As of Tuesday's close, the S&P 500 was challenging a rare feat, achieving a gain of over 20% for two consecutive calendar years. According to Dow Jones Market Data, the S&P 500's gain for the year has surpassed 20% for the first time, and this marks the 41st time the index has hit a new all-time high this year.
By Wednesday's close, the S&P 500 had retreated somewhat but remained near its highs. With the Federal Reserve's significant rate cuts, investors have ample reason to believe the index will rise again.
Such consecutive strong growth has not been seen for some time. According to Dow Jones Market Data, the last time the S&P 500 rose more than 20% for two consecutive years was in 1998. At that time, driven by a surge in public enthusiasm for stock trading and the commercialization of the internet, the S&P 500 began a four-year streak of gains over 20% starting in 1995. This uptrend almost lasted into the fifth year, but in 1999, the index only rose by 19.5%. Prior to that, the stock market had not seen such strong consecutive gains for two years, a feat not witnessed since 1955.
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The strong performance of stocks has sparked market speculation on whether large-cap stocks can continue to climb. According to FactSet data, the S&P 500 has risen by 60% since its low point in October 2022. However, some market participants believe that this bull market may be about to slow down or even reverse.
Some analysts suggest that investors should sell large-cap stocks and turn to small-cap or mid-cap stocks, or seek investment opportunities in overseas markets. But others firmly believe that large-cap stocks remain the best choice for investors, even though their valuations are already at a higher level compared to historical standards.
Similar to the Internet Bubble Era
Comparing the current market to the era of the internet bubble is not a completely reassuring signal. Wall Street professionals quickly point out the differences between then and now, while also acknowledging the similarities.
"It's interesting that the last time we saw such performance was in the late '90s," said Steve Sosnick, Chief Strategist at Interactive Brokers, in a media interview on Wednesday. "I don't want to overstretch this analogy to the internet era because that wouldn't be fair. But I would say that the public was also very enthusiastic about stocks at that time, and they were willing to put a lot of money into the market."
Now, as then, technology stocks dominate the market. The information technology and communication services (the successor to the telecommunications industry) sectors hold a disproportionate share of the S&P 500's market value. According to data from Eric Wallerstein, Chief Market Strategist at Yardeni Research, the S&P 500's valuation is even higher today than it was then, based on the ratio of stock trading to company sales. According to FactSet data, as of the end of August, the S&P 500's forward price-to-sales ratio was 2.9 times, compared to 2.4 times at the end of 1999.
However, the largest companies in the United States are now more profitable than they were then, which means that current prices are actually lower relative to expected future earnings. According to Wall Street's forecasts for profits over the next year, the S&P 500's forward price-to-earnings ratio has recently been 21.6 times, compared to just under 24 times at the end of 1999.Valuation Issues
Sosnick points out that although indicators such as the price-to-sales ratio are more difficult for corporate management to manipulate, ultimately, profits are what investors care about the most. Nevertheless, some Wall Street professionals believe that the current high valuation of the S&P 500 may signal that the index's returns over the next decade will be below average.
Earlier this month, several analysts at J.P. Morgan Securities warned that, according to their models, the average return of the S&P 500 over the next decade will drop to 5.7%, significantly lower than the index's average annual return of 8.5% since its inception in 1957. On the other hand, Wallerstein and his colleagues at Yardeni Research believe that the earnings and returns of the S&P 500 will benefit from higher-than-expected economic growth, at least until 2030. Increased productivity should help large companies continue to expand their profit margins, thereby driving the market to rise at a rate above the average.
Wallerstein stated: "I believe one of the reasons valuations can remain high today and in the future is that a significant portion of the market's gains come from the 'Seven Giants,' which are information technology and communication services companies. We are not dismissing the valuation argument, but this issue has been present for the past 15 years."
Market Expansion
This does not mean that technology stocks and tech-related stocks will continue to dominate the market as they did in 2023 and early 2024. In fact, the market landscape has already changed since the third quarter began.
Wallerstein noted that the performance of other large-cap stocks has begun to stand out more. As long as sectors that were previously lagging, such as finance, industry, and utilities, continue to rebound, with data showing they are approaching their best quarterly performance since 2003, there is still plenty of room for the S&P 500 to rise.
According to Dow Jones data, as of earlier this week, the proportion of S&P 500 companies outperforming the index is about 34%, higher than the 29% for the entire year of 2023. The average level of this proportion over the past decade has been 46.2% (excluding this year).History indicates that the good momentum of the stock market may continue, but the growth rate will slow down. Since 1957, the S&P 500 has averaged a slightly higher increase of just over 9% in the year following a 20% gain.
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