The Stock Market Is Doing Something It Last Did in 2016. It May Signal a Big Move in 2025 (and Beyond).

The S&P 500 (SNPINDEX: ^GSPC) has soared through more than four dozen record highs, advancing 28% year to date. Factors contributing to that upside include strong consumer spending, cooling inflation, excitement about artificial intelligence (AI), and expectations that interest-rate cuts will keep the economy in growth mode.

Additionally, the stock market is reacting to the recent election of Republican presidential nominee Donald Trump, something it last did in 2016. Trump won a decisive victory in November over Democratic contender Kamala Harris, unleashing what some analysts have called "animal spirits" on Wall Street.

This term, coined by economist John Maynard Keynes, refers to decision-making driven by emotion instead of logic. It's OK for investors to follow their animal spirits to some degree, but doing so blindly leads to inflated expectations and dangerous overconfidence. While history says the S&P 500 may soar with Trump in the White House, there's a big asterisk by that statement. Read on to learn more.

History says the stock market could soar under President-elect Donald Trump

The S&P 500 tracks the performance of 500 large-cap stocks. Its constituent companies cover approximately 80% of domestic equities by market value and come from all 11 stock market sectors. For those reasons, the S&P 500 is generally viewed as the best barometer for the overall U.S. stock market.

The chart below shows the S&P 500's compound annual growth rate (CAGR) under each Republican president since the index was created in 1957. It also shows the average CAGR across all Republican presidencies in that period.

Data source: YCharts, The American Presidency Project. Chart by author. Note: Returns are measured from one Inauguration Day (typically Jan. 20) to the next and are rounded to the nearest percentage point.

As shown above, the S&P 500 returned 14% annually when Donald Trump was president between 2017 and 2021, which is equivalent to a 70% gain during the four-year period when he held office. That is significantly higher than the average CAGR of 6% across all Republican presidencies.

Additionally, another data point suggests the stock market could perform well next year. Analysts expect S&P 500 companies, in aggregate, to report earnings growth of 15% in 2025, an acceleration from 9.4% in 2024. That would be the fastest growth rate since 2021 and the third-fastest growth in the last decade.

Beyond 2025, corporate tax cuts could theoretically translate into robust earnings growth. Specifically, Trump has suggested lowering the corporate tax rate to 15% for at least some companies (i.e., those that make products domestically), and a smaller tax bill means companies should see more revenue hit the bottom line of the income statement.

Additionally, Ed Yardeni and Eric Wallerstein at Yardeni Research believe the looser regulatory environment and potential tax cuts under Trump may "boost investment and propel productivity-led economic growth." That led Yardeni to raise its year-end targets for the S&P 500 to 7,000 by 2025 and 8,000 by 2026. Those forecasts imply upside of 16% over the next year and 32% over the next two years.

Of course, past performance is never a guarantee of future results, and there's a potential catch to everything I just said. Yes, the stock market performed extraordinarily well the last time Donald Trump was president, but valuations were also much more reasonable when his first term as president started.

Image source: Getty Images.

Why the stock market may not perform as well during Trump's second term

The S&P 500 had a price-to-earnings ratio (P/E) of 23.5 when Trump became president in 2017, and the P/E multiple generally stayed below 24 until the Covid-19 pandemic. At that point, the market initially plunged but quickly recovered as the government pumped stimulus into the economy. And valuations became detached from business fundamentals as investors followed their animal spirits.

In fact, the S&P 500 traded near 40 times earnings when Trump left office in 2021. That multiple expansion was a major factor in why the stock market performed so well during his first presidency -- and therein lies the catch. Trump will inherit a much more expensive stock market this time around. The S&P 500 currently trades at 28 times earnings, a premium to the five-year average of 24 times earnings.

Here's the bottom line: The stock market was basically running downhill during Trump's first term because valuations moved from reasonable to expensive. But the stock market will be running uphill during his second term. Investors shouldn't assume the bull market will carry on uninterrupted over the next four years.

Moreover, while presidents can influence the stock market and economy with appointments and budget priorities, no single person controls either one. Macroeconomic conditions, corporate financial results, and valuations are the more important variables. Considering that valuations are currently stretched, investors should err on the side of caution when making decisions.

That may lead to FOMO (fear of missing out) in the near term, but limiting how much we listen to those animal spirits could prevent catastrophic losses in the long run.

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Trevor Jennewine has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.