The S&P 500 is on the brink of an unprecedented feat, a feat it last achieved 26 years ago. I'll share my thoughts on how this could impact stock markets in 2025.
It's not usual for the S&P 500 to yield 20% profits in a single year. However, this index is on track to achieve it for the second year in a row, with an approximate 23% increase in 2024, after a 24% increase in 2023. This is excellent news for investors, indicating significant returns since the last market downturn.
The buzz surrounding artificial intelligence (AI) and its potential impacts on industries has generated numerous business growth opportunities, causing their valuations to surge.
However, the worry is that the index is surpassing its capacity, and a slowdown might be imminent. Such performance is highly unusual. Let's explore its possible implications for the markets in the approaching year.
The S&P 500's remarkable run in the '90s
Excluding a year-end slide or correction, it appears likely that the S&P 500 will close the year with at least a 20% gain. The last time it recorded consecutive years with such high gains was a four-year stretch from 1995 to 1998, during which it saw a 34% increase, followed by 20%, then 31%, before barely managing to miss the 20% mark to halt the streak in 1999. The subsequent three years, however, saw the index decline by at least 10%, marking the dot-com crash.
While it isn't uncommon to witness a strong market return in a year, that '90s success run is far from the norm. Similarly, investors should be wary of assuming that the recent impressive gains will persist without interruption.
Predicting the S&P 500's performance in 2025
The S&P 500's success in two consecutive years is infrequent, limiting the historical data to refer to when attempting to forecast its potential pattern. However, there are some intriguing parallels to consider.
In the late '90s, the internet was gaining prominence and impacting businesses and entire industries, much like AI today. Consequently, numerous companies saw their valuations inflate, fueled primarily by sky-high expectations about the internet's potential benefits - similar to AI's situation today.
Another similarity is the Shiller price-to-earnings ratio, an indicator based on a 10-year period and considering inflation. This ratio gauges the stock market's affordability. It reached a peak of 44 in December 1999. Today, it's around 37, which is near the level it was at in 2021, before the market plummeted the following year. Before that, however, the last time the ratio was that high was in 1999.
Given the inflated valuations and excessive enthusiasm surrounding AI, it wouldn't surprise me if the markets experienced a downturn next year. However, even if a crash does not occur, the market appears to be overdue for a substantial correction in the relatively near future.
Why investors should maintain their investments
It's impossible to predict the market's performance in 2025 with certainty. It could plummet, or it could continue to rally. Bearish investors probably predicted a crash when the S&P 500 notched a second consecutive year of significant gains in 1996. While a crash ultimately occurred, it happened after five years of remarkable growth.
Instead of trying to time the market and wait for a crash before buying stocks, investors might consider maintaining their portfolios and reassessing their holdings, removing vulnerable stocks and investing in more reasonably priced options with higher potential gains. Overreacting and taking money out of the stock market entirely due to its current success could result in missing out on future profits, potentially proving to be a costly mistake.
Despite the concerns about a potential market slowdown or correction due to the S&P 500's remarkable performance, it's important for investors to consider their long-term financial goals. As history has shown, market downturns can offer opportunities for savings to be converted into investments at lower prices, potentially leading to higher returns in the future. In light of this, investors might want to consider diversifying their portfolios, allocating funds to sectors that could provide stability and growth, and continuously monitoring their finance and investing strategies.
Given the current market situation, it would be prudent for investors to weigh the potential risks and rewards when making decisions about their investments, and to have a well-thought-out investing plan. By adopting a disciplined and strategic approach to investing, investors can better manage their expectations, remain resilient even during challenging times, and seek sustainable returns in the long run.
