The S&P 500 is on pace to pull off a rare feat: two consecutive years of gains of 20% or more.

At least that was the case as of Tuesday's close, with the S&P 500 up more than 20% year to date, according to Dow Jones Market Data, and hitting its 41st record closing high of the year on the same day.

By Wednesday's close, the S&P 500 had pulled back somewhat, but it remained near its all-time high, and investors had good reason to expect it to reach new highs following the Federal Reserve's aggressive rate cuts.

It’s been a while since the index has had such a strong run of back-to-back years. The last time that happened was in 1998, according to Dow Jones Market Data.

Surging public enthusiasm for stock trading and hype around the Internet fueled a stock market boom. The S&P 500 rose 20% or more for four consecutive years starting in 1995, and the strong momentum almost continued into the following fifth year, when the index rose 19.5% in 1999.

Prior to this, U.S. stocks had not seen such strong gains for two consecutive years since 1955, even before the S&P 500 was created.

The strength of the stock market’s rally will reignite speculation about how much more upside there is and whether this stunning bull run could slow or even reverse. The S&P 500 is up 60% since its October 2022 low, according to FactSet.

Some suggest abandoning large-cap stocks altogether and looking for better deals in the small- and mid-cap space, or even buying foreign stocks on dips.

But others insist that large-cap stocks remain the best bet for investors, even if their valuations have reached high levels relative to recent history.

Comparison with the Internet Bubble Era

It's not exactly a strong case to draw parallels between the current state of U.S. stocks and the dot-com bubble. Wall Street professionals are quick to highlight the similarities and differences between now and then.

“The last time we saw this kind of performance was in the late 1990s,” Steve Sosnick, chief strategist at Interactive Brokers, said in an interview on Wednesday. “I don’t want to over-analogize the dot-com era because that’s not necessarily fair, but I would say that was also the era when the public fell in love with stocks. So, you know, they were really willing to put money into the market.”

Then, as now, technology stocks dominated the market. Information technology and communications services — the successor to the telecom industry — together accounted for a sizable share of the S&P 500’s market value, said Eric Wallerstein, chief market strategist at Yardeni Research.

The S&P 500 is even more expensive than it was then, based on how stocks trade relative to company sales, with the index trading at 2.9 times forward sales at the end of August, compared with 2.4 times at the end of 1999, according to FactSet.

But the largest U.S. companies today are also more profitable than they were then, which means prices are actually lower relative to expected future earnings.

The S&P 500 recently traded at 21.6 times Wall Street's earnings forecasts for the coming year, compared with just under 24 times in late 1999.

High valuation not a problem?

Sosnick said that while it is difficult for company management teams to manipulate metrics such as price and sales, at the end of the day, profits are what matter most to investors.

Still, some on Wall Street believe high valuations could set the S&P 500 up for delivering below-average returns over the next decade.

Earlier this month, JPMorgan analysts warned that their model would shrink the S&P 500's average return over the next decade to 5.7%. That's below the S&P 500's average annual return of 8.5% since its inception in 1957, according to Dow Jones.

On the other hand, Wallerstein and his colleagues at Yardeni Research believe that S&P 500 earnings and returns will be supported by higher-than-expected economic growth through at least 2030.

Rising productivity should help profit margins at large companies continue to expand, which in turn should help drive the stock market higher at an above-average pace.

“One reason I think valuations are higher now and going forward is that the Big Seven, information technology and communications services, are becoming a bigger and bigger part of the market,” Wallerstein said in an interview. “We don’t take the valuation thesis lightly, but it’s probably been worn out over the last 15 years.”

The market breadth is expanding

This is not to say that tech and tech-related stocks will continue to dominate the market as they did in 2023 and early 2024. In fact, that has begun to change since the beginning of the third quarter.

Wallerstein said he sees plenty of signs that other large-cap stocks have begun to make a bigger contribution. Data shows that financial stocks, industrial stocks and utilities are approaching their best quarterly performance since 2003, and as long as these once lagging sectors continue to rise, the S&P 500 has a lot of room to continue to climb rapidly.

History also suggests that the good times for U.S. stocks can continue, although the pace of gains may slow. According to Dow Jones data, since 1957, the S&P 500 has averaged a gain of just over 9% in the year following a 20% gain.

Article forwarded from: Jinshi Data