Why History Says to Stick With Stocks, How to Invest: BMO

• Nearly two straight years of strong stock returns are making some in markets nervous.
• But history says that there’s precedent for robust market rallies to last.
• Here’s what BMO Capital Markets is saying about stocks and how to invest next year.

Stocks aren’t bound by gravity, so what goes up doesn’t have to come down.

Investors have experienced that firsthand, as the S&P 500 is up 785% since the financial crisis and 68% from its bear-market low set in October 2022. A return of that caliber in two years is exceedingly rare, ranking in the 90th percentile since 1950, according to BMO Capital Markets.

As 2025 approaches, most strategists see more gains ahead since the economy looks strong. Still, some can’t help but wonder whether this robust market rally has legs after this huge run.

“Given the strength of gains over the past two years, there still is a vocal minority questioning the sustainability of market gains,” wrote Brian Belski, BMO’s chief investment strategist, in a mid-December note.

However, history suggests those concerns are misplaced.

In the last 75 years, the S&P 500 has followed a 40% to 50% gain over two years with a positive return in the next year an impressive 58% of the time. Double-digit gains happened 33% of the time, which was more than four times as often as a double-digit loss. Furthermore, the most common outcome in such scenarios was another gain of at least 20%, BMO researchers found.

There are a few caveats. A 0% to 5% return was just as likely as another outstanding showing, and the next two most common results were single-digit losses. And investors only have two directly applicable parallels to today’s setup: 1954-55 and 1995-96. The S&P 500’s encore after back-to-back 20% gains was 2.6% in the mid-1950s and 31% in the mid-1990s, which aligns with that boom-or-bust dichotomy. Plus, the ’90s run ultimately ended in the dot-com bubble.

Don’t expect another tech bubble, despite rich valuations

At first glance, there are several similarities between today’s market and the late 1990s.

In both cases, US stocks soared for years and reached sky-high valuations due to excitement about a transformative technology, like the internet or artificial intelligence. Large growth stocks led the way in each instance, and above-average economic growth underpinned the move.

That euphoria ended in tears in the early 2000s once investors realized that valuations weren’t justified by underlying earnings, even though the internet eventually exceeded all expectations. A jump in interest rates and, by extension, the unemployment rate resulted in a mild recession.

Equities are expensive once again. The S&P 500’s forward earnings multiple has been above 20x throughout 2024, which hasn’t happened outside the tech bubble or pandemic boom.

But BMO doesn’t believe the past will be prologue. The Montreal-based firm believes US stocks are set for another double-digit gain, based on their end-of-year S&P 500 price target of 6,700.

Valuations are traditionally a terrible market timing mechanism, as stocks have risen for years despite trading at rich multiples. Besides, Belski and his team noted that the typical stock actually isn’t too pricey. The equal-weight S&P 500’s multiple is close to its long-term average.

“This suggests that valuation for the ‘average’ S&P 500 stock is much more reasonable and average market performance has been favorable following similar levels historically,” Belski wrote. He added: “As a result, we [are] less concerned about the impact that valuation may have on market performance going forward, based on these findings.”

A 2-part trade as stocks rally

Those looking to ride the market’s momentum higher should consider companies in two sectors, in BMO’s view: technology and consumer discretionary.

Tech stocks have consistently beaten the market in the last decade and have led each time that the S&P 500 ends the year higher, according to BMO. The firm is optimistic about 2025, and they’re not ready to bet on another group taking the leadership mantle.

“Since the end of the GFC [great financial crisis], it has been rare for technology to underperform the S&P 500 during years of positive market performance,” Belski wrote.

And while tech companies are disproportionately expensive, they’re less so now than they were in the last two years, since robust earnings have helped the cohort grow into its valuation. Analysts are calling for further gains in the year ahead, which may help that trend continue.

“While traditional valuation metrics such as P/E may be historically high, the growth outlook has improved significantly over the past year and is helping to mitigate some of the expensiveness,” Belski wrote. “If the sector was able to outperform by wide margins with a slightly less optimistic growth outlook previously, we would expect that the sector can continue to outperform given that current conditions are slightly more optimistic in this regard.”

Meanwhile, consumer discretionary stocks are easily the market’s best-performing sector in the last three months, despite a wave of negative earnings revisions from analysts. Sentiment seems to have bottomed, which BMO sees as a contrarian bullish signal for the sector since it’s been correlated with outperformance in the past.