As we enter 2025, the general consensus is that stocks are set to deliver another year of decent returns. Most strategists contend that we will be in a goldilocks environment characterized by positive readings on economic growth, profits, inflation , and rates. This sentiment is particularly evident in the current valuation level of the S&P 500 Index.
Regardless of which metric one uses, the index is extremely elevated relative to its historical range. Interestingly, U.S. stocks are an outlier when compared to other major markets (including Canada), which are trading at valuations that are in line with historical averages.
The best of times and the worst of times
Unfortunately, the history books are quite clear about what can happen to markets that attain peak valuations. The four largest debacles in the history of modern markets were all preceded by peak valuations.
- In 1929, the U.S. stock market traded at the highest PE multiple (or price-to-earnings ratio) in its history up to that time. This lofty multiple presaged the worst 10 years in the history of the U.S. stock market.
- In 1989, the Japanese stock market was trading at 65 times earnings. The aggregate value of Japanese stocks exceeded that of U.S. stocks despite the fact that the U.S. economy was three times the size of its Japanese counterpart. Soon after, Japanese stocks suffered a particularly prolonged and steep decline.
- In early 2000, the S&P 500 Index, aided and abetted by a tremendous bubble in technology, media, and telecom stocks, reached the highest multiple in its history. Not long after, the index suffered a peak trough decline of roughly 50 per cent over the next few years.
- In early 2008, the S&P 500 stood at its highest valuation in history, with the exception of the multiples that preceded the great depression and the tech wreck. The ensuing mess brought the global economy to the brink of collapse and required an un