The S&P 500's Historic Performance and Future Projections

The S&P 500 (^GSPC) is often seen as the best indicator of the overall performance of the U.S. stock market. This index comprises 500 companies that represent around 80% of the total market value of American stocks. It includes a mix of both value and growth stocks across all 11 sectors of the market.

As of December 30, the S&P 500 has risen by 24% this year, driven by robust economic growth and excitement surrounding artificial intelligence (AI). This surge means that the index has realized gains exceeding 20% for two consecutive years, a feat observed last in 1998. While such momentum could signal further growth in 2025, high valuations could introduce challenges in the near future.

Potential for Continued Growth in 2025

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

The table below highlights how the S&P 500 fared in the 12 months following two consecutive years with gains above 20%:

Two-Year Periods with Back-to-Back 20% Gains	S&P 500 Return (Next 12 Months)
1995 and 1996	31%
1996 and 1997	27%
1997 and 1998	20%
Average	26%

The data indicates that, historically, the S&P 500 has averaged a 26% return during the year following such strong performance. This trend supports the belief that upward momentum in the stock market often leads to further gains.

Based on this historical performance, the S&P 500 could potentially increase by 26% in 2025. However, it is essential to remember the market collapse that occurred following the dot-com bubble. After reaching its peak in March 2000, the S&P 500 fell nearly 50% as investors recognized that many internet companies were significantly overvalued.

While the current excitement around AI differs from the dot-com hype, it is crucial to note that the so-called 'Magnificent Seven' stocks have more reasonable valuations compared to the leading tech firms of the late 1990s. However, even if valuations are better, they remain high, which could pose problems in 2025.

Possible Decline in 2025

To evaluate the S&P 500, investors often use the cyclically adjusted price-to-earnings ratio (CAPE), also known as the Shiller P/E. Developed by Nobel Prize-winning economist Robert Shiller, this metric considers average inflation-adjusted earnings from the last decade.

Currently, the S&P 500 has a CAPE ratio of 38, a level seen only during the dot-com bubble and pandemic in 2021. Since the index's launch in 1957, there have only been 52 months when the CAPE ratio exceeded 35, which accounts for about 6% of the total period. This suggests that the S&P 500 has been cheaper than its current valuation for 94% of the time.

This high CAPE ratio implies that 2025 could be a challenging year. Historically, after surpassing a CAPE ratio of 35, the S&P 500 has seen an average decline of 1% in the following year. However, this does not guarantee a decrease; the actual performance could be either better or worse.

Given the current market landscape, investors should exercise caution by steering clear of stocks with unreasonable valuations. It might also be wise to keep extra cash on hand for opportunities that arise from market corrections or downturns.

Ultimately, market downturns are a matter of 'when' rather than 'if.' Despite experiencing regular declines, the S&P 500 has historically generated substantial wealth over the long term. The key to successful investing in the stock market lies in patience and resilience.

S&P500, Investing, Market