During Donald Trump's initial tenure as President, key stock market indices demonstrated remarkable appreciation. By the end of his first term, the Dow Jones Industrial Average had increased by 57%, the S&P 500 rose 70%, and the Nasdaq Composite nearly more than doubled, surging 142%. Continuing into his second term, the momentum has persisted. As of December 29, the Dow advanced 14%, the S&P 500 gained 17%, and the Nasdaq Composite climbed 22% year-to-date.
Despite these gains, investors should be mindful that long-term market expansions are rarely linear, and volatility has been a recurring theme in market history. Looking ahead to 2026, amidst a shifting political landscape and complex economic backdrop, the possibility of a market downturn cannot be dismissed. Examining historical valuation measures and market cycles provides insight into this potential risk.
Market Valuation Levels Raise Caution Flags
A fundamental consideration for assessing market vulnerability is valuation. The S&P 500’s Shiller Price-to-Earnings ratio (also known as the cyclically adjusted P/E or CAPE ratio) offers a long-term perspective by measuring current price relative to average inflation-adjusted earnings over the prior ten years.
Since 1871, the Shiller P/E has averaged approximately 17.3. Entering 2026, it sits at 40.59, making it the second-highest reading on record. Only during the dot-com bubble preceding the market crash did the ratio peak higher, reaching 44.19. Elevated valuations of this magnitude historically precede notable market declines.
Historical trends spanning over 150 years show that the Shiller P/E exceeding 30 has coincided with six major episodes, including the current period. Each prior occurrence was followed by significant reductions in major indexes—losses ranged from 20% declines to nearly 90%, as during the Great Depression. While such severe contractions are now considered less likely, notably the S&P 500 and Nasdaq suffered declines of 49% and 78%, respectively, after the dot-com bubble burst.
Additional Historical Indicators Point to Elevated 2026 Risk
Beyond valuation, other historical patterns increase the relevance of caution moving into the coming year. Midterm election years typically correlate with enhanced stock market volatility. Data analyzed by market strategist Ryan Detrick indicates that since 1950, the S&P 500 experienced peak-to-trough drawdowns during midterm years ranging from 4.4% to 37.6%, averaging a correction of 17.5%—the steepest average among the four-year presidential term segments.
Midterm election dynamics, including the potential for a shift in Congressional control, contribute to uncertainty that can undermine investor sentiment. With Republicans holding a slim majority in the House of Representatives, even modest electoral swings in 2026 have the potential to produce substantive shifts in legislative power by January 2027.
Moreover, historical observations reveal a strong linkage between Republican presidencies and recession occurrences. Since 1913, all ten Republican administrations—including Donald Trump’s—have presided over at least one recession. In contrast, of the nine Democratic presidencies in the same timeframe, four did not experience a recession. While this pattern does not guarantee a recession during Trump's second term, it reinforces the historical tendencies associated with political leadership and economic cycles.
Trade policies implemented under the Trump administration may also foreshadow potential market headwinds. A 2024 study commissioned by economists at the New York Federal Reserve examined the effects of tariffs on Chinese imports enacted in 2018 and 2019. Their findings indicated that companies directly impacted by these tariffs faced declines in employment, productivity, sales, and profits between 2019 and 2021, indicating a broader economic drag linked to such protectionist measures.
Market Corrections as a Natural Phase of Investing
While heightened valuations, midterm uncertainties, and historical recession patterns suggest an elevated risk of market declines in 2026, these corrections are an integral part of the investment landscape. Market pullbacks are typically unpredictable in timing and magnitude but are necessary mechanisms to recalibrate pricing and sustain long-term growth.
Studies comparing bull and bear market durations highlight that bear markets, on average, are significantly shorter than bull markets. Analysis by Bespoke Investment Group, covering data since the Great Depression, indicates that bear markets have lasted roughly 286 calendar days, whereas bull markets have extended over 1,000 days on average, approximately 3.5 times longer.
Complementing this perspective, Crestmont Research’s examination of rolling 20-year periods for the S&P 500, including dividends, since 1900, found a consistent trend of positive annualized returns across all periods studied. This underscores the enduring capacity of the stock market to generate gains over extended horizons despite episodic downturns.
Ultimately, while the risk of a downturn in 2026 under President Trump appears statistically elevated, disciplined investors with a long-term orientation may find these cycles present opportunities to build wealth, supported by a history of extended bull markets following declines.