Fear of Heights: Understanding the S&P 500’s Record Momentum

The atmosphere is electric with optimism, indicating the good times have returned, particularly for investors. The pulse of this excitement can be felt strongly in the performance of the S&P 500. The index plunged almost 19% below its preceding peak by early April, teetering on the brink of dreaded bear market territory. Yet, it confounded expectations as it bounced back spectacularly, erasing its losses. Currently, the S&P 500 is flexing its muscle once more, soaring to new record heights. Does this suggest it’s time to purchase stocks in a frenzy with the index at an unprecedented peak? The lessons from history provide some valuable insights.

Before diving into the specific takeaways from the S&P 500’s historical performance, we need to understand two broader points that should provide some comfort to investors. First and foremost, it is crucial to remember that every historical pinnacle reached by the S&P 500 has been the result of it breaking previous records. This might seem like stating the obvious, yet, it is a fact that investors often overlook when gripped with anxiety at the sight of the market at its zenith.

This fear, akin to the unease experienced by those wary of heights, escalates as the market touches unprecedented levels. However, the key is not to get spooked by the sheer height of the S&P 500 index. Record-breaking levels don’t necessarily signify amplified risk of a market decline. Therefore, investors need to train their minds to see opportunity, not threat, when the index once again scales record heights.

The second concept an investor needs to grapple with is that of momentum, which is as much a principle of physics as it is an inviolable law of the stock market. According to research, buying into the recent winners and selling the lagging players resulted in noticeably superior short-term returns compared to the wider stock market, at least from 1965 to 1989. The effectiveness of the ‘momentum investing’ strategy has raised many an eyebrow in the expert community, and though its application seems clear, determining its precise working mechanism remains elusive.

One logical reason behind the success of momentum investing is rooted in psychology, specifically the concept of ‘herding behavior’. This refers to the propensity of individuals to move with the crowd. As the S&P 500 index continues its upward march, the more investors experience the gnawing fear of missing out (FOMO). This FOMO urges investors to join the group, yielding to the buying frenzy and further propelling the index skyward.

Trends seen since the turn of the 21st century also hint at a generally optimistic future. When observed historically, the S&P 500, when taking a downward hit and subsequently rebounding to set new highs, tends to ascend even more. Notably, this pattern emerged twice during the last six years.

Consider 2020, for instance. The S&P 500 was negatively affected in early stages of the Covid-19 pandemic, but staged an impressive comeback only a few months later. Not only that, it managed to deliver even stronger gains by the conclusion of 2021. Similarly, the recovery after the prolonged sell-off in 2022 took a bit more time and once the recovery stage was set, the upward momentum continued for a substantial period.

I examined the performance of the S&P 500 since the index was revamped and standardized with 500 companies in 1957. Generally, strong returns followed periods of steep decline and subsequent recovery, much like what we are witnessing now. Nevertheless, it’s important to acknowledge that some historical instances did not adhere to this general trend.

Specifically, after the bursting of the dot-com bubble in 2000, it took the S&P 500 quite some time to find its feet and hit new highs. The euphoria surrounding this recovery in 2007 was rather short-lived due to the financial crisis triggering the Great Recession. These occurrences remind us that while historical patterns of the S&P 500 provide useful insights, they should not be relied upon as definitive predictors.

Accelerating investments with the S&P 500 at an unprecedented milestone could well turn out to be a savvy move if we go by historical precedents. Despite this, history isn’t a foolproof guide, and it’s vital for investors to remember that market conditions are subject to change and can deviate substantially from past patterns.

Today’s financial landscape is vastly different from the past few decades. Two elements, in particular, could pose immediate problems for investors. Firstly, the uncertainty surrounding President Trump’s tariff policies lingers. The Federal Reserve Chairman, Jerome Powell, expressed this concern in his latest conversation with the U.S Congress. Earlier this year, worries about these tariffs led to a drop in the S&P 500, and these policy outcomes, predicted to materialize in late 2025, could continue to cast a cloud over the market.

Secondly, the valuation of the S&P 500 raises eyebrows. The Shiller CAPE ratio for the index is dangerously close to the highest figures seen just before the considerable market sell-off of 2022 and not too far from the all-time high prior to the multi-year decline in 2000. This could suggest an impeding drop in the market.

It’s encouraging to note, however, that making diversified long-term investments seems to yield favorable outcomes for investors more often than not. Despite this, whether we could pronounce confidently that we’re basking in the return of the ‘roaring days’ remains to be seen.