Yesterday, Donald Trump was inaugurated, marking the start of a new chapter for Wall Street.

After his election win in November, the stock market surged, buoyed by financial stocks anticipating a reduction in regulations.

Moreover, many of the stock market’s most significant players have seen their shares rise, believing Trump may bring about another wave of corporate tax cuts, particularly for companies manufacturing within the U.S. Following the signing of the Tax Cuts and Jobs Act by Trump in December 2017, stock buybacks among S&P 500 (SNPINDEX: ^GSPC) firms skyrocketed.

Investors are optimistic about a repeat of past successes. During Trump’s initial term, key indices like the Dow Jones Industrial Average (DJINDICES: ^DJI), the benchmark S&P 500, and the tech-focused Nasdaq Composite (NASDAQINDEX: ^IXIC) climbed by 57%, 70%, and 142%, respectively.

While Trump’s second term has many on Wall Street feeling hopeful, he is also making concerning stock market history—something investors should take seriously.

Trump Sets Unfortunate Stock Market Record

Compared to all the presidents before him, Trump has stepped into office with the most expensive stock market in history.

The standard method for evaluating “value” on Wall Street is the price-to-earnings (P/E) ratio. This ratio is calculated by dividing a company’s share price by its earnings per share (EPS) over the last 12 months, with lower values generally indicating better value.

While the P/E ratio is a quick way to gauge whether a stock is overpriced or underpriced, it can be distorted by short-term shock events that affect corporate profits. For example, during the COVID-19 pandemic in 2020, EPS data from the prior 12 months became less reliable for many companies.

This is where the S&P 500’s Shiller P/E Ratio becomes useful. You might also see the Shiller P/E referred to as the cyclically adjusted P/E Ratio (CAPE Ratio).

S&P 500 Shiller CAPE Ratio data by YCharts.

The Shiller P/E relies on average earnings adjusted for inflation over the previous 10 years. This decade-long benchmark helps to minimize the impact of sudden economic shocks on the valuation metric. Essentially, it’s the most consistent valuation measure available when referenced over a span of more than 150 years.

As of January 17’s market close, the Shiller P/E for the S&P 500 reached 38.11. This is the highest level recorded for an incoming president since January 1871 (the earliest data for the Shiller P/E). For comparison, the average Shiller P/E over the last 154 years is 17.19.

What’s particularly alarming is the pattern seen in previous instances when stock valuations soared.

Since 1871, there have only been six cases where the Shiller P/E exceeded 30 during a bull market, including the current situation. Historically, following those previous five instances, the Dow Jones, S&P 500, and/or Nasdaq Composite posted declines ranging from 20% to 89%. While the timing of these declines has varied, the clear conclusion is that high valuations cannot be maintained indefinitely.

Despite many of President Trump’s policies being viewed as beneficial for corporate America, stepping into one of history’s priciest stock markets could lead to a bear market or a quick downturn during his second term.

There Could Be Hope for Investors

History indicates that high stock valuations aren’t sustainable long-term. Eventually, the market will undergo a correction, and the Shiller P/E will need to return from its current extraordinary heights.

However, this doesn’t mean all is bleak for investors — it really depends on how long you plan to invest.

In June 2023, researchers at Bespoke Investment Group shared a comparison of bull and bear markets for the S&P 500 since the Great Depression began in September 1929.

Their findings revealed 27 distinct ups and downs spanning 94 years. Typically, a bear market lasts about 286 calendar days, whereas a bull market tends to persist for around 1,011 calendar days, which is approximately 3.5 times longer.

This is not the only evidence suggesting that taking a long-term perspective on investments is likely to be profitable.

Every year, Crestmont Research updates a dataset that tracks rolling 20-year total returns (including dividends) for the S&P 500 going back to 1900. Even though the S&P wasn’t officially established until 1923, Crestmont managed to monitor the performance of its component stocks in other indexes from 1900 to 1923 to accumulate historical return data.

Out of 105 rolling 20-year intervals studied, from 1919 to 2023, every single period yielded positive returns. Regardless of the market’s challenges, hypothetically investing in an S&P 500 index fund and holding for 20 years has proven to be successful every time since the early 20th century.

Additionally, returns were often quite substantial. Around 90% of these rolling 20-year periods yielded an average annual return of at least 6%, and nearly half of those periods produced returns of 9% or more per year.

Though President Trump’s stock market achievements may pose a concerning forewarning for short-term investors, the long-term upward trend for stocks remains solid.

Sean Williams has no stake in any of the stocks mentioned. The Motley Fool has no investments in the stocks mentioned. For details, refer to The Motley Fool’s disclosure policy.

The Motley Fool collaborates with YSL News to provide financial news, analysis, and commentary aimed at helping individuals manage their financial decisions. This content is generated independently of YSL News.

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