This year has been remarkable for the stock market, kicking off with the S&P 500 confirming a bull market back in January, leading to substantial gains across the three main stock indices. The S&P 500 has surged by 27%, while the Nasdaq and Dow Jones Industrial Average have increased by 34% and 15%, respectively.

The driving force behind this growth? Investors were optimistic about the first interest rate cuts in four years, boosting expectations for a stronger economy. Additionally, a growing emphasis on artificial intelligence (AI) prompted companies to invest heavily in this area, leading investors to flock to stocks promising robust returns. These factors fueled the positive trend seen in the stock market throughout 2024.

However, even in such a thriving market, unexpected factors can emerge that might dampen enthusiasm. Currently, there is a situation that has occurred only three times in 67 years, since the S&P 500 began as a 500-stock index in the late 1950s. Could this event stop the S&P 500’s upward trajectory in 2025? Let’s explore.

The Bull Market Continues

To begin with, it’s clear that the bull market is robust, with the S&P 500 achieving several record highs this year. Stocks in various sectors have seen gains, but growth stocks—especially those related to AI—have excelled, benefiting from a healthy economy. Noteworthy performers include Nvidia, a leading chip manufacturer, and Palantir Technologies, which focuses on AI-driven software, both of which have excelled within the Dow Jones Industrial Average and S&P 500.

This positive momentum has resulted in soaring valuations. This brings us to a notable event of this year that has only happened twice before in the last 67 years: the Shiller CAPE ratio for the S&P 500 has exceeded 35. The Shiller CAPE ratio provides a long-term perspective on stock valuations, accounting for inflation and averaging earnings-per-share over a decade.

Currently, this indicator suggests that S&P 500 stocks are among the most overpriced in history. To assess whether this could impede growth in 2025, it’s useful to examine historical events. Historically, whenever the Shiller CAPE ratio peaked, the S&P 500 has subsequently declined. Thus, when stocks become exceedingly costly, past trends indicate a drop in the index and a subsequent return to more affordable valuations.

Is a Decline in the S&P 500 Inevitable Next Year?

Does this information imply the S&P 500 is poised for a downturn in 2025? Not necessarily. We cannot predict when valuations will peak; they could be at their highest now, or there might be a slight adjustment before both the index and valuations rebound significantly. Alternatively, they could continue to rise from current levels. So, while stocks appear pricey nowadays, this doesn’t guarantee a major decline in the S&P 500. The index could still achieve notable gains in 2025.

For investors contemplating their next moves, it’s crucial to assess the valuation of individual stocks prior to making purchases—a practice that is always advisable, regardless of the overall market conditions. In any situation, there are undervalued stocks alongside those that are overvalued, making it an opportune moment to find quality investments if you’re mindful of this factor.

Finding Well-Priced Stocks

Even in the flourishing AI sector, some companies remain attractively priced. For example, Alphabet (NASDAQ: GOOG) (NASDAQ: GOOGL) is currently valued at only 24 times its projected earnings, despite experiencing double-digit revenue growth in its cloud services division. Similarly, Meta Platforms (NASDAQ: META) also stands out as fairly priced at 27 times forward earnings estimates.

While history suggests that the S&P 500 will eventually fall and valuations will decrease, this does not necessarily mean that a downturn is imminent next year or that every stock is overvalued. Therefore, now is an excellent time to continue investing. By carefully selecting strong companies available at reasonable prices, you can position yourself for potential success in 2025 and build wealth over time.

Suzanne Frey, an executive at Alphabet, serves on The Motley Fool’s board of directors. Randi Zuckerberg, a former Facebook market development director and sister of Meta Platforms CEO Mark Zuckerberg, also serves on The Motley Fool’s board. Adria Cimino has no shares in any of the discussed stocks. The Motley Fool is invested in and recommends Alphabet, Meta Platforms, Nvidia, and Palantir Technologies. For more details, please refer to The Motley Fool’s disclosure policy.

The Motley Fool partners with YSL News to provide financial news, insights, and commentary aimed at empowering individuals to manage their finances. This content is produced independently of YSL News.

Should You Invest $1,000 in Alphabet Today?

Motley Fool Offer: Before purchasing stock in Alphabet, consider this:

The Motley Fool Stock Advisor analyst team has identified what they consider to be the 10 best stocks to buy right now and Alphabet is not among them. The selected ten stocks have significant potential for high returns in the future.

For instance, when Nvidia was recommended on April 15, 2005 a $1,000 investment would now be worth $799,099!

Stock Advisor provides a straightforward approach for investors, offering guidance on portfolio development, regular analyst updates, and two new stock picks every month. The Stock Advisor service has more than quadrupled the return of the S&P 500 since 2002.