Research from the Federal Reserve Bank of New York finds an ominous correlation between the performance of stocks and the implementation of tariffs during Trump’s first term.
In less than four weeks, President-elect Donald Trump will be sworn in as the 47th president and become only the second U.S. leader to ever serve nonconsecutive terms. However, Wall Street decided to kick off the party a bit early.
Since Election Day, the iconic Dow Jones Industrial Average (^DJI 0.91%), benchmark S&P 500 (^GSPC 1.10%), and growth stock-dependent Nasdaq Composite (^IXIC 1.35%) have all ascended to record-closing highs. This is a continuation of the robust gains Wall Street’s major indexes enjoyed during Trump’s first term. Between Jan. 20, 2017 and Jan. 20, 2021, the Dow Jones, S&P 500, and Nasdaq Composite soared 57%, 70%, and 142%, respectively.
But to quote Wall Street’s favorite warning: “Past performance is no guarantee of future results.”
Although stocks thrived with Trump in the Oval Office, there’s genuine concern that his desire to implement tariffs on Day One could undermine American businesses and cause the stock market to plunge. Based on what history tell us, this isn’t out of the realm of possibilities.
Former President and President-elect Donald Trump giving remarks. Image source: Official White House Photo by Andrea Hanks.
Analysis: Trump’s prior tariffs had a deleterious effect on U.S. equities
Last month, President-elect Trump laid out his plan to impose a 25% tariff on imports from its direct neighbors, Canada and Mexico, as well as 35% tariff on imported goods from China, the world’s No. 2 economy.
The general purpose of tariffs is to make American-made goods more price-competitive with those being brought in from beyond our borders. They’re also designed to encourage multinational businesses to manufacture their goods destined for the U.S. within the confines of our borders.
But according to an analysis from Liberty Street Economics, which publishes research for the Federal Reserve Bank of New York, Trump’s tariffs have previously had a decisively negative impact on U.S. equities exposed to countries where those tariffs were targeted.
The four authors of Do Import Tariffs Protect U.S. Firms? make it a point to distinguish between the impacts of tariffs on outputs versus inputs. An output tariff is an added cost placed on the final price of a good, such as a car imported into the country. Meanwhile, an input tariff would affect the cost of producing a final good (e.g., higher costs on imported steel). The authors note that higher input tariffs make it difficult for U.S. manufacturers to compete on price with foreign businesses.
The authors also examined the stock market returns of all publicly traded U.S. companies on the day Trump announced tariffs in 2018 and 2019. They found a clear negative shift in equity prices on the days tariffs were announced, with this effect being most pronounced on businesses that were exposed to China.
Furthermore, the authors noted a correlation between companies that performed poorly on tariff announcement days and “future real outcomes.” Specifically, these businesses experienced 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 being implemented on Day One of Donald Trump’s second term can be a downside catalyst for the Dow, S&P 500, and Nasdaq Composite.
This may be Wall Street’s bigger concern — and it has nothing to do with President-elect Trump
Unfortunately, history has a bit of a double whammy for investors. While comparing the historic performance of equities on tariff announcement days during Trump’s first term provides a limited data set, one of Wall Street’s top valuation indicators, which can be back-tested 153 years, offers ample reason for concern.
A lot of investors are probably familiar with the price-to-earnings ratio (P/E), which divides a publicly traded company’s share price into its trailing-12-month earnings per share (EPS). The traditional P/E ratio is a fairly effective valuation tool that helps investors determine if a stock is cheap or expensive, relative to its peers and the broad-market indexes.
The downside to the P/E ratio is that can be easily disrupted by shock events. For instance, lockdowns that occurred during the early stages of the COVID-19 pandemic rendered the trailing-12-month EPS relatively useless for most companies for about a year.
This is where the S&P 500’s Shiller P/E Ratio, which is also known as the cyclically adjusted P/E Ratio (CAPE Ratio), can come in handy.
S&P 500 Shiller CAPE Ratio data by YCharts.
The Shiller P/E Ratio is based on average inflation-adjusted EPS from the previous 10 years. Looking at a decade’s worth of inflation-adjusted earnings data makes shock events something of a moot point when assessing the valuation of equities, as a whole.
As of the closing bell on Dec. 20, the S&P 500’s Shiller P/E sat at 37.68, which is more than double its 153-year average of 17.19. But what’s more worrisome is how the stock market has responded following previous instances where the Shiller P/E has topped 30.
Dating back to January 1871, there have only been six instances where the S&P 500’s Shiller P/E crested 30 during a bull market rally, including the present. Each prior occurrence 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 doesn’t give us any clues as to when stock market downturns will begin. Sometimes stocks have extended valuations for a matter of weeks before tumbling, such as the two-month stretch preceding the start of the Great Depression in 1929. Meanwhile, the Shiller P/E topped 30 for four years prior to the dot-com bubble bursting. Nevertheless, this historic valuation metric suggests stocks can plunge — and it would have made no difference which presidential candidate won in November.
Image source: Getty Images.
History also strongly favors long-term investors (regardless of who’s president)
However, history can be a beacon of hope and inspiration, too, depending on your investment horizon.
No matter how much investors would prefer to do away with stock market corrections, bear markets, and crashes, they’re ultimately a normal and inevitable aspect of the investing cycle. But what’s important to note is that the ups and downs associated with investing aren’t linear.
For example, the analysts at Bespoke Investment Group calculated the average calendar-day length of S&P 500 bull and bear markets since the beginning of the Great Depression and discovered night-and-day differences between the two.
On one hand, the 27 S&P 500 bear markets between Sept. 1929 and June 2023 averaged just 286 calendar days (around 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 endured 1,011 calendar days over the 94 years examined. Further, 14 out of 27 bull markets (if you include and extrapolate the current bull market to present day) have stuck around longer than the lengthiest bear market.
^SPX data by YCharts. YCharts S&P 500 return data begins in 1950.
An analysis from Crestmont Research looked back even further on the performance of equities over long periods and came to an even more encouraging conclusion.
Crestmont calculated the rolling 20-year total returns (including dividends) of the S&P 500 since the start of the 20th century. Even though the S&P didn’t officially exist until 1923, researchers were able to track the performance of its components in other indexes to satisfy its back-test to 1900. This 20-year hold timeline produced 105 ending periods (1919 through 2023).
What Crestmont’s annually updated data set shows is that all 105 rolling 20-year periods would have generated a positive total return. Hypothetically speaking, if you had purchased an S&P 500 index fund just prior to the start of the Great Depression in 1929, or before Black Monday in 1987, and held that stake for 20 years, you’d have still made money.
Crestmont Research’s data set also conclusively shows that the stock market can make patient investors richer regardless of which political party is in power. No matter how you arrange the political puzzle pieces, 20-year total returns have always been decisively positive.
