The stock market is experiencing a remarkable surge, with major indices hitting multiple all-time highs this year.
The S&P 500 became 500 stocks in 1957.
57 new highs in 2024.
Coincidence? 😀 pic.twitter.com/BuHksytj09
— Ryan Detrick, CMT (@RyanDetrick) December 6, 2024
The Dow Jones Industrial Average, S&P 500, and Nasdaq Composite have risen by 19%, 28%, and 31% respectively as of December 4, 2024. Factors such as the rise of artificial intelligence, better-than-expected corporate earnings, and investor optimism are contributing to this outperformance.
However, history suggests caution.
One year ago right now we saw a huge surge in stocks hitting a new 20-day high.
The S&P 500 had been up a yr later 15 out of 15 times.
Make that 16 for 16 after today.
There were clues this was going to be a good year if you looked. pic.twitter.com/M8Jhzy2zhL
— Ryan Detrick, CMT (@RyanDetrick) December 5, 2024
The S&P 500’s Shiller price-to-earnings ratio, which compares current prices to average inflation-adjusted earnings from the past 10 years, stands at 38.87. This is more than double its historical average of 17.17 and marks only the third time in 153 years that the ratio has neared or topped 39.
Previous instances of such high Shiller P/E ratios have preceded significant market downturns.
A Bloomberg chart on the intensification of a combination of two pro-momentum factors—leverage and seamless low-cost market access—that has helped propel US stocks to many new highs.#economy #markets #investing #investors #stocks pic.twitter.com/3UMlxhvzVr
— Mohamed A. El-Erian (@elerianm) December 7, 2024
In January 2022, the ratio briefly surpassed 40 before a bear market where major indices lost over 20% of their value. Similarly, the ratio climbed higher before the dot-com bubble burst in December 1999.
When back-tested to 1871, the Shiller P/E has consistently foreshadowed major stock market pullbacks. While not a precise timing tool, its historical accuracy in predicting corrections suggests that investors should be cautious. Despite these concerns, it’s important to remember that economic cycles include both recessions and expansions.
From John Authers' daily note:
"In absolute terms, the S&P 500 has now set its 56th all-time high for the year, which is impressive. But US stocks’ performance relative to the rest of the world is even more remarkable."@opinion #markets #investing #investors @johnauthers pic.twitter.com/ReANK3fumm
— Mohamed A. El-Erian (@elerianm) December 5, 2024
Recessions are typically short-lived, while economic expansions tend to last much longer. Since World War II, most economic expansions have lasted multiple years, with some extending for a decade or more. This pattern also holds true for bull and bear markets.
Since the Great Depression, the average bear market has lasted about 9.5 months, while the typical S&P 500 bull market has endured around 3.5 times longer. This long-term perspective can offer comfort to investors who may experience short-term volatility but often see growth over the long run. As we approach the end of 2024, concerns about a potential bubble have emerged despite the strong performance of the S&P 500.
Warren Buffett’s Berkshire Hathaway has been a net seller of stocks every quarter this year, stockpiling cash instead. Some investors have questioned the billions being invested in AI infrastructure, suggesting that the consumer end market may not justify such investments. Additionally, stock valuations are high by historical standards.
The S&P 500’s valuation ratio has reached 30.3, indicating that stocks are expensive compared to historical averages. Looking at previous years with high numbers of all-time highs in the S&P 500, the results in the following year have been mixed.
Caution advised amid market euphoria
In 1964, the index gained another 9% in 1965 but fell 13% in 1966. The dot-com boom began in 1995, with the market peaking in 2000. In 2017, the index fell 6% in 2018 due to various factors.
After the pandemic-era bull market left valuations inflated in 2021, stocks fell 18% in 2022. While it’s impossible to predict the market’s performance in 2025 accurately, investors should be prepared for the current momentum to temper itself, given the current valuations. However, with new administrative changes and ongoing developments in AI, the future remains uncertain.
Over a longer time horizon, the stock market has consistently climbed to fresh all-time highs, even after bear markets. For example, the S&P 500 was back to a record by 2019, and this year’s results demonstrate that investing in 2022 paid off. Betting on the S&P 500 over the long term, despite volatility, is a proven strategy to build wealth.
As we’ve seen over the past three years, stock investors don’t like recessions, not even the no-shows. From January 3, 2022, through October 12, 2022, the S&P 500 dropped 25.4% due to anxiety about an imminent recession. Industry analysts confirmed these fears by slightly lowering their consensus expectations for the operating earnings per share of the S&P 500 companies.
Despite these modest cuts, investors reacted sharply by reducing the forward price-to-earnings ratio for the S&P 500 from 21.7 at the start of 2022 to 15.3 on October 12, 2022. This 29.5% drop in the forward P/E, combined with a 5.8% increase in forward earnings, led to a P/E-led bear market. However, during this period, the forward P/E rebounded to 22.3 by the final week of November of the following year, reflecting a 45.8% increase bolstered by a 15.5% increase in forward EPS.
This noteworthy rebound showcases investors’ growing confidence in the resilience of the economy despite significant monetary tightening. The forward P/E is a critical determinant of stock market performance, driven by investors’ expectations for earnings growth. The longer investors believe an economic expansion will last, the higher the P/E they are willing to pay, which justifies the current high valuations.
Despite rationales for high valuations, current metrics are stretched by historical standards. The trailing P/E of the S&P 500 rose to 27.1 during Q3-2024, surpassing the historical average of 19.6. The “Buffett Ratio” reached a record high of 2.96 during Q2-2024, indicating potential overvaluation. Similarly, the forward P/E of the S&P 500, which sits at 22.3, is approaching the record high of 25.0 recorded during the Tech Bubble of 1999.
While today’s elevated valuations can be partially justified by strong earnings growth and economic resilience, they remain high by historical standards. Investors should stay cautious, as further increases in valuation metrics might prompt concerns reminiscent of the Tech Bubble era. Monitoring geopolitical developments and other economic indicators will be critical in anticipating any potential shifts in the market’s trajectory.
