The S&P 500 ended 2025 with its third straight year of gains, locking in a bull market that has now lasted 38 months.
Since 1958, when the index took its modern form, the S&P 500 has finished higher in three-quarters of all calendar years. What’s even more surprising is that while it has gained more than 20% in 19 years, it has experienced declines of any size in just 17 years.
These long-term odds are consistent with what investors are seeing now. Earnings forecasts for next year point to double-digit increases, but the Federal Reserve has already cut interest rates by 1.75 percentage points over the past 15 months and is expected to do so again.
This background explains why Wall Street’s forecasts for 2026 are centered around an additional 10%+ advance. Recent trading hasn’t changed that view, with index spending remaining flat within 3% of its all-time high over the past two months.
Wall Street turns bullish as valuations cool
The continued sideways trading served to cool some parts of the market. Some AI-related stocks have lost their inevitability, speculative behavior has eased, and price pressure has eased.
The Nasdaq 100 currently trades at 26 times earnings, a few points below its average over the past two years. The valuation premium to the broader S&P is at its narrowest level in six years.
Although expectations are now higher, optimism remains strong. According to FactSet, 57.5% of analyst ratings for S&P 500 companies are marked “buy,” matching the highest level since February 2022, just before the nine-month bear market.
Bespoke Investment Group noted that the index’s three-year return to its October peak was 87%, ranking it in the top 5% of all periods on record. History shows that profits usually continue after similar runs, but tend to be much weaker than average.
The election cycle is also a factor. Past midterm election years have seen long periods where prices go nowhere, suggesting that 2026 will see slower upside and stalled momentum for several months.
Still, broad trends do not act alone. This year’s 16.2% increase isn’t due to just a handful of names. The equal-weighted S&P 500 index rose 10.7%, but the difference still points to the risk of too little exposure to the largest stocks.
If Nvidia, Alphabet, and Broadcom had ended the year flat, the index’s gain would have been about a third lower.
Defense stocks bring rare high-risk gains
Aside from tech, defense stocks were among the market’s biggest movers. The 24-company S&P 1500 Aerospace & Defense group is on track for its best 41% gain since 2013, supported by commercial aerospace demand.
That return is more than double the S&P 500’s gain and about 16 percentage points higher than the Magnificent Seven, according to CNBC data.
In Europe, weapons manufacturers such as Rheinmetall, Saab and Leonardo rose as governments around the world moved to significantly increase their military budgets.
In the United States, established companies such as RTX and Northrop Grumman posted double-digit profits, helped by enthusiasm for military spending and projects such as the Golden Dome missile defense program.
Investor demand did little to dampen concerns that President Donald Trump’s administration could prompt contractors to buy back stock or cut dividends.
But like Kratos, drone maker AeroVironment issued a subdued outlook for the third quarter, sending its stock price down significantly, with AeroVironment down about 40% from its October high.
Even after the drop, Kratos still trades at nearly 100 times next year’s expected earnings, while Palantir trades at more than 190 times next year’s expected earnings. By comparison, RTX is 27 times more expensive, while Lockheed Martin, known for its C-130 Hercules transport plane, is 16 times more expensive.
