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I S&P 500 increased by 23.3% last year, the second consecutive annual increase of more than 20%. And it’s already up 2% by 2025.
But is the rising index headed for a correction (ie, a 10% fall)? Here are my thoughts.
Arguments for
Remarkably, the S&P 500 has delivered returns of more than 20% in four of the last six years. On a total return basis (including dividends), it was over 25% for four of those years, while the Covid-hit 2020 produced ‘just’ 18.4%.
| A year | Price refund | Refund amount |
|---|---|---|
| 2019 | 28.88% | 31.49% |
| 2020 | 16.26% | 18.40% |
| 2021 | 26.89% | 28.71% |
| 2022 | −19.44% | −18.11% |
| 2023 | 24.23% | 26.29% |
| 2024 | 23.31% | 25.02% |
Historically, these returns are significantly higher than the average for the index. Indeed, the last time such monstrosities were brought back together was in the late 1990s. And we know what followed that boom…
| A year | Price refund | Refund amount |
|---|---|---|
| 1995 | 34.11% | 37.58% |
| 1996 | 20.26% | 22.96% |
| 1997 | 31.01% | 33.36% |
| 1998 | 26.67% | 28.58% |
| 1999 | 19.53% | 21.04% |
| 2000 | −10.14% | −9.10% |
| 2001 | −13.04% | −11.89% |
| 2002 | −23.37% | −22.10% |
Of course, this does not guarantee that the same thing will happen this time. But both then and now, there was the onset of revolutionary new technologies that got investors excited (the Internet and artificial intelligence (AI), respectively). Does history have a rhythm here? It is possible.
In addition, Donald Trump has promised/threatened widespread taxes, which many economists predict will decrease with inflation. If so, this would be a hindrance to reducing the interest rate.
Finally, the index is extremely richly valued, with a forward price-to-earnings (P/E) ratio of 21.6. This high starting point makes it very difficult for companies’ profits to grow at a rate that allows for scaling.
The index did the most during the last time Trump was in charge of the US economy. However, turnover is currently about 27% higher than it was when he took office in early 2017. Therefore, a correction may be on the cards.
Controversial arguments
Yesterday (January 20), the new President was sworn in. In his speech, he promised to increase consumer spending power by reducing energy bills, taxes, and inflation, thus making the economy stronger in the process. He even talked about putting an American flag on Mars.
Given this prospect, it can be said that 2025 will be another good year for the S&P 5OO. Talk of the US recession is over, animal spirits are strong, and interest rates still look set to fall.
How do I answer?
The mood in the US right now is very positive. My guess is that the index will rise significantly this year, but that it won’t deliver a third consecutive double-digit return. Naturally, I could be completely wrong.
What I am most certain of is that certain stocks in the S&P 500 appear to be very valuable. One is Palantir Technologies (NASDAQ: PLTR), its share price has exploded 1,017% since the beginning of 2023.
Palantir provides AI solutions to both government organizations and corporations. It continues to grow like wildfire, with third-quarter profits up 30% year-on-year to $725m.
Revenue has actually accelerated for six straight quarters!
Palantir also made a record $144m in net profit. And CEO Alex Karp struck a very positive tone: “A juggernaut emerges. This is the century of software, and we intend to take over the entire market.”
Obviously, there’s a lot to like about this AI company. However, the stock trades at an eye-watering price-to-sales ratio (P/S) of 66 times. The forward P/E ratio is over 150. If growth is normal, these rates are likely to be unsustainable.
Palantir is the kind of overvalued S&P 500 stock I’m avoiding right now.
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