November was a busy month for Wall Street. It represented the heart of earnings season for many of the most-influential businesses in America, and featured key economic reports that’ll shape the Fed’s monetary policy in the coming quarters.
But perhaps most importantly, November provided resolution to the all-important question of, “Who will lead America forward over the next four years?” Shortly after the polls closed on Election Night, the Associated Press declared former President Donald Trump as the new president-elect.
The stock market soared during Trump’s first term in the White House, with the mature stock-powered Dow Jones Industrial Average (^DJI -0.22%), broad-based S&P 500 (^GSPC 0.82%), and innovation-driven Nasdaq Composite (^IXIC 1.77%) respectively rising by 57%, 70%, and 142%.
Former President and President-elect Donald Trump giving remarks. Image source: Official White House Photo by Andrea Hanks.
But to quote Wall Street’s favorite disclaimer: “Past performance is no guarantee of future results.”
With the Dow Jones, S&P 500, and Nasdaq Composite soaring to uncharted territory since Election Day, it’s raising questions about the validity of the current bull market rally and whether a stock market crash awaits President-elect Trump.
Policy concerns persist
As is the case following every major election, there are more questions than answers when it comes to what policies the Trump administration will be able to put into action, as well as what impact those policies might have on the U.S. economy and/or stock market. While having a unified government — Republicans hold a majority of seats in both houses of Congress — should, on paper, help Trump pass key pieces of legislation, the GOP majority in the House is narrow enough that this is far from a guarantee.
Perhaps the biggest policy concern pertains to President-elect Trump’s desire to impose tariffs on goods imported into the U.S. He recently laid out a plan to implement 25% import tariffs on goods from Canada and Mexico on Day One, as well as 35% on imports from China, the world’s No. 2 economy by gross domestic product (GDP).
The purpose of tariffs is to encourage domestic manufacturing and to make homemade goods more price-competitive with those brought in from overseas markets. But tariffs run the risk of increasing prices for businesses and consumers and reigniting the prevailing rate of inflation. With the nation’s central bank currently in a rate-easing cycle, this could position the U.S. economy for a period of stagflation if the prevailing inflation rate were to meaningfully pick back up.
US Public Debt data by YCharts.
There’s also some level of worry about national debt. With the exception of 1998 through 2001, the federal government has spent more than it’s brought in every year since 1970. The pace at which national debt is climbing isn’t sustainable over the long run.
While Republicans have traditionally looked for ways to reduce federal spending, Trump’s plan also aims to reduce corporate and/or personal income tax rates. Though an even lower corporate income tax rate would likely spur share repurchase activity, it runs the risk of further widening the federal deficit.
A short-lived stock market crash is a possibility, according to history
But rather than focusing on the “what-ifs?” that follow every major election cycle, let’s take a closer look at what history has to tell us about the probability of a stock market crash taking shape during Trump’s second term.
Although there’s no definitive metric or forecasting tool that can predict sizable short-term moves in the Dow, S&P 500, and Nasdaq Composite with 100% accuracy, there are a number of correlative events and data points that have very strongly correlated with big moves higher or lower in the broader market throughout history. A few of these metrics suggest that a short-lived stock market crash is possible with Donald Trump at the helm.
Before proceeding any further, let me make clear that these forecasts have nothing to do with Trump or his having won the November election. If Democratic Party presidential nominee Kamala Harris had won, we’d be having the exact same discussion with the same historic data points and parameters.
With the above being said, Donald Trump is inheriting one of the priciest stock markets in history — and that’s a big problem.
S&P 500 Shiller CAPE Ratio data by YCharts.
When the closing bell tolled on Dec. 6, the S&P 500’s Shiller price-to-earnings (P/E) Ratio, which is also known as the cyclically adjusted P/E ratio (CAPE Ratio), sat at 38.89. This is more than double its average multiple of 17.17 dating back to the start of 1871.
However, the bigger concern is what’s happened previously when stock valuations become extended to the upside. The 38.89 reading is the third-highest during a continuous bull market spanning 153 years. The only two times Wall Street has been pricier — prior to the dot-com bubble (Shiller P/E of 44.19 in December 1999) and in late 2021/early 2022 (the Shiller P/E briefly topped 40) — led to eye-popping declines in the major indexes.
After the dot-com bubble peak, the S&P 500 and Nasdaq Composite gave back 49% and 78% of their respective value. Meanwhile, the 2022 bear market shaved more than 20% off the Dow Jones, S&P 500, and Nasdaq Composite at their respective troughs.
The so-called “Buffett Indicator,” named for Warren Buffett’s then-favorite valuation tool in 2001, is also at an all-time high. This valuation measure divides the cumulative market cap of public companies into U.S. GDP. Since 1970, the Buffett Indicator has averaged a ratio of 85% — i.e., the aggregate value of public companies equals about 85% the value of U.S. GDP. Last week, the Buffett Indicator topped 208%.
By historic measures, the stock market looks to be headed for a short but sizable correction, if not crash, at some point in the not-too-distant future.
Image source: Getty Images.
History favors patient investors and unified Republican governments
But the great thing about history is that the pendulum swings in both directions. Even though select valuation metrics foreshadow trouble for Wall Street and suggest Trump will oversee a sizable decline in the Dow, S&P 500, and Nasdaq Composite while in office, a wider-lens view tells a completely different story.
In June 2023, the analysts at Bespoke Investment Group posted a data set on social media platform X that examined that average length of every bear and bull market in the S&P 500 dating back to the start of the Great Depression in September 1929. All told, there have been 27 separate bear and bull markets spanning 94 years (through June 2023).
Bespoke’s data set shows the average S&P 500 bear market lingers for only 286 calendar days, or roughly 9.5 months. Further, seven out of 27 bear markets hit their respective nadirs in 101 or fewer days.
By comparison, the typical S&P 500 bull market has endured for 1,011 calendar days, which is approximately 3.5 times longer than the average S&P 500 bear market. Additionally, more than half (14 out of 27) of the bull markets have stuck around longer than the lengthiest bear market (630 calendar days). Simply being patient has allowed investors to grow their wealth on Wall Street over time.
To add, Wall Street has historically done very well when Republicans control the White House and both houses of Congress. From 1926 through 2023, there have been 13 years with a unified Republican government, and the S&P 500 has averaged a hearty 14.52% annual return in those years, based on data from Retirement Researcher.
To be fair, the stock market does well no matter how you arrange the political puzzle pieces, with positive average annual returns in every scenario. But with the exception of a Democratic president and divided Congress, a unified Republican government has delivered the highest average annual returns spanning almost a century.
Even if a short-lived crash occurs during President-elect Trump’s second term, history suggests it’ll mark a phenomenal opportunity for patient investors.
Sean Williams has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
