The S&P 500's Recent Surge: Implications for 2025

The S&P 500 (^GSPC) is considered one of the best indicators of the overall U.S. stock market. This is largely due to the fact that the 500 companies within the index account for roughly 80% of the market value of domestic equities. The index encompasses a mix of value stocks and growth stocks across all 11 sectors of the stock market.

As of December 30, the S&P 500 has risen by 24% this year, thanks to strong economic growth and rising interest in artificial intelligence (AI). This surge means the index has experienced over a 20% return for two consecutive years, a feat not accomplished since 1998. While this trend could signal positive outcomes for 2025, investors should be cautious as high valuations may introduce some volatility in the upcoming year.

Historical Trends Suggest Continued Growth for the S&P 500 in 2025

Since its inception in 1957, the S&P 500 has only shown back-to-back increases of over 20% three times. Each of these instances occurred close to the time of the dot-com bubble.

Below is a summary of how the S&P 500 performed in the year following periods where it gained more than 20% in two consecutive years:

Two-Year Periods With S&P 500 Returns Above 20% in Both Years	S&P 500 Return (Next 12 Months)
1995 and 1996	31%
1996 and 1997	27%
1997 and 1998	20%
Average	26%

The data suggests that historically, the S&P 500 tends to average a 26% return during the year that follows a two-year cycle of over 20% gains. This supports the common notion on Wall Street that existing momentum can lead to future momentum.

These trends hint that the S&P 500 could see a 26% increase in 2025. However, it is important to remember the significant market crash that occurred post-dot-com bubble, where the S&P 500 fell nearly 50% after peaking in March 2000, as investors began to question the high values of many tech startups.

It's important to note that the current interest in AI is not necessarily a mirror image of the dot-com bubble. The leading tech stocks today, often referred to as the "Magnificent Seven," are trading at comparatively lower valuations than those prominent in the late 1990s. Nevertheless, the overall stock market is still perceived as quite expensive, which could foster potential challenges in 2025.

Potential Risk for the S&P 500 in 2025

One tool frequently employed by investors to assess the value of the S&P 500 is the cyclically adjusted price-to-earnings ratio (CAPE), which is also known by some as the Shiller P/E. This measure was created by Nobel Prize-winning economist Robert Shiller.

What distinguishes CAPE from traditional price-to-earnings (P/E) ratios is that CAPE takes an average of earnings from the last decade, adjusted for inflation. Currently, the S&P 500's CAPE ratio is 38, a level seen during only two previous significant events: the dot-com bubble and the pandemic in 2021.

Over the 815 months since the S&P 500's establishment in 1957, the index has recorded a CAPE ratio above 35 for a mere 52 months, which is around 6% of the time. This means the S&P 500 has been cheaper relative to its current valuation 94% of the time.

This record points to challenges in 2025. Following periods when the CAPE ratio exceeded 35, the S&P 500 has typically seen an average decline of 1% over the subsequent 12 months. While this figure doesn't guarantee a decline, it serves as a reminder for investors to stay alert in today's market landscape.

Given the current scenario, it's advisable for investors to be cautious and to avoid stocks that are overvalued. It might also be wise to accumulate cash reserves in order to take advantage of potential market corrections or downturns.

It's crucial to remember that market corrections are not a question of whether they will happen, but rather when. Over time, the S&P 500 has generated substantial wealth, despite facing regular downturns, and success in the stock market hinges on traits such as patience and perseverance.

This article has been neutral and has no affiliation with any external site.

stock, market, investors