Historical patterns indicate potential challenges for the U.S. economy and stock market during Trump’s second term.
For over two years, optimism has dominated Wall Street. As 2022 drew to a close, the renowned Dow Jones Industrial Average (^DJI -0.37%), closely monitored S&P 500 (^GSPC -0.01%), and rapidly evolving Nasdaq Composite (^IXIC 0.41%) have increased in value by 35%, 59%, and 91%, respectively, as of the close on Feb. 13.
Investors have leaned on various catalysts to drive the broader market upward, including the artificial intelligence (AI) boom and enthusiasm surrounding stock splits. However, the recent momentum in Wall Street’s favor is significantly tied to President Donald Trump’s return to the Oval Office.
During Trump’s first term, the Dow Jones, S&P 500, and Nasdaq Composite rose by 57%, 70%, and 142%, respectively. It’s reasonable to assert that Trump’s emphasis on reducing the peak marginal corporate income tax rate and advocating for deregulation has been positively embraced by Wall Street.
Despite investors’ hopes for a repeat of Trump’s successful first term, over a century of historical data hints that the president may face a significant challenge.
President Trump overseeing a ceremony in the White House. Image source: Official White House Photo by Shealah Craighead, courtesy of the National Archives.
Historical Recessions Under Republican Presidents
Since Trump was inaugurated four weeks ago, he has taken charge of a remarkably strong economy. Despite the longest yield-curve inversion on record and the first significant decline in the U.S. M2 money supply since the Great Depression—two traditional indicators that often signal a recession—the U.S. economy has continued to push forward.
While Trump’s ambitious plan to further decrease the corporate income tax for manufacturers based in the U.S. might boost the stock market and the economy, the longstanding correlation between Republican presidents and the onset of recessions cannot be ignored.
Since Woodrow Wilson became president in March 1913, there have been 10 Republican presidents and nine Democrats. Among those nine Democrats, four did not preside over a recession that started during their administration (for example, Barack Obama inherited a recession that initiated under George W. Bush).
In contrast, all 10 Republican presidents experienced an economic downturn during their time in office. Although these recessions aren’t necessarily triggered by Republican policies (e.g., the COVID-19 recession was unrelated to decisions made during Trump’s initial term), this correlation has persisted for over a century.
While the U.S. economy and stock market are not identical, downturns in the economy typically have a negative effect on corporate profits. According to an analysis by Bank of America Global Research covering the period from 1927 to March 2023, around two-thirds of the drawdowns in the S&P 500 from peak to trough occurred after a recession was declared. Thus, a repeat of historical trends during Trump’s second term could be detrimental to stock performance.
Current Valuations in Context
However, the history of GOP presidencies correlating with economic downturns is not the only concerning trend with Trump in office. Upon taking the presidency four weeks ago, he inherited one of the highest-valued stock markets on record.
Most investors use the reputable price-to-earnings (P/E) ratio to assess whether a stock or the broader market is relatively undervalued or overvalued. The P/E ratio is calculated by dividing a company’s share price by its trailing-12-month earnings per share. This approach is effective for established companies, but high-growth stocks and recessions can complicate its usefulness.
S&P 500 Shiller CAPE Ratio data by YCharts.
The Shiller P/E Ratio, also known as the cyclically adjusted P/E ratio (CAPE Ratio), offers a more precise evaluation tool, enabling better long-term comparisons. This metric is based on the average inflation-adjusted earnings of the last 10 years.
As of the closing bell on Feb. 13, the S&P 500’s Shiller P/E stood at 38.54, nearly matching the current bull market’s peak of 38.89. This is over twice the historical average of 17.21 when analyzed back to 1871, and it represents the third-highest reading during a continuous 154-year bull market.
While there are justifications for why investors have continued to accept elevated valuations, such as the emergence of AI and easier access to trading and information, a review of over 150 years of valuation trends indicates that the stock market could be facing challenges ahead.
Historically, there have only been six instances where the S&P 500’s Shiller P/E has exceeded 30, including now, and each of the previous five instances was followed by substantial losses ranging from 20% to 89% for the Dow Jones, S&P 500, and/or Nasdaq Composite.
Image source: Getty Images.
The Value of Time for Investors
The historical data provides a strong argument for anticipating a recession and considerable stock market downturn during Trump’s second term. However, history also shows that its effects can ebb and flow, often unevenly.
Though over a century of data aligns with recessions coinciding with Republican presidencies, it’s crucial to remember that recessions tend to be relatively short. Since September 1945, there have been twelve recessions, averaging approximately 10 months in duration. In contrast, periods of economic growth typically last around five years. Investors betting on economic expansion in the U.S. are likely to reap substantial rewards.
A similar trend can be observed by analyzing the duration of bull and bear markets on Wall Street.
In June 2023, Bespoke Investment Group shared a dataset on X calculating the duration of every bull and bear market for the S&P 500 since the onset of the Great Depression. On average, bear markets lasted 286 calendar days, while bullish rallies typically extended for approximately 1,011 calendar days—3.5 times longer.
It’s official. A new bull market is confirmed.
The S&P 500 is now up 20% from its 10/12/22 closing low. The prior bear market saw the index fall 25.4% over 282 days.
Read more at https://t.co/H4p1RcpfIn. pic.twitter.com/tnRz1wdonp
— Bespoke (@bespokeinvest) June 8, 2023
The irregularity of investment cycles is also evident in annual data released by Crestmont Research.
Crestmont analysts calculated the rolling 20-year total returns (including dividends) for the S&P 500 dating back to 1900. Despite the S&P’s inception in 1923, analysts traced its components in earlier indexes to back-test returns from 1900 to 1923.
The Crestmont dataset yielded 106 rolling 20-year periods ranging from 1919 to 2024. Crucially, every one of these periods generated positive annualized total returns. If an investor had purchased an index tracking the S&P 500 at any time since 1900 and held that investment for 20 years, they would have profited 100% of the time.
While historical trends and correlations can be daunting, history has definitively shown that time is the greatest asset for investors.
