Will the Stock Market Crash or Soar Under President-Elect Donald Trump? Here's What History Shows.

Due to its scope and diversity, the S&P 500 (SNPINDEX: ^GSPC) is considered the best barometer for the entire U.S. stock market. The index advanced 23% in 2024, the second consecutive year in which it gained over 20%, something it last did in 1997 and 1998. Factors contributing to that upside included enthusiasm about artificial intelligence, cooling inflation, and strong economic growth.

However, there is a major inflection point at hand: Donald Trump will be inaugurated as the 47th U.S. president on Jan. 20, and investors are curious about how the stock market will perform during his second stint in the White House. Unfortunately, history offers conflicting insight. The S&P 500 performed well during Trump's first term, but it has usually performed poorly from its current valuation.

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Here is what investors need to know.

Donald Trump speaking with reporters during his first presidency. Image source: Official White House Photo by Andrea Hanks.

The S&P 500 performed very well during Donald Trump's first presidency

Investors should bear in mind that the president controls neither the stock market nor the economy. However, they influence both with the policies they prioritize and the people they nominate to lead government agencies, like the Treasury, the Securities and Exchange Commission (SEC), and the Federal Trade Commission (FTC).

For instance, Donald Trump signed the 2017 Tax Cuts and Jobs Act during his first term as president. That legislation reduced taxes for consumers and businesses, which promoted economic growth. Indeed, the U.S. gross domestic product (GDP) increased by 2.7% annually between 2017 and 2019, growing nearly twice as fast as the average during the previous decade.

Of course, GDP fell sharply in 2020 when the COVID-19 pandemic hit the economy, but the stock market still delivered exceptionally strong returns during Trump's first presidency. In fact, since its creation in 1957, the S&P 500 performed better under Trump than any president except Bill Clinton, as shown in the chart below.

Data source: YCharts, The American Presidency Project. Note: Returns are measured from one Inauguration Day to the next for most presidents. Exceptions include the assassination of John Kennedy and the resignation of Richard Nixon.

Looking ahead, some analysts think the stock market will keep soaring as Trump pushes for deregulation and tax cuts during his second term. For instance, while on the campaign trail, he proposed lowering the corporate tax rate to 15% for domestic manufacturers. That could boost net profit margins and send the stock market higher.

However, Trump also proposed sweeping tariffs across all imported goods, especially those from China, and conducting large-scale deportations of undocumented immigrants. Those policies could worsen inflation, weaken the labor market, and increase the federal debt. That could send the stock market lower.

Importantly, investors should be aware of another problem that goes beyond presidential policy objectives: The S&P 500 currently trades at a historically expensive valuation.

The S&P 500 has historically performed poorly from its current valuation

The S&P 500 currently trades at a forward price-to-earnings (PE) ratio of 21.6. That is a material premium to the five-year average of 19.7 and the 10-year average of 18.2, according to FactSet Research. By comparison, the S&P 500 traded at 17 times forward earnings when Trump first became president in 2017, and the multiple generally stayed below 18 until the COVID-19 pandemic hit the economy.

The current valuation portends weaker returns during Trump's second presidency. In October, chief economist Torsten Slok at Apollo Global Management wrote, "Looking at the historical relationship between the S&P 500 forward PE ratio and subsequent three-year returns in the benchmark index shows that the current forward PE ratio at almost 22 implies a 3% annualized return over the coming three years."

Here is the bottom line: Donald Trump's first presidency was marked by extraordinary stock market returns, but the current valuation implies below-average returns in the coming years. Investors can prepare for either outcome by staying invested while simultaneously building an above-average cash position. That advice leaves room for profit if stocks move higher but also leaves investors with capital to deploy in the event of a stock market correction or bear market.

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Trevor Jennewine has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends FactSet Research Systems. The Motley Fool has a disclosure policy.