Election Day will be an ominous turning point for Wall Street

In just three days, Americans will head 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 win. will lead our great nation. the next four years.

Considering that all three major stock market indices are ageless Dow Jones Industrial Average (JINDITS: ^DJI)wide base S&P 500 Index (SNPINDEX: ^GSPC)and driven by stock growth Nasdaq Composite (NASDAQINDEX: ^IXIC)hit several record highs in 2024, all eyes are on this highly controversial presidential race.

While each candidate raises unanswered questions (and it’s no secret that Wall Street doesn’t like uncertainty), a potentially bigger problem looms on the horizon for stocks.

Vice President and Democratic presidential candidate Kamala Harris speaks with reporters. Image source: Official White House photo by Lawrence Jackson.

Investors weigh uncertainties for each presidential candidate

Let me preface this discussion by noting that campaign promises do not always come to fruition. If the winner faces a divided Congress on Nov. 5, it is unlikely they will be able to implement many of the policies they proposed during the campaign.

With that said, there are proposals on both sides of the political aisle that are causing concern on Wall Street.

For example, Harris proposed solving the problem of America’s rapidly growing national debt by increasing taxation of certain groups of the population. Specifically, Harris wants to quadruple the stock buyback tax for public companies from 1% to 4%, increase the regular capital gains tax from 20% to 28% and raise the top corporate tax rate by a third from a historically low 21%. . % up to 28%.

While all of these actions will increase federal revenue, they could also have a negative impact on the stock market. Buybacks have become a particularly useful tool that America’s largest publicly traded companies have used to reward investors and increase earnings per share (EPS). Apple has reduced its shares outstanding by more than 42% since the start of 2013, which has had a noticeable positive impact on earnings per share.

Meanwhile, Trump wants to impose tariffs on US imports to stimulate domestic production. According to Trump, tariffs on Chinese products imported into the United States will reach 60%, and on imports from other countries – 20%.

The problem with tariffs is that they could trigger a trade war, which could drive up domestic prices and hamper supply chains. Tariffs can be controversial when it comes to corporate profits.

While there are undeniable question marks on Wall Street, there is much more concern about stocks that extends beyond Election Day.

Image source: Getty Images.

As we move past Election Day, we’ll refocus our attention on Wall Street’s biggest problem.

Even though some states won’t have complete election data on November 5th, America will know relatively soon after whether Kamala Harris or Donald Trump will be the next president. Once that important 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 expensive compared to its peers and the broader market. The most well-known of these tools is the price-to-earnings ratio (P/E), which divides a company’s share price by its earnings per share over the past 12 months.

While the traditional P/E ratio has its uses, there is another valuation tool that provides a comprehensive look at broader market valuations dating back over 150 years. This metric is the Shiller price-to-earnings ratio for the S&P 500 index, which is also known as the cyclically adjusted price-to-earnings ratio (CAPE ratio).

Shiller’s P/E is based on average inflation-adjusted earnings per share over the previous 10 years. While the traditional P/E ratio can be confused by one-time events such as lockdowns during the Covid-19 pandemic, the Shiller P/E does a great job of smoothing out these shock events by creating like-for-like comparisons.

As of October 30’s close, the S&P 500’s Shiller P/E ratio was 37.05, more than double its all-time average of 17.17 backtested to January 1871. This is also the third highest figure during the entire period. continuous bull market in history.

S&P 500 Shiller CAPE Ratio data from YCharts.

The story was very much unkindness toward the Dow Jones, S&P 500 and Nasdaq Composite after several previous occasions when the Shiller P/E exceeded 30. Including now, exceeding 30 during a bull market has happened only six times in 153 years. All five previous cases resulted in losses ranging from 20% to 89% of Wall Street’s major stock indexes.

The caveat to the Shiller P/E is that it is not a timing tool. Valuations may remain extended for weeks, as they were before the Covid-19 crash, or for years, as we witnessed before the dot-com bubble burst. However, this indicator clearly shows that premium estimates are unstable over long periods of time.

So Election Day could be an ominous turning point for Wall Street.

Patience is richly rewarded on Wall Street

While some forecasting tools and valuation metrics suggest the Dow Jones Industrial Average, S&P 500 and Nasdaq Composite are headed for a meaningful correction, history also has something positive to offer patient investors.

Each year, Crestmont Research analysts update a published data set that calculates the 20-year total return of the broad-based S&P 500 Index, including dividends paid. Thus, Crestmont was able to estimate the total return of the S&P 500 index over 105 separate rolling 20-year periods (1919-2023).

The Crestmont Research data set shows that all 105 rolling 20-year periods produced positive cumulative returns. In fact, more than 50 of these periods produced annualized returns of at least 9%. In another context, if you had hypothetically bought the S&P 500 tracking index at any point since 1900 and held it for 20 years, you would have made money every time.

No matter who was elected president, what political party was in power, or how expensive or cheap Wall Street was perceived to be, patience on Wall Street was invariably rewarded.

This isn’t the only piece of data that shows how useful time can be for investors.

In June 2023, analysts at Bespoke Investment Group published a dataset on X, the social network formerly known as Twitter, that examined the calendar day lengths of 27 individual S&P 500 bear and bull markets since the start of the Great Crisis. Depression of September 1929.

According to Bespoke’s calculations, the average S&P 500 bear market lasted 286 calendar days, while the typical bull market lasted 1,011 calendar days. Additionally, 14 of the 27 bull markets lasted longer than the longest S&P 500 bear market ever.

Regardless of what forward indicators suggest what might happen in the short term, timing and history are still important for long-term investors.

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Sean Williams has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Apple. The Motley Fool has a disclosure policy.