The Stock Market's Recent Performance and Its Implications for 2025

The S&P 500 (^GSPC) achieved a total return of 25% in 2024, on the heels of a remarkable 26% gain in 2023. This is significant because the index has accomplished back-to-back annual returns of at least 25% only once since its inception in 1957: during the dot-com boom with gains of 33% in 1997 and 29% in 1998.

While the current stock market appears more rational than during the dot-com era, emerging trends such as artificial intelligence (AI) are once again driving strong performance in certain areas of the technology sector. This article explores potential outcomes for the S&P 500 in 2025 based on historical trends and upcoming developments.

Evidence Suggests Potential for Continued Growth in 2025

Historically, after the surge in returns during 1997 and 1998, the S&P 500 rose an additional 21% in 1999. This could imply that the index has more room to grow in 2025, yet one data point alone can’t predict a trend.

The period during the dot-com era was characterized by extreme irrationality, with many internet start-ups going public without revenue or a solid business plan. Investors, nevertheless, poured money into these companies.

In contrast, the current AI revolution is showing more promise. A prime example is Nvidia, which leads in supplying GPUs essential for AI, witnessing its revenue projected to grow by 112% during its fiscal year ending soon, driving its stock up by 178% in 2024.

Nonetheless, there are still signs of overenthusiasm in the market. For instance, Serve Robotics has generated only $221,555 in revenue in its latest quarter but boasts a market cap exceeding $600 million, with a hefty price-to-sales (P/S) ratio of 278.

Similarly, stocks like Palantir Technologies saw rises of 350% in 2024, with its valuation considerably higher than Nvidia’s.

While these companies are expected to see revenue growth in 2025, which adds some justification for their high valuations, predicting the conclusion of speculative trends is always challenging. However, the tangible growth reported by AI companies could signal a possible rise for the S&P this year.

Marketplace Valuations Are Elevated

One factor that could hinder further growth for the S&P 500 is its current valuation. As of now, the index has a price-to-earnings (P/E) ratio of 25.2, representing a 38% premium over its historical average of 18.1 since the 1950s.

That being said, investors are advised against hastily selling their stocks. Valuation alone is not a dependable timing mechanism, as markets can remain at inflated levels longer than anticipated. For example, the S&P 500 reached a P/E ratio of 34 back in 1999, and yet continued to rise despite the overvaluation.

However, inflated valuations do not last indefinitely. The S&P 500 experienced a drop over three consecutive years from 2000 to 2002, not reaching an all-time high again until 2007.

As 2025 begins, the S&P has positive momentum, aided by the Federal Reserve’s decision to cut interest rates three times since September. Analysts expect at least two more rate cuts this year, which could make stocks more appealing as the yield on risk-free assets decreases. Moreover, these lower interest rates allow companies to access borrowing more easily, which can boost their earnings.

Indeed, AI is anticipated to be a significant driving force in 2025, with forecasts from Morgan Stanley suggesting that leading tech firms such as Microsoft, Amazon, Alphabet, and Meta Platforms collectively may invest a staggering $300 billion in AI data centers and chips this year.

Possible Market Volatility Ahead

A key political transition is coming with Donald Trump’s upcoming election victory. This will usher in a new set of economic policies sharply contrasted with those of the previous administration. Investors might experience some turbulence as the market adjusts to these changes.

Trump's proposals include cutting corporate taxes and rolling back regulations, which tend to please the stock market. However, his plans to impose tariffs on major trading partners, including China and Canada, to protect American businesses could reignite trade tensions, posing potential risks.

During his previous term, Trump’s tariffs on steel and aluminum sparked retaliatory actions that resulted in market jitters. This was particularly evident in 2018 when fears of a trade war nearly pushed the S&P into a bear market.

Given the current elevated stock valuations, a slight trigger could lead to a substantial market correction. Even a 10% drop would not suffice to bring valuations back in line with historical averages. Thus, it wouldn’t be surprising if the market experiences a downturn after Trump’s inauguration due to anticipated disruptive trade policies.

Such corrections, though painful, can also present attractive opportunities to purchase quality stocks at lower prices. In the event of a market dip, investors are encouraged to remain calm and consider investing rather than panic selling.

Stock, Market, Valuation