- Donald J. Trump will be inaugurated today as US president for the second time
- The Republicans control the House of Representatives and the Senate as well as the White House
- Stock markets have lost momentum after their initial euphoria in November and bond markets have wobbled
- Campaign promises are seen by markets as potentially inflationary and as adding to the US deficit
- History shows that the economic backdrop and starting point valuations are the key factors to US equity performance during a presidency
“The Dow Jones Industrials, S&P 500 and Nasdaq Composite stock market indices have given up the bulk of the gains they made in the immediate aftermath of Donald Trump’s election victory last November, the dollar has surged and the US bond market has stumbled badly, so investors are yet to really make up their minds about the next (and returning) president,” says AJ Bell investment director Russ Mould.
“The post-election ‘Trump bump’ was the result of relief that corporate taxes would not go back up and enthusiasm for a focus on deregulation and growth, but doubts clearly remain about some of the promises made during the campaign, notably tariffs and tax cuts that are seen to potentially add to a federal deficit that continues to soar.
“The past is no guarantee for the future, but the US equity market does tend to put in a fairly pedestrian performance during the first year of a Republican presidency, with an average advance of just 2.0%, but then Trump is hardly a typical hair-shirt Republican who focuses on fiscal probity.
Source: LSEG Refinitiv data. Based on calendar year from inauguration day (20 January) and the performance of the Dow Jones Industrials index.
*John F. Kennedy assassinated in November 1963 and replaced by Lyndon B. Johnson
**Richard M. Nixon resigned August 1974 and replaced by Gerald R. Ford
***Joseph R. Biden’s first term concludes on 19 January 2025
“Nor should investors forget that Trump was perceived as a risk to markets before his election in 2016, thanks in particular to his policies on trade and international relations, only for US stocks to enjoy strong gains during his term.
“How his planned programme affects the economic backdrop is likely to be one key driver of returns from the US stock market (not forgetting its bond market and its currency) but the starting point (from a valuation perspective) is likely to be another.
“The presidencies which showed the best returns were the first terms of Barack Obama and Bill Clinton, both Democrats, and the second of the Republican Ronald Reagan.
“In all three cases, the US was emerging from a recession, an equity bear market or both and as a result share prices were relatively depressed and valuations manageable or even lowly. Based on Robert Shiller’s cyclically adjusted price earnings (CAPE) ratio, the US equity market traded on 10.0 times (Reagan), 21.1 times (Clinton) and 15.2 times (Obama).
“By contrast, the only four presidential terms to show a negative return were those of Nixon (and his successor Ford), Jimmy Carter and both terms of George W. Bush, so three Republicans and one Democrat. On each occasion, a recession or inflation (or both) hit and those shocks came after a strong run in US equity prices, with the result that the valuation starting point was often much higher – 18.7 times under Nixon, 11.4 times under Carter, 28.6 times the first time around under George W. Bush and 26.6 times the second time.
Source: Shiller Data
“It is therefore worth bearing in mind that the Dow Jones is up by 15% in the past year alone, and the S&P 500 is up 25%. Based on Shiller’s work, the CAPE ratio is currently 37.0 times and US stocks therefore look expensive relative to their history.
“This is particularly pertinent when it comes to comparisons with another great tax-cutter and deregulator, Ronald Reagan.
“The Gipper won two terms, from 1981-1985 and then 1985-89 and his reforms won huge plaudits from investors as America shook off the inflationary economic malaise of the 1970s, helped by a large dose of interest rates and tight monetary policy from the US Federal Reserve under Paul Volcker. The economy and stock markets boomed for much of the decade.
“Whether this iteration of the Fed, under chair Jay Powell, has quite so much appetite, or room, for maintaining such a monetary squeeze is open to debate, even as inflation runs stubbornly above target. Since the late 1990s the Fed has become increasingly interventionist, stepping in regularly to provide cheap liquidity during times of difficulty, while Trump spent much of his first term berating Powell and calling for lower interest rates.
“There are further differences which do not sit entirely comfortably with the beguiling narrative that the 2020s could be a repeat of the Reaganite 1980s (or even the 1920s when economic growth was strong and a stock market boom was fuelled by a technological revolution, with the spread of the wireless radio and the relentless surge in shares in the Radio Corporation of America, or RCA).
“First, the US economy double dipped as Reagan’s first administration applied what it saw as the necessary reforms. The S&P 500 fell by nearly a third during this sticky start.
Source: LSEG Refinitiv data
“Second, the US Federal deficit was barely 30% of GDP in 1981, compared to 120% now, to leave Reagan with so much more room for fiscal manoeuvre.
Source: FRED – St. Louis Federal Reserve database
“Finally, again, the S&P 500 was much less highly valued than now, using the CAPE ratio as a guide. When Reagan took office on 20 January 1981, the CAPE ratio was 9.3 times, not 37.0 times as it is now.
“The valuation starting point for investors under a second Trump presidency may not therefore be particularly helpful. Any unexpected shocks, such as those suffered during the Nixon, Carter and Bush presidencies, or simply a divergence from the current preferred narrative of cooling inflation, a soft economic landing and lower interest rates, could therefore have a sizeable impact, and not necessarily a positive one.
“Federal Reserve policy could then become be a huge factor here and the central bank is independent – although some may be tempted to argue it caved into presidential pressure from Donald Trump when it pushed through three interest rate cuts in 2019.
“Others will note the Fed’s willingness to intervene, in size, in 1998, 2001-03, 2007-09 and 2020-21 via interest rate cuts and bond-buying Quantitative Easing schemes upon signs of dislocation in financial markets.”
