Is the S&P 500 at Risk? Rare Event Occurring Only 3 Times in 67 Years Could Be the Cause in 2025

The stock market has had a remarkable year, starting with the S&P 500’s establishment of a bull market in January, and continuing with all three major indexes poised to close the year with substantial double-digit gains. The S&P 500 has ascended by 27% this year, while the Nasdaq and the Dow Jones Industrial Average have surged by 34% and 15% respectively.

What’s behind these impressive gains? At the beginning of the year, investors were optimistic about the first round of interest rate reductions in four years, betting on a stronger economic future. Additionally, there was a surge in interest and investment in the artificial intelligence (AI) sector, with corporations increasingly focusing on and investing in AI technologies. This drew significant investor interest towards stocks associated with AI advancements, providing a significant boost to the stock market’s upward trajectory in 2024.

However, even in a robust market, there are always factors that could temper the enthusiasm. One such factor, a rarity that has occurred only three times since the S&P 500 was established as a 500-company index in the late 1950s, might pose a challenge to the S&P 500 continuing its upward trend into 2025. Let’s explore what that could mean.

Continued Strength in the Bull Market

The bull market remains strong, with the S&P 500 achieving multiple record highs throughout the year. Stocks from various sectors have enjoyed gains, particularly growth stocks which typically perform well when the economy is robust. Notably, AI-focused stocks like Nvidia and Palantir Technologies have led the gains, showing some of the strongest performances in the Dow Jones Industrial Average and S&P 500 respectively.

This momentum has led to soaring valuations. This year, the S&P 500 Shiller CAPE ratio, which adjusts stock valuations for inflation over a 10-year earnings period, surpassed 35—a level only reached two other times in the past 67 years.

Currently, this metric indicates that S&P 500 stocks are among their most expensive ever. Historical data suggests that whenever the Shiller CAPE ratio peaks, it is typically followed by a decline in the S&P 500. This pattern suggests that when stocks become overly pricey, the market tends to correct itself, bringing valuations back down to more moderate levels.

Could the S&P 500 Decline in 2025?

Does this mean we should expect a downturn in the S&P 500 for 2025? Not necessarily. It is difficult to predict exactly when valuations will peak. They might already be peaking, which could lead to a near-term decline, or they could stabilize or even dip slightly before climbing higher again. Thus, while the market does appear expensive currently, it doesn’t necessarily signal a significant drop in the S&P 500 for the upcoming year. The index could still potentially see substantial gains.

For investors, the current market conditions suggest a cautious approach is wise. Pay attention to the valuations of individual stocks rather than broad market movements. There are always opportunities to find value, regardless of market conditions, making it a good time to consider stock investments if careful valuation assessments are made.

Finding Value in AI Stocks

Even within the high-flying AI sector, there are stocks that remain attractively priced. Alphabet (NASDAQ: GOOG) (NASDAQ: GOOGL), for example, is trading at 24 times forward earnings despite its cloud services unit seeing substantial revenue growth. Meta Platforms (NASDAQ: META) also appears reasonably priced at 27 times forward earnings estimates.

History indicates that the S&P 500 will experience corrections, but this doesn’t necessarily mean a downturn is imminent or that all stocks are overvalued. This makes it an opportune time to invest by selecting high-quality stocks at reasonable prices. Doing so could lead to significant gains in 2025 and help build wealth over the long term.

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to Meta Platforms CEO Mark Zuckerberg, is a member of The Motley Fool’s board of directors. Adria Cimino has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Alphabet, Meta Platforms, Nvidia, and Palantir Technologies. The Motley Fool has a disclosure policy.

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