Titled for Today: Will the Stock Market Tumble Under President-Elect Trump? A Peek Into History
November was a bustling month on Wall Street, marking the peak of earnings season for numerous influential American businesses and featuring key economic reports that would shape the Federal Reserve's monetary policy in the upcoming quarters. However, the month was probably most notable for providing an answer to the burning question, "Who will steer America for the next four years?" Shortly following the polls' closure on Election Night, the Associated Press announced former President Donald Trump as the new president-elect.
Trump's first term in the White House saw a considerable surge in the stock market. The Dow Jones Industrial Average, the S&P 500, and the Nasdaq Composite climbed by 57%, 70%, and 142%, respectively. But as Wall Street's favorite disclaimer goes, "Past performance is not an indicator of future results."
Amid the soaring Dow Jones, S&P 500, and Nasdaq Composite since Election Day, there has been an increased discussion regarding the validity of the current bull market rally and if a stock market crash is imminent under President-elect Trump.
Policy uncertainty lingers
As is customary following major elections, there are more questions than answers regarding the policies the new administration will implement and their impact on the U.S. economy and/or stock market. Although having a unified government, with Republicans holding a majority of seats in both houses of Congress, should theoretically aid Trump in passing key legislation, the thin majority in the House leaves plenty of room for doubt.
Trump's primary policy concern revolves around his desire to impose tariffs on imported goods. He recently unveiled a plan to implement 25% tariffs on goods from Canada and Mexico on day one and 35% tariffs on imports from China, the world's second-largest economy by gross domestic product (GDP). The objective of tariffs is to encourage domestic manufacturing and make domestic goods more price-competitive against imports from overseas markets. However, tariffs run the risk of triggering inflation and potentially reigniting stagnation, given the Federal Reserve's current rate-easing cycle.
There's also concern about mounting federal debt. Apart from the exceptions in 1998 through 2001, the federal government has been in the red almost every year since 1970. The escalating debt rate is unsustainable over a long term.
While Republicans have traditionally been advocates for reducing federal spending, Trump's plan also entails reducing corporate and personal income tax rates. Although a lower corporate tax rate would likely boost share repurchase activity, it may exacerbate the federal deficit.
Is a short-term stock market crash a probability?
Instead of dwelling on speculations following every major election cycle, let's examine historical insights regarding the likelihood of a stock market crash with Donald Trump at the helm.
Though no denominator can predict significant short-term movements in the Dow Jones, S&P 500, and Nasdaq Composite with complete accuracy, certain events and data points have exhibited a strong correlation with market swings over history.
Donald Trump is stepping into one of the priciest stock markets ever, posing a significant challenge. The S&P 500's Shiller price-to-earnings (P/E) Ratio, also known as the cyclically adjusted P/E ratio (CAPE Ratio), stood at 38.89 on Dec. 6. This is over two times its average multiple of 17.17 since 1871.
Historically, when stock valuations become inflated, it can lead to a prolonged correction or crash. The current 38.89 reading holds the third-highest CAPE Ratio during a continuous bull market spanning 153 years. The previous record-high was reached during the dot-com bubble and shortly after in 2021/2022.
After the dot-com bubble peak, the S&P 500 and Nasdaq Composite dropped by 49% and 78%, respectively, while the 2022 bear market saw the Dow Jones, S&P 500, and Nasdaq Composite lose over 20% of their respective values.
That being said, history tells us that the market can pivot in either direction. Valuation metrics that suggest trouble on Wall Street under President Trump also highlight the likelihood of a market correction or crash. Historically, short but significant declines can prove advantageous for patient investors.
In light of the inflated stock valuations, with the S&P 500's Shiller P/E Ratio at 38.89, there are concerns about a potential prolonged correction or crash in the market. This valuation is over twice the average multiple of 17.17 since 1871, suggesting a possibility of a correction similar to the 49% drop in the S&P 500 after the dot-com bubble. Meanwhile, in terms of finance and investing, President-elect Trump's proposed policies, such as reducing corporate and personal income tax rates, could have mixed effects on the stock market and the federal deficit.
