Since election day, iconic Dow Jones Industrial Average(DJI: ^DJI)standard Standard & Poor’s 500(SNPINDEX: ^GSPC)Growth depends on inventory Nasdaq Composite(NASDAQ: ^IXIC) All rose to record highs. This is a continuation of the strong gains that Wall Street’s major indexes enjoyed during Trump’s first term. Between January 20, 2017 and January 20, 2021, the Dow Jones, S&P 500, and Nasdaq Composite indexes rose 57%, 70%, and 142%, respectively.
But to quote Wall Street’s favorite caveat: “Past performance is no guarantee of future results.”
Although stocks are booming with Trump in the Oval Office, there is real concern that his desire to implement tariffs on day one could undermine American companies and send the stock market lower. Based on what history tells us, this is not outside the realm of possibility.
Former President and President-elect Donald Trump makes statements. Image source: Official White House photo by Andrea Hanks.
Last month, President-elect Trump laid out his plan to impose a 25% tariff on imports from its immediate neighbors, Canada and Mexico, in addition to a 35% tariff on goods imported from China, the world’s second-largest economy.
The general purpose of tariffs is to make American-made goods more price competitive with those brought in from outside our borders. It is also designed to encourage multinational companies to manufacture their goods destined for the United States within our borders.
But according to an analysis by Liberty Street Economics, which publishes research for the Federal Reserve Bank of New York, Trump’s tariffs have previously had a decisive negative impact on U.S. stocks exposed to countries where they were targeted.
The four authors L Do import tariffs protect American companies? Make it a point to distinguish between the effects of tariffs on outputs versus inputs. An excise tariff is an additional cost placed on the final price of a good, such as a car imported into the country. At the same time, the input tariff would affect the cost of producing the final good (for example, higher costs of imported steel). The authors point out that high input tariffs make it difficult for American manufacturers to compete on prices with foreign companies.
The authors also examined the stock market returns of all publicly traded US companies on the day Trump announced the tariffs in 2018 and 2019. They found a clear negative shift in stock prices on the days when tariffs were announced, and this effect was most pronounced for companies with exposure to China.
Furthermore, the authors note a relationship between companies that performed poorly on the days of the tariff announcement and “future real outcomes.” Specifically, these companies saw declines in profits, employment, sales, and labor productivity from 2019 through 2021, based on the authors’ calculations.
In other words, history would suggest that tariffs implemented on the first day of Donald Trump’s second term could be a negative catalyst for the Dow. Standard & Poor’s 500and Nasdaq Composite.
Unfortunately, history has something of a double whammy for investors. While comparing the historical performance of stocks on the days of tariff announcements during Trump’s first term provides a limited set of data, one of Wall Street’s most important valuation indicators, which can be tested over 153 years, provides ample reason for concern.
Many investors are probably familiar with the price-to-earnings (P/E) ratio, which divides a publicly traded company’s stock price into its 12-month earnings per share (EPS). The traditional P/E ratio is a fairly effective evaluation tool that helps investors determine whether a stock is cheap or expensive, compared to its peers and broad market indices.
The downside of the P/E ratio is that it can be easily disrupted by shocking events. For example, the lockdowns that occurred during the early stages of the COVID-19 pandemic made trailing 12-month EPS relatively useless for most companies for about a year.
This is where the S&P 500’s P/E ratio, also known as the cyclically adjusted P/E ratio (CAPE ratio), can come in handy.
Shiller’s P/E ratio is based on average inflation-adjusted earnings per share from the past 10 years. Looking at inflation-adjusted earnings data over a decade makes shock events a moot point when assessing the valuation of stocks as a whole.
As of the closing bell on Dec. 20, the S&P 500’s P/E was 37.68, more than double its 153-year average of 17.19. But what’s even more troubling is how the stock market has responded following previous instances of the Shiller P/E exceeding the 30 level.
Dating back to January 1871, there have only been six instances in which the S&P 500’s P/E reached 30 during a bull market rally, including the present. Each previous event was eventually followed by a 20% to 89% decline in the S&P 500, Dow Jones Industrial Average, and/or Nasdaq Composite.
To be clear, the Shiller P/E does not give us any clues about when a stock market downturn will begin. Sometimes stocks extended their valuations for weeks before falling, such as the two-month period before the start of the Great Depression in 1929. Meanwhile, the Shiller P/E exceeded 30 for four years before the dot-com bubble burst. . However, this historical valuation measure suggests stocks could fall — and it wouldn’t have made any difference which presidential candidate won in November.
Image source: Getty Images.
However, history can be a beacon of hope and inspiration as well, depending on your investment horizon.
No matter how much investors would love to ride out stock market corrections, bear markets, and crashes, they are ultimately a natural and inevitable aspect of the investing cycle. But what is important to note is that the ups and downs associated with investing are not linear.
For example, analysts at Bespoke Investment Group calculated the average calendar day length of bull and bear markets for the S&P 500 since the beginning of the Great Depression and discovered day-night differences between the two.
For one thing, the S&P 500’s 27 bear markets between September 1929 and June 2023 averaged just 286 calendar days (about 9.5 months), with the longest bear market clocking in at 630 calendar days. On the other side of the coin, the typical S&P 500 bull market lasted for 1,011 calendar days over the 94 years examined. Moreover, 14 out of 27 bull markets (if you include and extrapolate the current bull market to present day) have been stuck longer than the longest bear market.
^ SPX Data by YCharts. YCharts S&P 500 return data begins in 1950.
An analysis by Crestmont Research looked further into stock performance over long periods and came to a more encouraging conclusion.
Crestmont calculated the rolling 20-year total returns (including dividends) of the S&P 500 Index since the beginning of the 20th century. Although the S&P did not officially exist until 1923, researchers have been able to track the performance of its components in other indices to meet its backtest until 1900. This 20-year contract timeline has produced 105 final periods (from 1919 To 2023).
What the annually updated Crestmont data set shows is that all 105 periods spanning 20 years would have generated a positive total return. In theory, if you had bought an S&P 500 index fund before the start of the Great Depression in 1929, or before Black Monday in 1987, and held that stake for 20 years, you would still make money.
Crestmont Research’s data set also shows conclusively that the stock market can make patient investors richer no matter which political party is in power. No matter how the pieces of the political puzzle are arranged, total returns over twenty years have always been decisively positive.
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