The stock market has entered rarely charted territory as it approaches the end of a phenomenal year for Wall Street and investors. The Dow Jones Industrial Average, S&P 500, and Nasdaq Composite have risen by 17%, 27%, and 33%, respectively, through the close of trading on Dec. 12.
Investors have been buoyed by factors such as the artificial intelligence (AI) revolution, excitement over stock splits in leading businesses, and stronger-than-expected corporate profits. Despite these gains, one historical metric capturing attention is the S&P 500’s Shiller price-to-earnings (P/E) ratio, also known as the cyclically adjusted P/E ratio. The Shiller P/E is based on average inflation-adjusted earnings per share (EPS) over the previous 10 years.
At the closing bell on Dec. 12, the S&P 500’s Shiller P/E stood at 38.55, a level that has historically been a harbinger of significant market downturns. There have been notable instances when the Shiller P/E crossed above 30, including just before the Great Depression, following the dot-com bubble burst, and in the months before the COVID-19 pandemic.
In all prior instances since 1871, the S&P 500’s Shiller P/E topping 30 has been followed by a downturn of 20% to 89% in one or more of the major indexes. While the current high Shiller P/E suggests potential downside, history also provides encouragement for patient investors. According to Crestmont Research, rolling 20-year total returns for the S&P 500 (including dividends) have been positive every single time from 1900 to 2004.
Stocks rise amid record highs
This means investors who held an S&P 500 tracking index over any 20-year period have always made money, often achieving annualized returns between 9% and 17.1%. In conclusion, while the current high Shiller P/E suggests potential downside, long-term investors with patience and perspective can still expect to reap significant rewards.
The stock market’s lone bear, Stifel’s Barry Bannister, explained that a more hawkish Federal Reserve could prompt weaker-than-expected economic growth and weigh on equities. However, many strategists see a scenario where stocks go up even if the US economy does not exceed consensus expectations for the first time since the COVID-19 outbreak. The S&P 500 index has experienced a record rally spurred by influential factors like the AI boom and GLP-1 momentum.
Since it bottomed on October 13, 2022, at an intra-day low of 3,491.58, the benchmark has rebounded by 75%, reaching an all-time high of 6,099.97 on December 6. The S&P 500 is projected to extend its gains, with the median forecast from 48 equity strategists and analysts expecting it to reach 6,500 points by the end of 2025—a 7.4% gain from the close of 6,051.09 on December 13. Factors contributing to this optimism include the anticipated tax cuts and deregulation under President-elect Trump, as well as the Federal Reserve’s dovish stance on rate cuts, which are expected to further fuel the market.
Historically, Fed rate cuts have generally been favorable for the stock market, with notable one-year and three-year returns following such cuts unless conducted during a recession. Investors should note the impossibility of investing directly in the S&P 500 index. Instead, index funds, either as mutual funds or exchange-traded funds (ETFs), mirror its performance by investing in the same stocks or a representative subset.
A long investment horizon is crucial, as staying invested tends to yield better results. Oppenheimer’s study, examining data since 1950, found the index has never experienced a loss over a 20-year period, reinforcing the benefits of a long-term investment strategy.
