Historic correlations indicate potential challenges for the U.S. economy and stock market during Trump’s second term.
For over two years, optimistic sentiment has dominated Wall Street. As 2022 concluded, the well-known Dow Jones Industrial Average (^DJI -0.37%), the widely regarded S&P 500 (^GSPC -0.01%), and the Nasdaq Composite (^IXIC 0.41%) have seen increases of 35%, 59%, and 91%, respectively, as of February 13 closing.
Investors have leaned on a variety of factors to boost the broader market, including the excitement surrounding the artificial intelligence (AI) boom and stock splits. However, recent momentum on Wall Street can largely be attributed to President Donald Trump’s return to office.
During his initial term, the Dow Jones, S&P 500, and Nasdaq Composite surged by 57%, 70%, and 142%, respectively. Many on Wall Street view Trump’s emphasis on reducing the peak marginal corporate income tax and advocating for deregulation as favorable.
While investors hope for a repeat of Trump’s first term’s success, over a century’s worth of data indicates that the president may be heading into historically challenging territory.
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 over the past 112 years has faced a recession
Upon Trump’s inauguration four weeks ago, he was met with a remarkably resilient economy. Despite enduring the longest yield-curve inversion in history and the first substantial drop in the U.S. M2 money supply since the Great Depression—two key indicators usually foreshadowing a recession—the U.S. economy has remained operational.
While Trump’s ambitious proposals to lower the corporate income tax for domestically manufacturing businesses may benefit the stock market and U.S. economy, the historical link between Republican presidencies and recessions is notable.
Since Woodrow Wilson’s presidency began in March 1913, there have been ten Republican presidents alongside nine Democratic presidents. Out of these nine Democrats, four did not preside over a recession that began during their time in office (e.g., Barack Obama inherited a recession initiated under George W. Bush).
In contrast, all ten Republican presidents have experienced an economic recession during their tenure. While not all recessions are directly related to GOP policies (e.g., the COVID-19 recession did not stem from actions taken during Trump’s first term), this historic correlation is quite remarkable.
Although the U.S. economy and stock market do not mirror each other perfectly, weakness in the economy typically impacts corporate earnings negatively. According to an analysis by Bank of America Global Research from 1927 to March 2023, roughly two-thirds of drawdowns from peak to trough in the S&P 500 occurred after a recession was declared. In other words, if historical patterns repeat during Trump’s second term, stocks could face significant challenges.
The stock market is historically expensive, based on 154 years of analysis
However, the relationship between GOP presidencies and recessions is not the only concerning correlation as Trump resumes office. He has stepped into one of the most expensive stock markets in history.
Most investors utilize the traditional price-to-earnings (P/E) ratio to gauge the relative cheapness or expensiveness of stocks and the broader market. The P/E ratio calculates by dividing a company’s share price by its earnings per share over the previous twelve months. This approach is effective for established companies, though high-growth stocks and economic recessions can complicate its usefulness.
S&P 500 Shiller CAPE Ratio data by YCharts.
The Shiller P/E Ratio, or cyclically adjusted P/E Ratio (CAPE Ratio), is considered a superior valuation tool, allowing for long-term apples-to-apples comparisons. It is based on average inflation-adjusted earnings from the last decade.
As of the closing bell on February 13, the Shiller P/E of the S&P 500 was 38.54, nearing the closing high of 38.89 in this ongoing bull market. This is more than double the historical average of 17.21, dating back to 1871, and represents the third-highest level observed during a continuous 154-year bull market.
While investors have their reasons for accepting high valuations, such as the rapid advancement of AI and the ease of online trading, over a century and a half of valuation data indicates that the stock market may be at risk.
Historically, there have only been six occasions where the S&P 500’s Shiller P/E has exceeded 30, including the current situation, and all five previous instances were followed by significant losses ranging from 20% to 89% for the Dow Jones, S&P 500, and/or Nasdaq Composite.
Image source: Getty Images.
Time is the strongest ally for investors
The historical narrative indicates a significant likelihood of a recession and considerable declines in the stock market during Trump’s second term. Fortunately, history operates as a pendulum that can swing in both directions—often with disproportionate effects.
Despite the correlation between Republican presidencies and recessions over the last 112 years, it’s worth noting that recessions are historically brief. Since the conclusion of World War II in September 1945, there have been twelve recessions averaging around 10 months in duration, while economic expansions typically last about five years. Investors betting on U.S. economic growth could reap substantial rewards.
A similar pattern holds for bull and bear markets on Wall Street.
In June 2023, Bespoke Investment Group released a dataset on X tracking every bull and bear market’s calendar-day durations for the S&P 500 since the Great Depression. It found that bear markets generally resolve in an average of 286 calendar days, whereas bull markets tend to persist about 3.5 times longer (approximately 1,011 calendar days).
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 non-linear nature of investment cycles is also highlighted in a dataset by Crestmont Research.
Crestmont analyzed rolling 20-year total returns (inclusive of dividends) for the S&P 500, dating back to 1900. Although the index itself didn’t exist until 1923, its components were traced in earlier indexes to provide back-tested total return data from 1900 to 1923.
This research resulted in 106 rolling 20-year periods, spanning from 1919 to 2024. Notably, all 106 intervals produced a positive annualized total return. If an investor had purchased an index tracking the S&P 500 at any moment since 1900 and held that investment for 20 years, they would have profited in every case.
Even though historical precedents and correlations can evoke concern, history emphatically underscores that time serves as investors’ most reliable ally.
