/E ratio is almost 39, which is the highest since October 2000 -- right in the thick of the crash that followed the dot-com bubble.

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This isn't to sound the alarm, because there's no sure way to predict how the stock market will perform from here. However, it would be a good time to exercise some caution, because it hasn't worked out well in the past when the Shiller P/E Ratio has reached elevated levels.

Image source: Getty Images.

If you're looking to hedge against a potential S&P 500 crash, it would be helpful to look at investments outside of the U.S. One of the easiest ways to get exposure to such stocks is to scoop up shares of an internationally focused exchange-traded fund (ETF). My go-to in that category is the Vanguard Total International Stock ETF (NASDAQ: VXUS).

A lot of international ground covered with one ETF

While some international ETFs focus on specific regions, the Vanguard Total International Stock ETF covers virtually all parts of the world other than the U.S. Here is how its holdings are divided by region:

• Europe: 39%
• Emerging markets: 27.2%
• Pacific: 25.4%
• North America: 7.7%
• Middle East: 0.7%

There are inherent risks that come with investing in companies from some countries or regions; a fund that spreads your investment out among all of them reduces your level of risk exposure to any single economy. This ETF contains 8,615 stocks, so it's about as diversified an investment as you will find.

Given how many stocks the Vanguard Total International Stock ETF holds, you likely won't know most of them, but it does include some well-known companies that you should. Its largest holding is Taiwan Semiconductor Manufacturing Company (2.62% of the portfolio's weight), and its top 10 holdings include SAP (0.83%), Alibaba (0.76%), Samsung (0.67%), and HSBC (0.60%).

This ETF has a good risk-reward trade-off

Another perk of investing in this ETF is that it gives you exposure to companies from both developed and emerging markets.

Developed markets have advanced economies, well-established financial markets, stable political systems (in most cases), and good overall infrastructure. Examples include Canada, Japan, the U.K., South Korea, and Australia.

Emerging markets typically refer to countries that are in the process of rapid growth and development. They have less mature financial systems, a higher risk of political instability, and less extensive infrastructure. Examples include Brazil, India, Mexico, China, and South Africa.

Investing in developed versus emerging markets presents a similar risk-reward trade-off to what we see with investing in value stocks vs. growth stocks. There's typically more stability with companies in developed markets, but their growth potential is more modest. In an emerging market, the growth potential is higher, but so are the risks.

When in doubt, you can count on the dividend

The Vanguard Total International Stock ETF has typically underperformed the S&P 500 over the long term, but it does often hold steadier in periods when the S&P 500 stalls or goes into a bear market.

Take this year, for example. The S&P 500 experienced a sharp pullback after President Donald Trump revealed his extensive tariff plans, although the index has rebounded since then. Through Aug. 26, the Vanguard Total International Stock ETF is up by 22% year to date, more than double the S&P 500's gains.

I don't expect this ETF to outperform the S&P 500 over the long term, but one thing on its side is that it offers a relatively high dividend yield. That income can cushion its returns in the event of a market downturn.

VXUS Dividend Yield data by YCharts.

Its current 2.7% dividend yield isn't what you'd normally expect to see from an 8,600-plus stock ETF (or a non-dividend-focused ETF), so that's a nice bonus.

I wouldn't recommend putting a huge chunk of your portfolio into international stocks, but the Vanguard Total International Stock ETF can be a great supplement that helps hedge you against uncertainty in the U.S. economy and the seemingly overvalued S&P 500.

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HSBC Holdings is an advertising partner of Motley Fool Money. Stefon Walters has positions in Taiwan Semiconductor Manufacturing and Vanguard Total International Stock ETF. The Motley Fool has positions in and recommends Taiwan Semiconductor Manufacturing and Vanguard Total International Stock ETF. The Motley Fool recommends Alibaba Group and HSBC Holdings. The Motley Fool has a disclosure policy.