In just three days, Americans will go to the polls or mail in their ballots to determine which presidential candidate – current Vice President and Democratic presidential candidate Kamala Harris, or former President and Republican presidential candidate Donald Trump – will lead our great nation. the next four years.
Considering that all three major stock market indices, the timeless Dow Jones Industrial Average(DJINDICES: ^DJI)widely supported S&P500(SNPINDEX: ^GSPC)and driven by growth stocks Nasdaq Composite(NASDAQINDEX: ^IXIC)have soared to multiple record highs in 2024, all eyes are on this highly contested presidential race.
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While each candidate leaves unanswered questions on the table (and it’s no secret that Wall Street hates uncertainty), a potentially bigger problem looms for stocks.
Vice President and Democratic presidential candidate Kamala Harris speaks to reporters. Image source: Official White House photo by Lawrence Jackson.
Let me preface this discussion by pointing out that campaign promises do not always translate into action. If the winner faces a divided Congress on November 5, it is unlikely they will be able to implement many of the policies they proposed during their campaign.
With the above said, there are proposals on both sides of the political aisle that are causing concern on Wall Street.
For example, Harris has proposed tackling the rapidly rising US national debt by increasing the tax burden on selected groups. More specifically, Harris wants to quadruple the tax on share buybacks for listed companies from 1% to 4%, increase ordinary capital gains tax from 20% to 28%, and increase the peak corporate tax rate by a third, from an all-time low. % to 28%.
While all of these actions would increase federal revenues, they also have the potential to negatively impact the stock market. Buybacks have been a particularly useful tool that America’s largest publicly traded companies have used to reward investors and increase their earnings per share (EPS). Apple has reduced the number of shares outstanding by more than 42% since the beginning of 2013, which has had a remarkably positive impact on earnings per share.
Meanwhile, Trump wants to impose tariffs on US imports as a way to encourage domestic production. According to Trump, tariffs on Chinese products imported into the US would be 60%, with a 20% tariff on imports from other countries.
The problem with tariffs is that they have the potential to spark a trade war, which could increase domestic prices and hamper supply chains. Tariffs can be a mixed bag when it comes to corporate profits.
While there are undeniable question marks for Wall Street, there is a much bigger concern for stocks that extends beyond Election Day.
Image source: Getty Images.
Even with the possibility that a few states may not have complete election data by November 5, America will know relatively soon afterward whether Kamala Harris or Donald Trump will become the next president. Once this big question is answered, investors will turn their attention back to Wall Street’s glaring problem: its historically high valuation.
There are many metrics that help investors determine whether a stock is cheap or pricey compared to its peers and the broader market. The best known of these tools is the price-to-earnings ratio (P/E), which divides a company’s share price into its earnings per share over the past twelve months.
While the traditional price-to-earnings ratio has its uses, there is another valuation tool that provides a comprehensive insight into broader market valuations that date back more than 150 years. This measure is the Shiller price-to-earnings ratio of the S&P 500, also known as the cyclically adjusted price-to-earnings ratio (CAPE ratio).
The Shiller P/E is based on the average inflation-adjusted EPS over the past ten years. While the traditional price-to-earnings ratio can be disrupted by one-off events such as lockdowns during the COVID-19 pandemic, the Shiller price-to-earnings ratio does a great job of smoothing out these shocks to create apples-to-apples comparisons .
As of the closing bell on October 30, the S&P 500’s Shiller price-to-earnings ratio was 37.05, which is more than double the all-time average of 17.17, backtested to January 1871. This also represents the third highest stand during the closing bell on October 30. an ongoing bull market in history.
History has happened extremely unkind to the Dow Jones, S&P 500 and Nasdaq Composite after the few previous events where the Shiller P/E exceeded 30. Including the present, there have only been six times in 153 years that the price of 30 has been exceeded during a bull market. The five previous cases all resulted in losses ranging from 20% to 89% for Wall Street’s major stock indexes.
The caveat to the Shiller P/E is that it is not a timing tool. Valuations can remain extended for a few weeks, as before the COVID-19 crash, or for several years, as we saw before the dot-com bubble burst. However, this measure clearly shows that premium valuations are unsustainable over long periods of time.
So Election Day could mark an ominous turning point for Wall Street.
While select forecasting tools and valuation metrics indicate that the Dow Jones Industrial Average, S&P 500, and Nasdaq Composite are each headed for a meaningful correction, history also has something positive to offer for patient investors.
Each year, Crestmont Research analysts update a published data set that calculates the 20-year rolling total returns, including dividends paid, of the broad-based S&P 500. Although the S&P didn’t come into existence until 1923, researchers have been able to track the performance of its components in other indexes dating back to 1900. This allowed Crestmont to measure the total return performance of the S&P 500 over 105 separate rolling 20-year periods (1919-2023).
The Crestmont Research data set shows that all 105 rolling twenty-year periods produced positive total returns. In fact, more than 50 of these periods generated annualized returns of at least 9%. Put into another context, if you, hypothetically, had bought an S&P 500 tracking index at any time since 1900 and held it for 20 years, you would have made money every time.
Regardless of who was elected president, which political party was in power, or how expensive or cheap Wall Street was perceived to be, patience was consistently rewarded on Wall Street.
This isn’t the only data set that confirms how much ally time can be for investors, either.
In June 2023, Bespoke Investment Group analysts published a data set on 1929.
According to Bespoke’s calculations, the average bear market in the S&P 500 has lasted 286 calendar days, while the typical bull market has lasted 1,011 calendar days. Additionally, 14 of the 27 bull markets have lasted longer than the S&P 500’s longest bear market ever.
Regardless of what predictive numbers suggest may happen in the short term, time and history remain in the corner of long-term-oriented investors.
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Sean Williams has no position in any of the stocks mentioned. The Motley Fool holds and recommends positions in Apple. The Motley Fool has a disclosure policy.
Prediction: Election Day will represent an ominous turning point for Wall Street originally published by The Motley Fool
