Trump's Second Term: Testing the Historical Crash Signals

To navigate the uncertainty of a new presidential term, we turn to three century-old data sets that form a basic framework for assessing risk. These patterns, while not guarantees, provide a structural lens for understanding how market and economic conditions have historically unfolded under different political leadership.

The first metric is the Shiller CAPE Ratio, a valuation gauge that smooths earnings over a ten-year period. Its current level stands as the second-highest in history since 1871. This extreme valuation has consistently preceded major bear markets, suggesting the market is priced for perfection and vulnerable to disappointment.

The second pattern is a statistical one: since 1953, 10 of 11 U.S. recessions have begun under Republican presidents. This correlation, while not causal, highlights a recurring vulnerability. It frames the setup not just around policy, but around the cyclical timing of economic downturns.

The third and perhaps most direct measure is the historical return gap. Since 1926, the S&P 500 has delivered an average annual return of 9.32% under Republican presidents versus 14.78% under Democrats. This nearly 5.5 percentage point difference underscores a long-term performance divergence that investors must weigh.

Together, these data points paint a picture of a higher-than-average risk setup. Elevated valuations, a cyclical recession risk, and a documented underperformance under Republican leadership create a complex backdrop. Yet, this framework must be tempered by the anomaly of Trump's first term, which saw strong market performance despite the broader historical trends. The question for 2026 is whether this anomaly persists or if the historical data begins to reassert itself.

Trump's First Term: An Outlier to Test Against

The historical data points a clear direction, but the real test is how they interact with the unique case of Trump's first term. That period was an outlier, delivering a 70% cumulative return for the S&P 500 over four years. This performance was a massive beat against the long-term Republican average of 9.32%, suggesting the market priced in a transformative policy agenda that largely materialized.

Now, the setup for his second term is a direct divergence from that initial surge. The first year of his new presidency has been the weakest start for any president since 2005. The S&P 500 gained 13.3% from inauguration to January 20, 2026. That's a healthy gain, but it pales against the 24.1% climb in the first year of his first term. This stark contrast frames the critical question: was the first-term rally a repeatable trend or a one-time event fueled by specific, perhaps unsustainable, conditions?

The divergence is structural. The first term began from a lower base and was driven by a clear, immediate policy agenda-tax cuts and deregulation-that the market could price in quickly. The second term starts from a market that is already at record highs, with valuations stretched to historic levels. The policy environment is also more volatile, marked by tariff uncertainty and "policy whiplash" that rattled markets early in the year. The market's reaction-climbing to the brink of a bear market in April before rebounding-shows a new sensitivity to political noise.

Viewed another way, the first-term anomaly may have already played out. The second term's weaker opening suggests the easy gains from a fresh policy reset are gone. The market is now pricing in a more complex, less certain future. This isn't a simple reversion to the historical Republican average; it's a market adjusting to a new baseline where the initial optimism has faded, and the elevated risks-both cyclical and valuation-based-come into sharper focus.

The Current Setup: Valuation Meets Policy Whiplash

The historical risk framework now converges with present-day conditions, amplifying the vulnerability. The market is priced for a continuation of the easy gains from the first term, but the underlying setup is one of high valuations meeting acute policy uncertainty.

The valuation is extreme. The S&P 500 trades at a forward price-to-earnings ratio above 22. This is a level historically associated with oncoming bear markets, having been sustained only during the dot-com bubble and the pandemic. The market is not just expensive; it is pricing in very strong financial results for 2026. This creates a precarious high-wire act: any stumble in earnings growth, particularly if tariff-driven economic headwinds materialize, could trigger a sharp repricing.

That headwind is not theoretical. The policy environment has already demonstrated its volatility. In early 2025, tariff announcements triggered a nearly 20% market drop over seven weeks. That episode showed how quickly uncertainty can move prices, even when the broader economic data was mixed. The market's subsequent rebound-driven by targeted negotiations and easing fears-was a relief rally. But it also proved the market's sensitivity to political noise. The risk is that this volatility is not a one-off but a recurring feature of a second term marked by "policy whiplash."

This sensitivity is tested by the economic data. Despite claims that tariffs have strengthened the economy, GDP growth was below average during the first nine months of 2025. Real GDP increased 2.51%, which falls short of the 10-year average. This challenges the narrative of robust, tariff-fueled expansion and suggests the economy's recent performance may have been propped up by factors like AI spending, not trade policy. A market priced for perfection is now facing a reality check on growth.

The bottom line is a convergence of forces. High valuations, a historical median drawdown of 19% in midterm years, and a policy-driven volatility that has already caused a sharp drop, all point to a market with limited margin for error. The setup is less about a repeat of the first-term anomaly and more about the market's ability to navigate a new, more uncertain baseline where the easy gains are gone.

Midterm Year Catalysts and Global Guardrails

The historical data now points to a specific catalyst: the midterm election year itself. The S&P 500 has suffered a median intra-year drawdown of 19% during these years, a pattern driven by the policy uncertainty that weighs on investor sentiment. This is not a prediction of a 19% drop in 2026, but a structural risk. The setup is for a year that often grinds, marked by high volatility and a wait-and-see posture as political campaigns heat up and legislative grids lock.

This volatility is already on display. The market's early 2026 performance has been a rollercoaster, with the S&P 500 closing in the red year-to-date at one point. Yet, this is largely a U.S. grind. A critical divergence is emerging: in early 2026, international stocks have outperformed U.S. stocks for the first time in years. This is a significant signal. It suggests global sentiment is finding resilience elsewhere, potentially acting as a guardrail against a broader U.S. crash.

Viewed another way, the market is in a "sentiment grind." It is volatile, but the surprise catalysts typically needed for a bear market-like a sudden policy reversal or a global shock-are absent. The catalysts here are domestic and political, concentrated in the U.S. electoral calendar. The global market divergence means that when U.S. risk appetite wanes, capital can flow to markets with quieter political cycles. This provides a natural buffer, even as the domestic setup remains pressured by high valuations and the historical midterm drawdown pattern.

The bottom line is a market caught between two forces. The structural risk of a midterm year is real, with a history of sharp intra-year declines. Yet, the current global market divergence offers a potential shield. The market's ability to navigate 2026 may depend less on a single U.S. shock and more on whether this international outperformance can sustain enough capital to offset the domestic volatility. For now, the grind continues, but the guardrails are in place.

Catalysts and Guardrails: What to Watch

The setup for 2026 is a test of whether historical patterns will reassert themselves or if the market can navigate a new, more uncertain baseline. The key signals to watch are not abstract concepts but specific events and metrics that will determine the path.

First, monitor tariff levels and government funding deadlines for signs of escalating policy uncertainty. The market's reaction to the nearly 20% drop in seven weeks triggered by tariff announcements in early 2025 remains a stark warning. While the subsequent rebound showed resilience, it also proved the market's sensitivity to political noise. The critical watchpoint is whether this volatility becomes a recurring feature. Any new wave of tariff announcements or looming government shutdown deadlines could quickly rekindle that fear, testing the market's already-stretched valuation.

Second, watch for a sustained break below the 2025 high in the S&P 500. The index has been within a percentage point of its record high as it enters the second year of the term. A sustained move below that level would signal that the relief rally has run its course and that the bear market risk associated with high valuations and midterm uncertainty is becoming real. This would be the clearest technical signal that a correction is underway.

Third, track the divergence between U.S. and international market performance. This is emerging as a crucial guardrail. In early 2026, international stocks have outperformed U.S. stocks for the first time in years. This gap is significant. It suggests capital is finding resilience elsewhere, potentially acting as a natural buffer against a broader U.S. crash. A widening gap could indicate a flight from U.S. risk, while a narrowing gap would signal that the U.S. market's volatility is being contained by its own strength.

The bottom line is that 2026 will be defined by these specific catalysts and guardrails. The market's ability to avoid a sharp decline hinges on whether policy uncertainty can be managed and whether the global divergence in performance can sustain enough capital to offset domestic volatility. For the rest of the year, these are the concrete signals to watch.