Happy days are here again. At least, that seems to be the case.
The S&P 500 (^GSPC 0.47%) tumbled as much as 19% below its previous high in early April, nearly entering a full-fledged bear market. However, those losses disappeared as the widely followed index made a spectacular recovery. Today, the S&P 500 is once again hitting record levels.
Should you load up on stocks with the S&P 500 at an all-time high? Here’s what history shows.
Image source: Getty Images.
Two important things to know
Before we get to specific lessons we can learn from the S&P 500’s history, there are two important things on a more general level to know. And both should be encouraging for investors.
First, every all-time high set by the S&P 500 in the past broke a previous all-time high. This is an obvious fact, of course. However, sometimes people can experience an investing form of acrophobia. When the stock market reaches a high mark, their fear that it will fall increases. But just because the S&P 500 is again hitting record highs doesn’t necessarily mean it is at a greater risk of declining.
Second, momentum is a physics principle that often works in the stock market, too. A 1993 study published in the Journal of Finance found that buying stocks with recent momentum and selling stocks that were recent losers generated significantly higher short-term returns than the overall stock market between 1965 and 1989. Another study conducted in 2013 confirmed that momentum investing worked in U.S. stocks, international stocks, bonds, currencies, and commodities going back 215 years.
Experts aren’t completely sure why momentum investing works. However, the best explanation I’ve seen is based on psychology. One is “herding behavior,” which refers to the tendency of people to follow the crowd. The more investors see the S&P 500 rise, the more their fear of missing out (FOMO) increases. This FOMO can cause them to join the herd and buy stocks, creating buying pressure that pushes the index even higher.
Past precedents
Precedents so far in the 21st century are also generally positive. When the S&P 500 has fallen significantly and then rebounded to set a new high, it typically moves even higher. We’ve seen this happen twice in the past six years.
In 2020, the S&P 500 plunged during the early part of the COVID-19 pandemic. However, the index clawed its way back a few months later. It went on to deliver even stronger gains through the end of 2021.
It took longer for the S&P 500 to recover after the extended sell-off in 2022. Once it did, though, the momentum continued for quite a while.
I reviewed the S&P 500’s performance since the index adopted its current form with 500 companies in 1957. In most cases, the index delivered solid returns after a sharp decline that was followed by a strong rebound, like we’ve seen this year.
Granted, there have been some exceptions. For example, the S&P 500 took several years to recover after the dot-com bubble burst in 2000. Once it reached a new high again in 2007, the celebration didn’t last very long because of the financial crisis that led to the Great Recession.
The main drawback to looking back
If history is any guide, loading up on stocks with the S&P 500 at an all-time high could be a smart move. But history isn’t always a great guide. There’s a key drawback to looking back at the past: The market conditions present today are quite different than what they’ve been over the last several decades. In particular, I think two factors could present near-term challenges for investors.
First, there’s still significant uncertainty about President Trump’s tariffs. Federal Reserve Chairman Jerome Powell acknowledged as such in his recent comments before the U.S. Congress. Worries about tariffs caused the S&P 500 to fall earlier this year. The actual impact from tariffs later in 2025 could still weigh on the stock market.
Second, the S&P 500’s valuation is concerning. The S&P 500 Shiller CAPE ratio is near its highest level since the big stock market sell-off of 2022 and not too far below the all-time high in 2000, which preceded a multi-year decline.
S&P 500 Shiller CAPE Ratio data by YCharts
The good news is that buying stocks nearly always works out well for investors who diversify and hold long enough. But I’m not convinced that happy days are here again just yet.
Keith Speights 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.
