The Dow Jones Industrial Average, S&P 500 and Nasdaq Composite soared during Donald Trump’s first term and are doing well again in the first year of his second term.
Numerous historical correlations point to a greater likelihood of volatility in the stock market in the new year.
However, stock market cycles are not linear, which is a powerful realization for long-term investors.
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Stocks soared during President Donald Trump’s first term in the White House. When he leaves office, mature stock drivers Dow Jones Industrial Average(DJINDICES: ^DJI)benchmark S&P 500 Index(SNPINDEX:^GSPC)and driven by innovation Nasdaq Composite Index(NASDAQ: ^IXIC) Soared 57%, 70% and 142% respectively.
In the first 11 months and transition of Trump’s second term as president, he once again performed well. As of the close on December 29, the Dow Jones, S&P 500 and Nasdaq Composite were up 14%, 17% and 22% respectively so far this year.
President Trump delivers the State of the Union address. Image source: Official White House photo.
While history is clear that the stock market’s major indexes increase in value over decades, getting from point A to point B is never a straight line. As we turn the page in the new year, Wall Street and investors face a host of possibilities — one of which is the possibility of a stock market crash under President Trump.
The first historical headwind has nothing to do with Donald Trump or his policies. Instead, it’s about entering 2026 with the second-highest stock market valuation in history, dating back to January 1871.
While valuation is a subjective term, the S&P 500’s Shiller price-to-earnings ratio (P/E) leaves no doubt as to how much a stock is worth. The Shiller P/E ratio is also commonly known as the cyclically adjusted P/E ratio or CAPE ratio.
The S&P 500’s Shiller P/E ratio, based on average inflation-adjusted earnings over the past 10 years, has averaged about 17.3 going back to 1871. As of the close on December 29, Shiller’s price-to-earnings ratio was 40.59. The only consecutive bull market price rally was in the months before the dot-com bubble burst, when the Shiller P/E ratio peaked at 44.19.
S&P 500 Shiller CAPE Ratio data provided by YCharts.
While the Shiller P/E ratio isn’t helpful in predicting when a stock market correction, bear market, or crash might occur, it does have a perfect track record so far of predicting sharp declines in Wall Street’s benchmarks.
In 155 years, the Shiller P/E ratio has exceeded 30 six times, including this time. The first five events all resulted in declines of 20% to 89% for the Dow Jones Industrial Average, S&P 500 and/or Nasdaq Composite. While a Great Depression-style 89% drop in the Dow is unlikely in the modern era, we did witness peak-to-trough declines of 49% for the S&P 500 and 78% for the Nasdaq after the dot-com bubble burst.
Historically expensive stocks increase the likelihood of a 2026 stock market crash under President Donald Trump.
However, there’s more to this story than just why the stock market is historically expensive. Some historical correlations and precedents suggest that 2026 could be a challenging year for stocks.
First, stock market volatility typically intensifies during midterm election years. The S&P 500’s peak-to-trough decline over the medium term has ranged from 4.4% to 37.6%, averaging 17.5% since 1950, according to data compiled by Ryan Detrick, chief market strategist at Carson Group. The 17.5% average adjustment during the midterm period was the largest in a president’s four years in office.
That’s not surprising, as midterm elections could shake up which party controls Congress and make it harder for the president to implement his agenda. With Republicans holding a slim majority in the House of Representatives, small changes in voter support could lead to major changes in Congress in January 2027.
Furthermore, history shows that Republican presidencies and recessions go hand-in-hand.
Since 1913, 10 Republicans and 9 Democrats have served as President of the United States. Four of nine Democrats did not start a recession while in the Oval Office. Meanwhile, all 10 Republicans, including President Trump, have watched the recession unfold while in office. While this is not a guarantee that a recession will materialize during Trump’s second term, or that a recession will occur in 2026, it is a highly accurate historical precedent that spans more than a century.
Even President Trump’s tariffs and trade policies point to potential weakness for stocks in the new year.
In December 2024, four New York Fed economists wrote for Liberty Street Economics and published a report (“Do Import Tariffs Protect U.S. Businesses?”) that examined the impact of Trump’s tariffs on China in 2018 and 2019 on businesses and the stock market. Economists found that from 2019 to 2021, public companies directly affected by Trump’s tariffs on China experienced declines in employment, labor productivity, sales and profits.
While none of these historical correlations guarantee a crash in Trump’s second year in office, the risk of a crash in 2026 appears higher than usual.
Image source: Getty Images.
The great thing about history, however, is that it provides insights into decline and decline. and Stock markets rise.
While investors may not like the downward moves in the Dow Jones Industrial Average, S&P 500 and Nasdaq Composite, these are completely normal, healthy and inevitable events. While investor sentiment can make the speed and duration of a stock market downturn unpredictable, be aware that no amount of fiscal/monetary policy manipulation or good intentions can prevent these events from occurring.
That being said, stock market cycles are not mirror images of each other, which is a powerful realization for investors with a long-term mindset.
In June 2023, when the S&P 500 had officially rebounded more than 20% from its 2022 bear market lows and entered a new bull market, researchers at Bespoke Investment Group published a set of data on X (formerly Twitter) comparing the duration of every S&P 500 bull market and bear market since the beginning of the Great Recession.
Bespoke found that since September 1929, S&P 500 bear markets have lasted an average of only 286 calendar days, which equates to about 9.5 months. In comparison, a typical bull market lasts 1,011 calendar days, approximately 3.5 times longer.
Looking further back produces similar results.
Each year, analysts at Crestmont Research update a data set that calculates 20-year rolling total returns (including dividends) for the S&P 500 since the early 20th century. Although the S&P wasn’t officially founded until 1923, researchers were able to track the performance of its constituents in other major indexes dating back to 1900.
What Crestmont Research was able to demonstrate is that all 106 rolling 20-year periods it studied (1900-1919, 1901-1920, etc., through 2005-2024) produced positive annualized total returns. In short, assuming an investor holds an S&P 500-tracking fund for 20 years, all 106 periods will be profitable.
These retrospective analyzes are a testament to the power of time and optimism on Wall Street. While short-term trends are difficult to predict, history is very clear that the major stock market indexes should be higher in 20 years regardless of who is president.
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Sean Williams 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.
How likely is a stock market crash in 2026 under President Donald Trump? This is what history tells us. Originally posted by The Motley Fool
