Investors have been rewarded being invested in the US stock market. We are coming off back-to-back years of 20%+ returns for the S&P500, an occurrence that has only happened five other times since 1871. The number one question we are receiving from clients is whether or not the market can continue its assent in 2025. Embedded in this question is the lurking concern that the markets are overbought and potentially in a bubble.
What may surprise investors is that the historical data would argue that these markets have been very normal. That’s right, normal! Although our most recent shared experience is of rip-roaring equity prices, this ignores the fact that 2022 was an extremely difficult bear market. We believe looking at 3-year rolling returns of the stock market is a better way to look at market trends, as it smooths out seasonal factors and gives disruptive events the chance to be digested.
Under this lens, as shown in the chart below, the average rolling 3-year return since the 1960s is approximately 28%. This is marked by the dashed purple line. This equates to about 9% per year. The solid purple line is the current rolling 3-year return, and it is also printing 28%. Hence, as difficult as it is to say (and perhaps believe), we have simply experienced average returns in the market.
The market would need to earn 50%+ over a 3-year period in order to be considered ‘out of the ordinary’ (orange line). It would take an 80+% return over three years to be considered ‘extreme returns’ (red line). At existing levels, the market would have much more to rise before raising significant concerns of a bubble.
Equipped with this knowledge, we believe investors should enter 2025 with a more composed approach. The base case could be for ‘average’ returns to continue and one can adjust their expectations as the year develops. As reports come regarding Trump policies, Fed interest rate decisions, and corporate earnings, investors can tactically adjust the portfolio to under or overweight equities should they determine returns could be below or above average.
