The S&P 500 Soared in January. History Says the Stock Market Will Do This Next.

The S&P 500 (SNPINDEX: ^GSPC) advanced 2.7% in January despite rising bond yields and a sharp decline in the heavily weighted technology sector. That bodes well for the remaining months of 2025, because momentum in the stock market often leads to more momentum. Indeed, January gains have historically led to above-average returns for the full year.

History says the S&P 500 could soar in the remaining months of 2025

The S&P 500 tracks 500 large U.S. companies. The index is commonly regarded as the best benchmark for the entire domestic stock market because it covers approximately 80% of U.S. stocks by market capitalization.

In the past three decades, the S&P 500 has moved higher in January 17 times, and that early momentum often carried into future months of the year. The following chart shows the index's full-year returns following a positive January.

Data source: YCharts.

In the last three decades, the S&P 500 returned an average of 16% during years in which it increased in January. By comparison, the index returned an average of 3% during years in which it declined in January. It also achieved an average annual return of 11% during the entire period.

Here's what that means for 2025: The S&P 500 opened the year at 5,882. If its performance aligns precisely with the historical average, the benchmark index will advance 16% to 6,823 by the end of 2025. That implies 13% upside from its current level of 6,035.

Of course, past performance is never a guarantee of future results. How the stock market actually performs in the remaining months of 2025 depends on investor sentiment with respect to macroeconomic fundamentals, financial results, and valuations.

Potential headwinds and tailwinds for the stock market in 2025

The Federal Reserve estimates economic growth will decelerate to 2.1% by the fourth quarter of 2025, down from 2.5% in the fourth quarter of 2024. Policymakers also anticipate inflation (as measured by the personal consumption expenditure price index) will increase to 2.4% by the fourth quarter of 2025, up from 2.3% in the fourth quarter of 2024.

Based on those assumptions, the Federal Open Market Committee expects two quarter-point rate cuts this year, and the futures market is pricing in the same outcome, according to CME Group's FedWatch tool. But policymakers may effect fewer rate cuts if the economy grows faster or inflation accelerates further. That would likely be a headwind, at least temporarily, for the stock market.

Meanwhile, consensus estimates from Wall Street analysts call for S&P 500 companies to report faster earnings growth in 2025 as compared to 2024. Details are provided in the chart below.

Data source: FactSet Research. Numbers are rounded to the nearest whole percentage point. Not all S&P 500 companies have reported fourth-quarter earnings for 2024, so the figure shown in the chart is an estimate.

Importantly, investors tend to be forward-looking, so the consensus estimates in the chart have already been priced into the stock market to some degree. If actual earnings growth differs from projected earnings growth, the stock market will respond accordingly.

To elaborate, the median year-end target for the S&P 500 is about 6,600 in 2025. However, if earnings increase more slowly than anticipated, the index could finish the year much lower. And if earnings increase faster than anticipated, the index could finish the year even higher.

The final puzzle piece is valuation. The S&P 500 currently trades at 22 times forward earnings, a premium to the five-year average of 19.8, according to FactSet Research. Excluding the current bull market, the index's forward PE multiple has only hit 22 during two periods in the last four decades: the dot-com bubble in the late 1990s and the Covid-19 pandemic in the early 2020s.

Every stock market decline in history has been a temporary problem

In summary, the S&P 500 has typically followed January gains with above-average returns for the full year. That pattern may repeat itself in 2025. But investors should be cautious in the current environment. Valuations are elevated, so any bad news could derail the stock market.

Fortunately, if the S&P 500 does suffer a correction or bear market this year, the drawdown would undoubtedly be a buying opportunity. Every pullback in history has been temporary, and the S&P 500 has always recouped its losses. There is no reason to expect a different outcome the next time the stock market declines.

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Trevor Jennewine has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends FactSet Research Systems. The Motley Fool recommends CME Group. The Motley Fool has a disclosure policy.