November 10th, 2025
The market continues to recover from the spring sell-off. From the bottom on April 8th, the S&P 500 is up 38%. For the year, the S&P 500 is up almost 16%.
The S&P 500 closed at 3,583 on October 14th, 2022. The next month, OpenAI released a research preview of ChatGPT. Historians will look back at that moment as the beginning of the AI boom. Since that time, the S&P 500 is up 87%, closing today at 6,855. That is about 23% annually for the last three years. Recently, it has felt like the market is on a rocket ship, but this is not the best three-year run in history. This is not even the best three-year performance of this decade. The market was up over 100% from 1997 through 1999 and during a breath-taking two years, from early 2020 through early 2022, the market was up 114%.
It is hard to believe that the dot-com bubble began almost thirty years ago. The bursting of the dot-com bubble and the housing bubble were the most challenging investment periods of my career. The current bull market and the continued rise of leading technology companies is causing investors to worry that we are in another bubble.
Bubbles are often driven by enthusiasm that builds around a transformative technology, attracting investors, capital, and hype merchants. Typically, bubbles exhibit rapidly rising asset prices, extreme valuations and create significant risks to the economy driven by excess leverage. During the inflation of the dot-com bubble, the NASDAQ index, which is heavily weighted in technology stocks, increased fivefold between 1995 and 2000, before falling 80% from 2000 through 2002.
The cumulative performance of the NASDAQ over the last five years is 130%, which is 18% annually. This is above average performance, but nothing like the almost 40% annualized returns of the late nineties. Another key difference is that the appreciation of the technology sector has coincided with earnings and revenue growth rather than irrational speculation about future growth.
2025 has been a very productive year for stocks. At the beginning of the year, the S&P 500 was trading at 22 times 2025 earnings. Today, it trades at 23 times earnings. So, most of the 16% return year-to-date is attributable to earnings growth.
The leading companies that have seen the strongest returns have unusually strong balance sheets. Microsoft, according to some agencies has a better credit rating than the U.S. government. Google, Apple, and Amazon are among the highest quality companies in the world. In the late 1990s, speculative IPOs supplied much of the investment for internet expansion. The AI buildout has primarily been funded through operating profits.
There is no guarantee that the return will justify the trillion-dollar investment in AI. A crash in AI stocks would inflict substantial losses on investors in the S&P 500 index. But, unlike during the housing bubble, poor investment returns will not pose a systemic debt risk to the whole economy.
A group of about 30 AI-related companies represents 44% of the S&P 500’s total market value. AI stocks have been responsible for approximately 75% of the S&P 500’s gains since late 2022. The challenge is how do we balance participation in AI stocks, while protecting ourselves from the risk of a crash in AI stocks.
Effective risk management requires diversification. Small and mid-cap strategies, along with international stocks, have limited exposure to the AI theme. Given that the S&P 500 has experienced three consecutive years of above-average performance—fueled by excitement surrounding AI companies, it is imperative that we maintain our allocation in sectors of the market that have lagged during this AI gold rush era.
As 2025 ends, investors are beginning to look forward to 2026. Starting from the assumptions in which I am most confident, we can build a framework for our expectations for the next year or so.
• First, the economy is decelerating. Despite higher inflation than what the Federal Reserve targets, the Federal Reserve continues to lower interest rates. This suggests that they are concerned that slower economic growth is a more pressing risk than rising inflation.
• Second, earnings continue to grow. The analyst consensus is for almost 15% earnings growth both in 2026 and 2027.
• Third, if the economy continues to grow, valuations will stay stable or modestly increase.
The market trades on expectations for the next twelve months’ earnings. We began the year at 22 times 2025 earnings. Currently, the S&P 500 trades at 23 times earnings. The current forecast for next year is for the S&P 500 to earn $308, and then $345 in 2027. So, if we hold valuations steady at twenty-three times then we can estimate that the S&P 500 will be worth 7,084 at the end of 2025.
Applying the same method, using twenty-three times 2027 earnings, we project the S&P 500 will reach 7,935 by year-end. For us to see 7,900 on the S&P 500, we will need to avoid a recession. Most recessions result from the Federal Reserve raising interest rates to control inflation. Today, the Federal Reserve is signaling a slow but steady decline in interest rates over the next year. Forecasters suggest that a recession is unlikely, estimating about a 1 in 3 chance of a recession next year.
Turbulence in the markets is inevitable. Every year brings its share of surprises and disappointments. The challenge is to separate the signal from the noise and maintain the asset allocation that is consistent with your long-term investment objectives.
Eric Barden, CFA
