S&P 500 Enters Fifth Bull Market Year with Valuations Below Long-Term Averages

The S&P 500 (^GSPC) is entering the fifth year of its current bull market, a milestone reached by five of the six prior bull markets that lasted at least four years since 1957. While historical data suggests the index may continue climbing over the next year, the path forward depends on whether rising interest rates and capital-intensive artificial intelligence (AI) spending disrupt the current momentum.

Historical patterns indicate that bull markets do not end simply due to age. Instead, they typically terminate after specific catalysts. Of the last six bull markets that reached their fourth anniversary, only half extended significantly beyond their fifth year. The current market's health is supported by valuation metrics that remain below long-term averages, despite recent gains.

The primary risk to this trajectory involves rising interest rates. AI stocks, which have driven much of the market's performance over the past four years, are increasingly capital-intensive as developers build out new data centers. A higher cost of capital could weigh on these companies' results, particularly if there is a reassessment of the compute resources actually required. This risk is amplified by the fact that the largest technology stocks account for a significant share of the overall index.

However, the largest hyperscalers possess a distinct advantage: they are their own customers. This internal relationship provides them with direct insight into the returns generated by data center spending. As long as the cost of capital remains well below their projected returns on capital, a slowdown in spending is unlikely to trigger a market crash.

Earnings expectations further support the current valuation. Analysts project that S&P 500 aggregate earnings will grow by more than 27% per year over the next five years. This expected growth has pushed the index's forward P/E ratio down to 19.1, a level that sits below the five-year average and in line with the 10-year average. Based on recent history and these future expectations, stocks are not considered overvalued relative to their growth potential.

Much of this projected earnings growth relies on big tech companies continuing to deliver strong results. Expectations for other sectors have fallen, creating potential for broader participation if tech underperforms. Markets typically see wider stock participation before a bull market ends, but so far, leadership has been concentrated in a few non-tech spurts. Until a broader rise in stocks is observed, investors should expect further upside in the index.