Are Stocks Going to Crash if Donald Trump Wins and Republicans Control Congress? Here's What History Says About ...

It's that time again -- and I'm not talking about tax season. With many presidential primaries now in the rearview mirror, America is turning its attention to elections in November.

Though there are plenty of aspects of politics that don't intersect with what happens on Wall Street, fiscal policy changes drafted in Congress and signed into law by the president of the United States can have a meaningful impact on corporate profits and the economic growth trajectory.

As of this writing on April 17, former President Trump had secured 1,863 delegates, which is well over the 1,215 needed to earn the presumptive nomination for president from the Republican Party. During Trump's presidency, which began when he was sworn in on Jan. 20, 2017, the iconic Dow Jones Industrial Average (^DJI 0.40%), benchmark S&P 500 (^GSPC 1.02%), and innovation-driven Nasdaq Composite (^IXIC 2.02%) respectively rocketed higher by 57%, 70%, and 142%.

During Trump's tenure in the Oval Office, he worked with a unified Congress that was controlled by Republicans in his first two years, and a split Congress during his final two years (Democrats took control of the House from Jan. 3, 2019, through Jan. 3, 2021).

Former President Donald Trump on a teleconference call. Image source: Official White House Photo by Shealah Craighead.

The question is: Would Donald Trump winning a second term as President, coupled with Republicans taking control of the House and Senate, set up stocks for an epic crash? Let's take a closer look at the challenges a unified Republican Congress and Trump presidency would face and let history be the deciding factor.

Are stock going to crash if Trump wins in November and Republicans take control of Congress?

A unified Republican Congress with Donald Trump as president would contend with two types of challenges. The first are based on the policies that could be passed by the Trump administration. Meanwhile, the second group of headwinds are ingrained in the economy and could occur regardless of who wins the presidency or controls Congress.

There are two potential issues Wall Street and investors might have with a Republican-controlled Congress and Trump at the helm. To start with, Republicans may aim to pass tax reforms that would reduce corporate and personal income-tax rates. While people and businesses love having extra disposable income, America's debt levels are rising at an alarming pace. Tax cuts may worsen Capitol Hill's already unsightly annual budget deficits, as well as increase annual interest expenses for the federal government.

The second potential policy concern with Trump at the helm and Republicans in control of Congress is the likelihood of new tariffs being imposed on Chinese goods. In February, Trump stated on Fox News's "Sunday Morning Futures" that he'd institute tariffs of more than 60% on Chinese goods if reelected. Tariffs placed on Chinese goods during his first term led to higher prices being passed along to American consumers. It also hurt America's relationship with the world's No. 2 economy.

But the greater threat to the U.S. economy and stocks could be macroeconomic headwinds, which don't care who wins the presidency or which political party controls Congress.

WARNING: the Money Supply is officially contracting. ????

This has only happened 4 previous times in last 150 years.

Each time a Depression with double-digit unemployment rates followed. ???? pic.twitter.com/j3FE532oac

-- Nick Gerli (@nickgerli1) March 8, 2023

Perhaps the most-glaring concern at the moment is the meaningful decline we've witnessed since March 2022 in U.S. M2 money supply. M2 money supply accounts for everything in M1 (cash, coins, and demand deposits in a checking account), and adds in money market accounts, savings accounts, and certificates of deposit (CDs) below $100,000.

Most economists and investors pay little attention to U.S. money supply because it's been steadily rising for about 90 years. But following a historic expansion of 26% (year-over-year) during the COVID-19 pandemic, we've witnessed a nearly 4.3% aggregate pullback in M2 since March 2022. It's the first notable dip in M2 since the Great Depression.

As you can see in the post above from Reventure Consulting CEO Nick Gerli on X (the platform formerly known as Twitter), there have been only five instances in the last 154 years where M2 money supply endured at least a 2% decline on a year-over-year basis. The four prior instances where these drops occurred -- 1878, 1893, 1921, and 1931-1933 -- correlated with deflationary depressions and high levels of unemployment.

If there's a silver lining here, it's that the Fed and federal government have far more knowledge now than they did a century ago about how to avoid depressions. Despite this knowledge, declining M2 money supply suggests consumers will be forced to pare back their spending. This has historically been a recipe for a recession -- and stocks typically perform poorly during a recession.

S&P 500 Shiller CAPE Ratio data by YCharts.

The other key concern for Wall Street that isn't going away no matter who's elected in November is pricey stock valuations. Specifically, the S&P 500's Shiller price-to-earnings (P/E) ratio, which is also known as the cyclically adjusted price-to-earnings ratio (CAPE ratio), suggests the major stock indexes could crash.

As of the closing bell on April 17, the S&P 500 Shiller P/E ratio stood at 33.34. Aside from being nearly double the average reading of 17.11, when back-tested to 1871, it marks only the sixth time in history the Shiller P/E has surpassed 30 during a bull market rally. Following the five prior instances, the S&P 500 endured drops ranging from 20% to 89%.

To be clear, the Shiller S&P 500 isn't a timing tool. Stocks can stay pricey for years before deflating. But it does provide compelling evidence that extended stock valuations eventually (key word!) drag the Dow Jones, S&P 500, and Nasdaq Composite into a bear market.

These macro catalysts absolutely have the potential to cause a stock market crash.

Image source: Getty Images.

Here's what history says happens when Republicans control the presidency and Congress

Now that we've taken a good look at the possible challenges Donald Trump and a Republican-controlled Congress might contend with, let's get to the good news. Historically speaking, the stock market is a winner regardless of which party is victorious in November.

According to one study, which was conducted by independent financial intelligence company CFRA Research, a unified government controlled by Republicans has occurred for a total of eight years from 1945 through 2021. During those eight years of Republican control, the benchmark S&P 500 averaged a 12.9% return. That's actually better than the 10.5% average annual return for the S&P 500 under 23 years of unified Democrat control.

A separate report from Retirement Researcher yielded similar results. Retirement Researcher examined the annualized returns of the S&P 500 (when back-tested) from 1926 through 2023. Over nearly a century, a unified Republican Congress with a Republican president, which has occurred in 13 of these years, led to an average annual return of 14.52%.

No matter how the political puzzle pieces are moved, the S&P 500 has always generated a positive annual return over the long run.

^SPX data by YCharts.

The reason the stock market is such a bona fide wealth creator for patient investors is because the U.S. economy steadily expands over time.

Despite cautioning about the possibility of a recession because M2 is falling for the first time since the Great Depression, downturns in the U.S. economy are short-lived. Out of the 12 official recessions in the U.S. since the end of World War II, nine resolved in less than a year and the remaining three failed to surpass 18 months. By comparison, most expansions stick around for multiple years, with two periods of growth since 1945 lasting longer than 10 years.

Although the stock market and U.S. economy don't move in tandem, what's good for the goose is often good for the gander. If the U.S. economy is expanding, there's a strong likelihood corporate earnings are, too. Rising corporate earnings are what allows stock valuations to grow over time.

And it's not just U.S. economic growth that lasts disproportionately longer than contractions. Bull markets on Wall Street also stick around much longer than bear markets.

It's official. A new bull market is confirmed.

The S&P 500 is now up 20% from its 10/12/22 closing low. The prior bear market saw the index fall 25.4% over 282 days.

Read more at https://t.co/H4p1RcpfIn. pic.twitter.com/tnRz1wdonp

-- Bespoke (@bespokeinvest) June 8, 2023

In June 2023, researchers at Bespoke Investment Group analyzed every bear and bull market in the S&P 500 dating back to the start of the Great Depression in September 1929. Whereas the 27 bear markets for the S&P 500 resolved in an average of 286 calendar days (about 9.5 months), the typical bull market has lasted 1,011 calendar days, or 3.5 times longer.

To add, 13 bull markets for the S&P 500 have stuck around longer than the lengthiest bear market.

History makes it plainly evident that investors exercising patience and perspective are well-positioned to grow their wealth if Donald Trump wins in November and Republicans take control of both houses of Congress.