As of Monday's close, the S&P 500 (SNPINDEX: ^GSPC) was up around 27% in 2024. That's a phenomenal performance after an already strong year in 2023 when it rose by 24%. It's impressive but at the same time, it also begs the question of whether the market is due for a correction.
While the stock market has been doing well, there are three concerning numbers that investors should pay close attention to, as they could be indicative of just how inflated the index has gotten and why a crash may be overdue.
The index has been doing well for several years, far better than normal -- its long-term average annual return is around 10%. What's remarkable is that in five of the past six years, with 2022 being the lone exception, it has risen by at least 16%.
Year | Return |
---|---|
2024 | 26.9%* |
2023 | 24.23% |
2022 | (19.44%) |
2021 | 26.89% |
2020 | 16.26% |
2019 | 28.88% |
To put into context just how outstanding this is, prior to the years noted above, the S&P 500 achieved this feat (16% returns or more) five times in the past 20 years. Large returns like this have typically been sprinkled out over the years rather than clumped together as they have been recently. These aren't typical returns for the market, and the risk is that investors may be expecting them to be, leading to inflated expectations going into next year.
While bounce-back years may not be uncommon after a tough year, such as the one the market experienced in 2022, it has more than made up for that downturn with many top growth stocks and the S&P 500 now trading at record levels.
Another way to highlight the S&P 500's impressive performance is to simply look at its impressive gains since 2019. If you invested in the index back then, you would have more than doubled your money, as it has risen by 166% (when including dividends) over that time frame.
That averages out to a compound annual growth rate of 17.7%, which is far higher than its long-run average of just 10%. This factors in the off year in 2022 and shows how well the market has done even with such a bad performance included within those results.
The Shiller price-to-earnings (P/E) ratio is an effective way to measure how expensive valuations are in the stock market because it compares the S&P 500 to inflation-adjusted earnings over the past decade. This smoothing effect can give investors a better, longer-term perspective on how expensive valuations are right now.
Currently, the ratio is around 38.5, which is well above its historical average of 17. The last time it was around these levels was in 2021, and the S&P 500 would proceed to crash the following year. Previous to that, the Shiller P/E ratio hit a high of 44 in 1999, which occurred just before the dot-com crash.
It was also at elevated levels (over 20) prior to the Great Recession in 2008-09 but even that wasn't as extreme as where the Shiller P/E ratio is today. It's by no means a perfect indicator that a big crash is coming -- it has normally been well above 20 over the past decade and rising along the way -- but it can serve as an important reminder to investors of how expensive stocks are right now.
Regardless of whether you think a market crash is going to happen next year, it's never a bad idea to periodically evaluate your portfolio to see if there are better investing opportunities to consider.
If a stock has soared to an extreme valuation where it may be highly vulnerable to a correction, and there's potentially a more attractive growth stock to invest in, it could make sense to change your portfolio's holdings. You may also want to divert more money into dividend-paying stocks that can generate some recurring income to help offset a possible decline in your portfolio's value. What you don't need to do is completely take money out of the stock market and wait for a crash before buying back in. Trying to time the market can result in you missing out on gains by waiting.
To make your portfolio safer heading into next year, you may want to consider putting more of your money into bonds, dividend-paying stocks, or exchange-traded funds which can offer greater safety and diversification. Even if you're worried about a market crash, you can still remain invested and simply deploy a safer strategy.
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*Stock Advisor returns as of December 9, 2024
David Jagielski 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.