It's not typical for the S&P 500 to generate 20% gains in a single year. Yet the index is on pace to do it for a second consecutive year, as it's up roughly 23% in 2024 at recent prices after gaining 24% in 2023. That's great news for investors, as that means they've generated some incredible returns since emerging from the last bear market. The excitement surrounding artificial intelligence (AI) and what it can do for industries has opened up many new growth opportunities for businesses, sending their valuations soaring in the process.
The concern, however, is that the broad index is punching above its weight, and that a slowdown may be inevitable. This type of performance is rare. Let's look at what it might mean for the markets heading into next year.
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The last time the S&P 500 had such an impressive run was the 1990s
Barring an end-of-year crash or correction, it seems safe to assume that the S&P 500 will finish the year up by at least 20%. The last time it had back-to-back years with gains that high was a four-year run from 1995 to 1998 in which it gained 34%, then 20%, then 31% and 27%, before just missing 20% to break the streak in 1999. The next three years, however, would see the index falling by at least 10% amid the dot-com crash.
While it's not uncommon to see the market have a strong return in a single year, that run of success in the '90s is by no means normal. Likewise, investors should be careful not to assume that the past two years' impressive gains will continue unabated.
How might the S&P 500 perform in 2025?
It isn't often that the S&P 500 does this well in back-to-back years. That means there also isn't a whole lot of history to go on to try to predict what pattern it might follow. But there are some interesting parallels to consider.
In the late '90s, the internet was becoming more prominent and changing businesses and entire industries, not unlike what AI is doing these days. As a result, many companies swelled to inflated valuations, in large part due to sky-high expectations about what the internet might do for them -- also not unlike AI today.
Another similarity is that the Shiller price-to-earnings ratio, which is based on a period of 10 years and factors in inflation, was trading at elevated levels. It's a way to gauge how expensive the stock market is. It reached a peak of 44 in December 1999. Today, it's around 37, which is near the levels it was at in 2021, before the market nosedived the following year. Prior to that, however, the last time the ratio was that high was back in 1999.
Given the inflated valuations and the perhaps overblown hype around AI, I wouldn't be surprised if there is a crash in the markets next year. But even if it doesn't happen, it does look like the market is overdue for a sizable decline in the not-too-distant future.
Why investors should remain invested
There's no way to know for sure how the market will do in 2025. It could crash, but it could also rally again. When the S&P 500 turned in a second straight year of big gains in 1996, bearish investors were likely pounding on the table, warning that a crash was imminent. While that crash eventually came, it followed five years of truly impressive gains.
Rather than trying to time the market and wait for a crash before buying stocks, investors may simply want to remain invested and just reassess their portfolios, to see if they hold stocks that may be vulnerable to corrections. Moving money out of expensive stocks, and into ones that have more attractive valuations and may have greater upside, could be a good approach to take for the coming year. But taking money out of the stock market entirely, simply because it's doing too well, could mean missing out on further gains and may prove to be a costly mistake.
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David Jagielski has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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.
