As 2024 nears its end, the US stock market has posted exceptional gains, with the Dow Jones Industrial Average up 15%, the S&P 500 rising 27%, and the Nasdaq Composite surging 33% year-to-date. Key drivers of this rally include advancements in artificial intelligence (AI), robust corporate earnings, and market optimism surrounding President-elect Donald Trump’s November victory. However, historical indicators suggest caution for 2025.

Key Indicators Signaling Potential Market Downturn

  1. S&P 500’s Shiller P/E Ratio Signals Overvaluation
    • The Shiller price-to-earnings (P/E) ratio for the S&P 500 closed at 38.35 on Dec. 24, over double its 154-year average of 17.19. Historically, when the ratio exceeds 30 during a bull market, it has led to market corrections ranging from 20% to 89%.
    • Although the timing of such corrections is uncertain, the Shiller P/E’s perfect track record as a warning sign highlights the risks of elevated valuations.
  2. Decline in U.S. M2 Money Supply
    • U.S. M2 money supply, which includes cash, savings accounts, and money market funds, fell by 4.74% from its April 2022 peak, marking the first such drop since the Great Depression.
    • Historically, significant declines in M2 have been associated with economic downturns, such as those in 1878, 1893, 1921, and 1931-1933. Although M2 has stabilized, the contraction hints at reduced consumer spending, which could weaken economic growth in 2025.

Reasons for Optimism Beyond 2025

Despite potential turbulence in 2025, the long-term outlook for the U.S. stock market remains promising:

  1. Short-Lived Recessions
    • Since World War II, nine of 12 U.S. recessions have lasted less than a year, while economic expansions have endured much longer—often exceeding a decade.
  2. Resilient Bull Markets
    • Since the Great Depression, the average bear market for the S&P 500 lasted only 9.5 months, compared to 1,011 days for bull markets. This suggests that while market corrections are inevitable, recovery and growth typically follow.
  3. Warren Buffett’s Optimism
    • To quote Warren Buffett, “Never bet against America.” Historically, betting on the long-term strength of the U.S. economy has been a winning strategy.

While the Shiller P/E Ratio and M2 money supply trends highlight the possibility of a market correction in 2025, long-term investors have reason to remain optimistic. Economic expansions consistently outlast recessions, and historical data favors sustained bull markets over extended downturns. For savvy investors, any market correction in 2025 may present a valuable buying opportunity to capitalize on the stock market’s enduring upward trajectory.