Stock Market's Prolonged Bull Run Nears Unprecedented Milestones, Risking Undesirable Past Repeat
Last week saw some major events unfold on Wall Street. On January 20, 2025, Donald Trump became the second president to serve two nonconsecutive terms. During his initial tenure (2017-2021), the Dow Jones Industrial Average (^DJI), S&P 500 (^GSPC), and Nasdaq Composite (^IXIC) saw substantial growth. Specifically, they surged by 57%, 70%, and 142% respectively.
On January 21, 2025, the joint venture known as Stargate was unveiled. This venture aims to invest $500 billion over four years to develop the necessary infrastructure to accommodate artificial intelligence in America. The cherry on top was the S&P 500 ending January 23 at a new record-breaking high, nearly hitting 6,119 points. After a 5% drop from its previous high, it recovered in just over a week.
However, this bull market is knocking on the door of a historically troubling situation. While economists are discussing the possibility of a U.S. recession, yield-curve inversion, and the first significant decline in U.S. M2 money supply since the Great Depression, the stock market is pushing its valuation boundaries.
Valuation is a subjective concept, and what one investor considers expensive might not seem so to another. With a Shiller P/E ratio of 38.59 as of January 23, 2025, the stock market is getting dangerously close to its all-time high of 38.89, seen in December 2024. This is only the third time such a reading has been seen, with previous instances occurring in January 2022 and December 1999.
Historically, valuation ratios surpassing 30 for extended periods have resulted in significant stock market declines. Since 1871, there have been six occurrences of this, including the present. The aftermath has resulted in the Dow Jones Industrial Average, S&P 500, and Nasdaq Composite shedding anywhere from 20% to 89% of their value.
While valuation doesn't serve as a timing tool for market downturns, it does warn of potential trouble. Despite this, there's still a glimmer of hope. The past has shown that following periods of trouble have eventually led to new market highs for the Dow, S&P 500, and Nasdaq Composite. A long-term investor's perspective can help them recognize this nonlinear pattern of the market cycle.
Historically, each time the Shiller P/E ratio surpassed 30 for at least two consecutive months, the stock market experienced substantial declines. These declines ranged from 20% to 89% for major indices like the S&P 500, Dow Jones Industrial Average, and Nasdaq Composite. While these instances do not provide an accurate timing tool for predicting market downturns, they serve as an indicator of potential trouble ahead.
Investing always carries risks, and stock markets are no exception. While the current market situation appears to be pushing valuation boundaries, it's essential to maintain a balanced approach while making investment decisions. Remember, history has shown that the stock market has the power to rebound from these troubled times, eventually reaching new highs.
Financing the Stargate venture requires an investment of $500 billion over four years. Despite the potential trouble signaled by the stock market's high valuation, historical data suggests that markets often rebound from troubled times, reaching new highs in the long term.
