The Stock Market Just Did Something Last Seen in 1998. History Says This Will Happen in 2025.

The S&P 500 (SNPINDEX: ^GSPC) is widely regarded as the single best gauge for the overall U.S. stock market. That’s because its 500 member companies cover approximately 80% of domestic equities by market value, and the index includes value stocks and growth stocks from all 11 stock market sectors.

The S&P 500 has advanced 24% year to date, as of Dec. 30, propelled upward by strong economic growth and enthusiasm about artificial intelligence (AI). That means the index has returned more than 20% in two consecutive calendar years, something it last did in 1998. While that momentum bodes well for 2025, high valuations may create turbulence in the new year.

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Here’s what investors need to know.

History says the S&P 500 could continue soaring in 2025

The S&P 500 has only increased more than 20% in back-to-back years three times since it was created in 1957. All three incidents were clustered together in close proximity to the dot-com bubble.

The chart below shows how the S&P 500 performed during the 12 months following two-year periods in which the index gained more than 20% in both years.

Data source: YCharts. Chart by author.

As shown above, the S&P 500 has returned an average of 26% during the 12-month period following back-to-back calendar years with gains above 20%. That supports the Wall Street aphorism that momentum in the stock market begets more momentum.

The chart implies the S&P 500 could advance 26% in 2025. But what the chart doesn’t show is the market crash that followed the dot-com bubble. After peaking in March 2000, the S&P 500 plunged nearly 50% as investors realized many internet start-ups traded at absurd valuations.

To be clear, I don’t believe the artificial intelligence boom is a repeat of the dot-com bubble. For one reason, the “Magnificent Seven” stocks have much cheaper valuations, compared to the largest technology stocks in the late 1990s. But cheaper isn’t the same as cheap. The stock market is very expensive today, and that could lead to trouble in 2025.

History also says the S&P 500 could decline in 2025

The cyclically adjusted price-to-earnings ratio (CAPE) is often used to value the S&P 500. Investors may know the metric by another name, the Shiller P/E, because it was developed by Nobel Prize-winning economist and former Yale Professor Robert Shiller.

Traditional price-to-earnings ratios (P/E) are based on earnings from the previous 12 months, but CAPE ratios are based on the average inflation-adjusted earnings from the past decade. The S&P 500 currently has a CAPE ratio of 38, a value seen during only two previous periods — the dot-com bubble in the 1990s and the pandemic in 2021.

S&P 500 Shiller CAPE Ratio data by YCharts.

To elaborate, approximately 815 months have passed since the S&P 500 was created in 1957. In that period, the index has achieved a CAPE ratio above 35 during only 52 months, which is roughly 6% of the time. That means the S&P 500 has been cheaper (relative to its current valuation) 94% of the time.

That hints at a difficult year in 2025. After achieving a CAPE ratio above 35, the S&P 500 has declined by an average of 1% during the next 12 months. Of course, that doesn’t mean the index will definitely decline this year. Its actual return could be much better or much worse.

However, investors should be wary in the current market environment. That means avoiding stocks that trade at absurd valuations. It also means accumulating extra cash to capitalize on the next stock market correction or bear market.

Remember, the next drawdown is always a question of when, not if. But the S&P 500 has created tremendous wealth over time, despite regular drawdowns. The secret to making money in the stock market is perseverance and patience.

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Trevor Jennewine has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.