This year has been a fantastic one for stocks, from the moment the S&P 500 confirmed a bull market back in January to today, with the three major benchmarks heading for double-digit annual gains. The S&P 500 has climbed 27% this year, while the Nasdaq and the Dow Jones Industrial Average have advanced 34% and 15%, respectively.
The reason for such a performance? Investors early in the year anticipated the first series of interest rate cuts in four years, and they bet on a better economy ahead. On top of this, companies began talking more and more about the high-growth area of artificial intelligence (AI) and pouring investment into AI programs -- and investors piled into stocks that could score a win here. These two elements helped drive the positive momentum we've seen in the stock market in 2024.
Still, even in a strong market environment, there's always something that could put the brakes on some of the excitement. And today, this is something that's happened only three times since the S&P 500 launched as a 500-company index back in the late 1950s. Could this particular thing halt the S&P 500's gains in 2025? Let's find out.
Image source: Getty Images.
The bull market is going strong
First, it's important to note that the current bull market is going strong, after the S&P 500 reached multiple record highs this year. Stocks across industries have gained, though growth stocks have shown particular strength -- that's because these companies have an easier time expanding when the economy is doing well. And, as mentioned, AI stocks led the bunch, with names like chip giant Nvidia and AI-driven software company Palantir Technologies recording the best performances in the Dow Jones Industrial Average and S&P 500, respectively.
As a result of all of this momentum, valuations have taken off. And this leads us to the one thing that's happened this year and only two other times in the past 67 years. The S&P 500 Shiller CAPE ratio has increased past the level of 35. The Shiller CAPE ratio takes an inflation-adjusted look at stocks' valuations, considering earnings-per-share over a 10-year period.
S&P 500 Shiller CAPE Ratio data by YCharts
And today, this measure is telling us that S&P 500 stocks are at one of their priciest levels ever. Now let's consider whether this could halt gains in 2025, and we'll start by taking a look back in time. History shows us that every time the Shiller CAPE ratio reached a peak, the S&P 500 then declined. So, when stocks become too expensive, history shows us the index will fall and valuations, too, will return to lower levels.
S&P 500 Shiller CAPE Ratio data by YCharts
Will the S&P 500 fall next year?
Does this mean the S&P 500 is set to decline in 2025? Not necessarily. This is because we don't know when valuations will reach a peak. They could be there right now, and the index could soon slip, or valuations and the index could dip a bit at some point -- just enough for both to take off again for quite some time. Or valuations may continue to gain from today's level. So, though stocks overall are looking expensive right now, this doesn't mean the S&P 500 will decline significantly. The benchmark still could score a big win in 2025.
As an investor, what should you do right now? It's important to consider the valuation of individual stocks before buying -- and this is something you should do all of the time, not just when the general market looks expensive. In any market environment, you'll find bargain stocks and expensive ones, and this means that any time is a great time to shop for stocks as long as you take this into account.
Reasonably priced stocks
For example, even in an area like AI, where stocks have taken off, some players still remain reasonably priced. Alphabet (GOOG -1.55%) (GOOGL -1.45%) trades for only 24 times forward earnings estimates today even as its cloud services unit has grown quarterly revenue in the double-digits. Meta Platforms (META -0.59%) is another AI stock that looks reasonably priced today at 27 times forward earnings estimates.
So, yes, history says the S&P 500 will dip at a certain point and valuations will come down. But that doesn't mean the index will fall next year and it doesn't mean that all stocks are expensive. And that means now is a great time to keep investing -- by choosing quality players at reasonable prices, you could win in 2025, and most importantly, you could build wealth over time.
