For more than two years, optimists have firmly held the reins on Wall Street. Since 2022 came to a close, the iconic Dow Jones Industrial Average (^DJI 1.61%), widely followed S&P 500 (^GSPC 0.56%), and innovation-propelled Nasdaq Composite (^IXIC 0.26%) have respectively increased in value by 35%, 59%, and 91%, as of the closing bell on Feb. 13.
Investors have relied on a laundry list of catalysts to send the broader market higher, such as the artificial intelligence (AI) revolution and excitement surrounding stock splits. But the wind in Wall Street's sails in recent months has to do with President Donald Trump's return to the White House.
During Trump's first term in office, the Dow Jones, S&P 500, and Nasdaq Composite catapulted higher by 57%, 70%, and 142%, respectively. It's fair to say that Trump's focus on lowering the peak marginal corporate income tax rate and promoting deregulation are being viewed favorably by Wall Street.
But while investors are eager for a repeat performance of Trump's first term in office, more than a century of data suggests the president is on a collision course with history.
President Trump overseeing a ceremony in the White House. Image source: Official White House Photo by Shealah Craighead, courtesy of the National Archives.
Every Republican president for 112 years has overseen a recession
When Trump was inaugurated four weeks ago, he took over an incredibly resilient economy. Despite the longest yield-curve inversion in history and the first meaningful decline in U.S. M2 money supply since the Great Depression -- two indicators that would typically foreshadow a recession -- the U.S. economy has continued to chug along.
Although Trump's sweeping proposal to further reduce the corporate income tax for businesses manufacturing their goods domestically may be a positive for the stock market and U.S. economy, it's hard to overlook the correlation between recessions and Republican presidents.
Since Woodrow Wilson became president in March 1913, there have been 10 Republicans in the Oval Office and nine Democratic presidents. Out of these nine Democrats, four didn't oversee a recession that began during their stint in the White House (e.g., Barack Obama inherited a recession that began under George W. Bush).
In comparison, all 10 Republican presidents had an economic recession occur during their tenure. While these recessions aren't necessarily tied to GOP policy proposals (e.g., the COVID-19 recession had nothing to do with policies during Trump's first term in office), this correlation is more than a century old.
Though the U.S. economy and stock market aren't mirror images of each other, weakness in the U.S. economy would be expected to adversely impact corporate earnings. Based on an analysis from Bank of America Global Research from 1927 through March 2023, approximately two-thirds of the peak-to-trough drawdowns in the benchmark S&P 500 occurred after a recession was declared. In other words, history repeating itself during Trump's second term would spell trouble for stocks.
The stock market is historically pricey, based on 154 years of data
However, GOP presidencies and U.S. recessions going hand in hand isn't the only correlation that's worrisome under Trump. When he took office four weeks ago, he inherited one of the priciest stock markets in history.
Most investors tend to rely on the time-tested price-to-earnings (P/E) ratio to determine if a stock or the broader market are relatively cheap or pricey. The P/E ratio is arrived at by dividing a company's share price into its trailing-12-month earnings per share. This method works great for mature businesses, but high-growth stocks and recessions can make it less useful.
S&P 500 Shiller CAPE Ratio data by YCharts.
The S&P 500's Shiller P/E Ratio, which is also known as the cyclically adjusted P/E Ratio, or CAPE Ratio, is arguably a much better valuation tool and is capable of providing apples-to-apples comparisons over long periods. The Shiller P/E is based on average inflation-adjusted earnings over the last 10 years.
As of the closing bell on Feb. 13, the S&P 500's Shiller P/E stood at 38.54, which is just shy of the closing high of 38.89 during the current bull market. This is more than double the average reading of 17.21, when back-tested to the start of 1871, and the third-highest reading during a continuous bull market spanning 154 years.
While there are reasons investors have been willing to tolerate premium valuations, such as the rise of AI and ease of access to information and online trading, more than 150 years of valuation data suggests the stock market is in trouble.
There have only been six instances where the S&P 500's Shiller P/E has surpassed 30 throughout history, including the present, and the previous five were eventually followed by steep losses of 20% to 89% for the Dow Jones, S&P 500, and/or Nasdaq Composite.
Image source: Getty Images.
Time is the greatest ally investors have
Based on the clear picture history paints, there's a strong likelihood of a recession and sizable stock market decline during Trump's second term. Thankfully, history is a pendulum that swings in both directions -- and often disproportionately.
Even though 112 years of data strongly correlates to recessions occurring during GOP presidencies, it's important to note that recessions are historically short-lived. Since the end of World War II in September 1945, there have been a dozen recessions, which have lasted an average of 10 months. On the other end of the spectrum, periods of economic expansion have endured for roughly five years. Investors who wager on the U.S. economy to expand should be handsomely rewarded.
It's a similar story when examining the length of bull and bear markets on Wall Street.
In June 2023, Bespoke Investment Group published a dataset on X that calculated the calendar-day length of every bull and bear market for the benchmark S&P 500, dating back to the start of the Great Depression. Whereas the average bear market resolved in 286 calendar days, the typical bull market rally stuck around for 3.5 times as long (1,011 calendar days).
It's official. A new bull market is confirmed.
-- Bespoke (@bespokeinvest) June 8, 2023
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
The nonlinearity of investing cycles is even more apparent in a dataset updated annually by Crestmont Research.
The analysts at Crestmont calculated the rolling 20-year total returns (including dividends paid) for the S&P 500 dating back to 1900. Even though the S&P didn't exist until 1923, analysts were able to locate its components in other indexes to back-test total return data from 1900 to 1923.
Crestmont's dataset resulted in 106 rolling 20-year periods, with ending years ranging from 1919 to 2024. Most importantly, all 106 time frames generated a positive annualized total return. If an investor had, hypothetically, purchased an index that tracked the S&P 500 at any point since 1900 and simply held that position for 20 years, they would have made money 100% of the time.
Although historic precedent and correlations can sometimes be scary, history has conclusively shown that time is investors' greatest ally.
