A strong economy and excitement surrounding artificial intelligence (AI) have supercharged the stock market. The benchmark S&P 500 (SNPINDEX: ^GSPC) has returned nearly 27% so far in 2024, notching 57 record highs in the process. The index most recently peaked at 6,090 on Dec. 6, and it currently trades just below that level.
Most investors are wondering the same thing: Is it smart to buy stocks right now? The S&P 500 has historically performed well after reaching a record high, and the average bull market lasts much longer than the one currently underway. But there is also an alarm bell sounding that cannot be ignored: The S&P 500 is trading at a nearly unprecedented valuation.
Here's what investors should know.
The S&P 500 historically performed well after hitting an all-time high
Isaac Newton's first law of motion says moving objects will continue moving unless something stops them. That same principle tends to apply to the stock market. The S&P 500 has barreled through record highs like a freight train this year, and upward momentum generally persists until something goes wrong.
That suggests investors have little to fear from record highs. Indeed, J.P. Morgan analysts recently compared the average forward return from record highs in the S&P 500 versus the average forward return from non-record highs. The S&P 500 performs just as well or better from record highs as from all other times.
|
Time Period |
Average Return on Investments Made at Record Highs (1970-2024*) |
Average Return on Investments Made at Other Times (1970-1924*) |
|---|---|---|
|
Six months |
4% |
4% |
|
12 months |
9% |
9% |
|
24 months |
19% |
18% |
Data source: JPMorgan Chase. Calculations go up through Sept. 4, 2024.
As shown above, since 1970, the S&P 500 has returned an average of 9% over the 12 months following a day when the index hit a record high. The S&P 500 has also returned an average of 9% over the 12 months following any other day. That suggests 2025 will likely be a positive year.
Bull markets have historically run longer and higher than the current one
The average bull market since 1949 has lasted five and a half years, during which time the S&P 500 (and its precursor index) returned an average of 192%, according to Goldman Sachs. For comparison, the current bull market started about two years ago, in October 2022, and the S&P 500 has returned 70%.
The S&P 500 traded at 3,577 when the current bull market began. Adding 192% suggests the index could reach 10,445 before the bull market ends (if it's average). Reaching that level would require returns of 17% annually over the next three and a half years. That suggests double-digit gains are likely in 2025.
Image source: Getty Images.
The S&P 500 trades at a nearly unprecedented valuation
Robert Shiller is a Nobel Prize–winning economist who developed a valuation metric known as the cyclically adjusted price-to-earnings (CAPE) ratio. The metric is also known as the Shiller PE, and it is commonly applied to the S&P 500 to determine whether the stock market is overvalued or undervalued.
Traditional price-to-earnings ratios are calculated as price divided by earnings from the past 12 months. But the CAPE ratio is calculated as price divided by the average inflation-adjusted earnings from the past 10 years. Generally, high CAPE ratios correlate with worse forward returns, while low CAPE ratios correlate with better forward returns.
The S&P 500 currently has a CAPE ratio above 38, one of the highest readings on record. Since the index was created in 1957, its monthly CAPE reading has topped 35 only 52 times. To put that in context, 815 full months have passed since the beginning of 1957, and the CAPE ratio has exceeded 35 in just 6% of those months.
Here is the bad news: The S&P 500 has declined by an average of 1.3% in the year following a monthly CAPE reading above 35. That does not necessarily mean the index will decline next year. Under similar circumstances, the S&P 500 has generated a one-year return ranging from 38% upside to 28% downside. But the average has been 1.3% downside, and investors can't afford to ignore that.
Is it smart for investors to buy stocks right now?
The S&P 500 has generally performed well from record highs, and history suggests the current bull market can continue for several more years. But investors can't afford to be reckless. Valuations are stretched across the stock market, which could make 2025 a challenging year.
Anecdotally, I've heard a surprising number of pundits -- both professionals on Wall Street and amateurs on YouTube -- suggest valuations should be ignored right now. That advice is very dangerous. Valuations are like seat belts. They don't seem to matter until they do, and ignoring them even temporarily can have very bad consequences.
Personally, I think now is a good time to accumulate cash in portfolios. That does not mean investors should pass on reasonable buying opportunities. But it does mean they should scrutinize those opportunities closely. The S&P 500 is historically expensive, which hints at a drawdown (possibly a sharp one) once its momentum falters.
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JPMorgan Chase is an advertising partner of Motley Fool Money. Trevor Jennewine has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Goldman Sachs Group and JPMorgan Chase. The Motley Fool has a disclosure policy.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
