For over two years, the bullish sentiment has dominated Wall Street. Since the end of 2022, the renowned Dow Jones Industrial Average (^DJI -0.37%), the widely tracked S&P 500 (^GSPC -0.01%), and the technology-driven Nasdaq Composite (^IXIC 0.41%) have seen remarkable increases of 35%, 59%, and 91%, respectively, as of the close on February 13.

Investors have capitalized on multiple drivers pushing the broader market upward, including the surge in artificial intelligence (AI) and the enthusiasm surrounding stock splits. However, recent bullish momentum on Wall Street has been significantly influenced by President Trump’s return to power.

During his first tenure, the Dow, S&P 500, and Nasdaq Composite skyrocketed, achieving gains of 57%, 70%, and 142%, respectively. Trump’s commitment to reducing corporate income tax rates and advocating for deregulation has been positively perceived on Wall Street.

Despite investor hopes for a similar performance during Trump’s second term, over a century’s worth of historical data hints at a potential downturn.

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 in 112 Years Has Experienced a Recession

Upon Trump’s recent inauguration, he assumed control of a remarkably robust economy. Even in the face of the longest yield-curve inversion on record and the first significant decline in the U.S. M2 money supply since the Great Depression—two classic predictors of economic downturns—the U.S. economy has maintained its momentum.

While Trump’s aggressive proposal to cut corporate income taxes for domestically produced goods may boost the stock market and the economy, it’s crucial to acknowledge the persistent link between recessions and Republican administrations.

Since Woodrow Wilson’s presidency began in March 1913, the U.S. has seen ten Republican presidents and nine Democratic leaders. Among the Democrats, only four did not preside over a recession during their time in office, many of which were inherited (e.g., Barack Obama faced a recession started under George W. Bush).

Conversely, every Republican president has encountered an economic downturn during their tenure. Though these recessions may not directly stem from GOP policies (for example, the COVID-19 recession was unrelated to Trump’s first term), this historical correlation spans more than a century.

While the outcomes of the U.S. economy and stock market aren’t always aligned, a downturn typically leads to decreased corporate profits. Data from Bank of America Global Research spanning 1927 to March 2023 indicates that nearly two-thirds of significant declines in the S&P 500 occurred after a recession was declared. In summary, if history repeats itself during Trump’s second term, the stock market may face significant challenges.

The Current Stock Market Valuation Is Historically High

Moreover, the association between GOP leadership and economic recessions isn’t the only worrying trend for Trump’s presidency. Upon taking office, he also inherited one of the most expensive stock markets in history.

Many investors turn to the historical price-to-earnings (P/E) ratio to gauge whether stocks or the overall market are overvalued or undervalued. This ratio is calculated by dividing a company’s share price by its earnings per share over the previous twelve months. While effective for evaluating established companies, it can be less reliable for high-growth stocks and during recessions.

S&P 500 Shiller CAPE Ratio data provided by YCharts.

The S&P 500 Shiller P/E Ratio, also known as the cyclically adjusted P/E Ratio, is often considered a more reliable valuation metric, allowing for meaningful comparisons across extended periods. This ratio accounts for average inflation-adjusted earnings over the past ten years.

As of February 13, the Shiller P/E for the S&P 500 reached 38.54, close to the peak of 38.89 seen during the current bull market. This figure is more than double the long-term average of 17.21 since 1871 and ranks as the third-highest during a continuous bull market spanning 154 years.

Though several factors have contributed to investors’ willingness to accept elevated valuations, including advancements in AI and improved access to information and trading, over a century and a half of data suggests potential trouble ahead for the stock market.

The Shiller P/E has surpassed 30 only six times in history, including the current moment. Previous instances led to significant declines of 20% to 89% in the Dow, S&P 500, and/or Nasdaq Composite.

Image source: Getty Images.

Time: Investors’ Most Valuable Asset

Considering historical patterns, there is a strong potential for both a recession and considerable stock market decline during Trump’s second term. Fortunately, history tends to fluctuate like a pendulum, often in unexpected ways.

Despite the evident correlation between Republican presidencies and recession occurrences, it’s essential to remember that downturns are typically short-lived. Since World War II ended in September 1945, there have been twelve recessions, each lasting an average of only ten months. In contrast, periods of economic growth tend to last roughly five years. Investors who focus on long-term economic expansion should ultimately reap substantial rewards.

This phenomenon can also be observed when analyzing the duration of bull and bear markets on Wall Street.

In June 2023, Bespoke Investment Group released a comprehensive dataset tracking the duration of bull and bear markets for the S&P 500 since the Great Depression. The findings revealed that average bear markets last about 286 calendar days, while a typical bull market persists for 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 variability of investment cycles is further highlighted by a dataset updated annually by Crestmont Research. Their analysis tracks the rolling 20-year total returns (including dividends) of the S&P 500 dating back to 1900. Although the S&P didn’t officially launch until 1923, researchers were able to leverage historical index data to compute returns from 1900 onwards.

The results showed 106 rolling 20-year periods from 1919 to 2024, with a significant finding: all 106 periods resulted in positive annualized returns. Hypothetically, if an investor had purchased an S&P 500 index at any time since 1900 and held on for 20 years, they would have seen profits every time.

While historical trends and correlations may appear daunting, history has clearly demonstrated that time serves as investors’ most formidable ally.