In just over six months, Americans across the country will go to the polls or mail in their ballots to determine who will lead our great country for the next four years.
While there are many aspects of the presidency and lawmaking in general that have nothing to do with Wall Street and investing, changes in financial policy, typically crafted by Congress and signed into law by the President, Do impacting the health of the U.S. economy and the bottom lines of American businesses.
By the final bell on April 24, incumbent Joe Biden had won 3,237 delegates in the presidential primary. That’s far more than the 1,968 delegates needed to secure the Democratic Party’s projected nomination for president. Since taking office on January 20, 2021, Biden has seen a 23% increase in the icon Dow Jones Industrial Average (DJINDICES: ^DJI)32% in the benchmark S&P 500 (SNPINDEX: ^GSPC)and 17% in the growth-driven sector Nasdaq Composite (NASDAQINDEX: ^IXIC).
Similar to his predecessor Donald Trump, Biden worked with a unified Congress controlled by his party in his first two years in the Oval Office and with a divided Congress (Republicans took control of the House) in the second half of his presidency. Representative on January 3, 2023).
But could a second term for Joe Biden, coupled with Democrats taking control of both chambers of Congress, set stocks up for a huge crash? Let’s look at the challenges Biden and a Democratic Congress would face and let history ultimately judge things.
Will stocks crash if Joe Biden wins in November and Democrats control Congress?
Although it is impossible to predict exactly when a major stock market downturn will occur, the trigger for a “crash” would likely come from certain policy proposals from Biden and his colleagues, as well as select economic headwinds that could be problematic anyway will be elected president in November.
Two policy proposals in particular could give Wall Street and investors reason to head for the proverbial mountains. First, President Biden indicated in his State of the Union address in March that he wants to quadruple the stock repurchase tax to 4%. Companies that bought back their own shares have helped boost their earnings per share (EPS), which in turn has played a key role in boosting valuations. Quadrupling the existing buyback tax would make share buybacks less attractive and would have a negative impact on earnings metrics at a time when stocks are quite expensive.
The other proposal that could knock the Dow, S&P 500 and Nasdaq Composite off their respective pedestals is to increase the maximum marginal corporate tax rate from 21% to 28% and the alternative minimum corporate tax rate from 15% to 21%. . Not only would companies be discouraged from buying back their shares, but they would also have less disposable income to work with if corporate tax rates rise.
But as noted, the Democratic Party’s policy proposals are not the only concern. There are two economic headwinds that could cause problems for Wall Street regardless of whether Biden or Trump wins in November.
The first problem is that stocks are historically expensive. As of the closing bell on April 24, the S&P 500’s Shiller price-to-earnings (P/E) ratio (also known as the cyclically adjusted price-to-earnings ratio or CAPE ratio) was well above its historical norm.
While the traditional P/E ratio breaks down a company’s stock price into earnings per share over the trailing 12 months, the Shiller P/E ratio is based on average inflation-adjusted earnings over the past 10 years. By eliminating one-year fluctuations that could distort the P/E ratio, the Shiller P/E ratio becomes a potentially more attractive valuation tool over the long term.
As of April 24, the S&P 500’s Shiller P/E ratio was 33.67, which is nearly double the average of 17.11 when compared back to 1871.
The bigger concern is that in 153 years, there have only been six total cases where the Shiller P/E ratio has exceeded 30 during a bull market. After the previous five events, the S&P 500 or the Dow Jones Industrial Average lost 20% to 89% of their respective values. Whenever valuations rise, it ultimately leads to a sharp decline in stocks.
ATTENTION: The money supply is officially shrinking. 📉
This has only happened four times in the last 150 years.
Each time, a depression followed with double-digit unemployment rates. 😬 pic.twitter.com/j3FE532oac
– Nick Gerli (@nickgerli1) March 8, 2023
The other trigger for a possible stock market crash is the historic decline in the US M2 money supply. The M2 money supply includes everything in M1—cash and coins in circulation as well as demand deposits in a checking account—and adds savings accounts, money market accounts, and certificates of deposit (CDs) under $100,000.
Typically, there is little reason to pay much attention to the M2 money supply because the U.S. economy grows so consistently over long periods of time. But after peaking in March 2022, the M2 money supply has declined by almost 4.4%. It is the first time since the Great Depression that the M2 money supply has fallen by at least 2% year-on-year.
Based on data compiled last year by Nick Gerli, CEO of Reventure Consulting, there have only been five instances since 1870 in which M2 fell by at least 2% compared to the previous year. The four previous periods (1878, 1893, 1921, and 1931–1933) all coincided with deflationary depressions and high unemployment.
The caveat to the above is that the M2 money supply grew at the fastest rate ever during the COVID-19 pandemic. The decline we are seeing now could simply be a reversion to the mean. Still, in the past, having less capital available for transactions has been a recipe for a recession in the US.
This combination of policy proposals and economic headwinds could spell trouble for stocks if Democrats control Congress and the White House.
History says this is what happens when Democrats have unified government
With a better understanding of the potential challenges that await if President Biden wins in November and Democrats take control of Congress, let’s take a closer look at what history has to say.
Based on a study conducted by CFRA Research, there has not been a political scenario since 1945 that has resulted in a negative average annual return. No matter how the puzzle pieces are arranged, patient investors always come out on top.
According to CFRA Research, between December 31, 1944 and December 31, 2021, there were 23 years in which Democrats controlled Congress and the White House. Over these 23 years, the benchmark S&P 500 returned an average of 10.5%. While this is slightly below the average annual return of 12.9% under a unified Republican government, it is still an above-average return.
Retirement Researcher went a step further and examined the average annual return of the S&P 500 from 1926 to 2023 based on various political situations. The 36 years of unified government under Democrats over this nearly century period resulted in an average annual return of 14.01%!
The point here is simple: the stock market tends to provide benefits to patient shareholders over the long term, regardless of which political party is in control.
The reason stocks have outperformed all other asset classes over the last century is because they benefit from long-term economic recoveries.
On the one hand, recessions are an inevitable part of the economic cycle. Since the end of World War II, the U.S. economy has experienced a dozen downturns. But did you know that nine of these recessions have subsided in less than a year, while none of the remaining three lasted longer than 18 months?
On the other hand, phases of economic growth often last several years. Two of the expansions since World War II lasted longer than 10 years. It’s these lengthy expansions that allow company profits to really grow.
Perhaps the most convincing data set on the power of patience and foresight came from analysts at Bespoke Investment Group.
Last June, Bespoke calculated the duration of every bull and bear market in the S&P 500 since the start of the Great Depression in September 1929. The data showed that the average S&P 500 bear market lasted 286 calendar days, but the typical bull market over a 94-year period remained 1,011 Calendar days exist, i.e. about 3.5 times as long.
Additionally, there have been 13 bull markets in the S&P 500 since September 1929 that lasted longer than the longest bear market in the broad-based index.
Patience and foresight can reward investors regardless of which political party is in power. If Joe Biden wins in November and the Democrats control Congress, long-term investors should do well.
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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.
Will stocks crash if Joe Biden wins and Democrats control Congress? Here’s what history says about stock market returns if Democrats win. was originally published by The Motley Fool