Could the bull market make it
three-in-a-row in 2025?

Key takeaways:

• Stocks are on course for a second-consecutive year of gains over 20%--a rare occurrence in the stock market.
• Valuations at lofty levels may be a headwind for stock returns in 2025.

December 04, 2024 – Despite the volatile market and discordant economic cycle of 2024, the S&P 500^® Index has returned an impressive 28% year-to-date through November 29. If the S&P 500 ends the year with a gain of more than 20%, it will mark one of those rare achievements of consecutive calendar-year gains above 20%, which has only occurred five times in the past 75 years.

The stock market bears who have clung to their pessimistic outlooks, noting the narrow market breadth behind the stock market’s gain this year, must reckon with 51 new all-time highs for the S&P 500 so far in 2024. There is a bright spot for the gloomy bears in valuations: the price-to-earnings ratio for the S&P 500 now sits above 22 times forward earnings. This level has only been reached twice in modern history: first, during the tech bubble of the 2000s, and then at the peak of the COVID-19 pandemic in 2020.

As stock investors revel in the strong returns amid lofty valuations, they must also contemplate whether further gains are likely in 2025 or if elevated valuations will act as a headwind throughout the next year.

The accompanying chart underscores that consecutive returns exceeding 20% in the S&P 500 are a rare phenomenon. Moreover, only once in the last 75 years has the market extended a 20%-plus winning streak to a third year, highlighting the remarkable strength of the bull market in the 1990s. If we exclude the 1990s, in the four previous instances where the S&P 500 logged back-to-back 20%-plus returns, the following year (year three) saw gains in three of the four cases, with an average return of around 6%. In other words, more moderate returns in 2025 would be a reasonable expectation (assuming 2024 closes above 20%).

Regarding valuations, while they are a poor timing tool, they do tend to correlate with longer-term returns. The current forward P/E of the S&P 500 is about a 20% premium over its five-year average of around 18 times forward earnings. If earnings are expected to be the primary driver of equity returns next year, it raises the critical question of whether the lofty valuation of the S&P 500 will temper returns if the multiple rapidly contracts, as happened in 2018.

What will most likely determine stock returns next year includes the fundamental backdrop, corporate earnings, and Fed policy. These factors are expected to provide a tailwind for equity returns, albeit with tempered expectations.