The S&P 500 (^GSPC +1.01%) is one of three major U.S. financial indexes. It covers roughly 80% of domestic equities by market capitalization, and it includes a diversified mix of companies from all 11 market sectors. That scope and diversity make the index an excellent barometer for the overall U.S. stock market.
The S&P 500 soared 25% over the last five months, notching gains in each month along the way. That performance can be attributed to strong economic growth, encouraging financial results, and expectations that the Federal Reserve will begin cutting interest rates in the near future.
While five-month win streaks are not unheard of for the S&P 500, that type of momentum is not exactly common, and it hints at more gains over the next year.
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Key Data Points
History says the stock market could add another 12.5% over the next year
The S&P 500 was expanded to include 500 companies in March 1957, but hypothetical back-tested values can be generated by applying the index selection methodology to earlier time periods. With that in mind, the S&P 500 has closed higher in five consecutive months just 30 times since 1950, according to Carson Investment Research.
Two of those five-month win streaks are still too recent to collect 12-month performance data. I am referring the ones that ended in July 2023 and March 2024. But during the 12 months following the other 28 events, the S&P 500 increased 26 times (93% of the time) and returned an average of 12.5%. That is above the average 12-month return of 9% since 1950.
In other words, the S&P 500 tends to perform better than average during the year following a five-month win streak. In this case, the implied upside is 12.5% by March 2025. But past performance never guarantees future returns. Indeed, there are reasons to think the stock market could move lower in the next year.
Economic headwinds and elevated valuations could weigh on the stock market
The stock market tends to run on momentum over short periods. Modest gains can snowball into more substantial price appreciation as investors make irrational decisions driven by their fear of missing out. But macroeconomic and microeconomic forces are what actually matter over long periods, so investors should focus their attention on those variables.
When I say macroeconomic, I mean inflation, interest rates, gross domestic product (GDP), and other big-picture aspects of the economy. And when I say microeconomic, I mean spending patterns among individual consumers and businesses, and trends tied to specific industries and sectors. Those forces influence corporate revenue, earnings, and other financial metrics that ultimately determine stock prices.
From a macroeconomic perspective, the stock market could be turbulent over the next year. Inflation remains elevated, policymakers have raised the benchmark interest rate to its highest level in decades, and GDP growth is expected to decelerate. The stock market could struggle to move higher against that backdrop.
Historically high valuations are another potential problem. The S&P 500 currently trades at 20.9 times forward earnings, a substantial premium to the 10-year average of 17.7 times forward earnings, according to FactSet Research. That means many stocks could be overvalued at their present prices, which could lead to a stock market correction.
Indeed, certain Wall Street analysts see that outcome as likely. JPMorgan Chase and Morgan Stanley have set the S&P 500 with year-end targets of 4,200 and 4,500,, respectively, which imply 20% and 14% downside from the current level of 5,250. Even the most bullish year-end target of 5,500 implies just 5% upside.
History says patient investors will be well rewarded
Ultimately, it is impossible to know which direction the S&P 500 will move during the next 12 months, but history says investors that eschew market timing strategies will be well rewarded.
The S&P 500 returned 1,920% over the last three decades, compounding at 10.5% annually. That time period encompasses a broad range of economic environments, so investors can reasonably assume similar returns over the next three decades.
To be clear, that does not mean the S&P 500 will gain 10.5% every year, but rather that it will return an average of 10.5% annually (give or take a percentage point) over the next 30 years.
