With the election now over, investors will shift their focus back to other economic considerations such as the Federal Reserve’s next rate decision, corporate earnings, and consumer spending. The fact that a significant source of uncertainty has been lifted could be enough to improve investor sentiment, as it has in past election seasons.
The week following the election saw significant gains across major indices. Financial markets have quickly pivoted from election results to focus on upcoming policy changes, monetary policy decisions, and economic fundamentals.
From a broad perspective, history shows that the stock market and economy have performed well under both parties over the past century. In the coming weeks and months, there will likely be both bullish and bearish predictions. When it comes down to it, long-term investors benefit from being prudent and staying invested, diversified, and focused on fundamentals.
Market valuations exceed historical norms
Looking beyond political developments, the economic environment shows strength. Following a period of elevated inflation driven by pandemic-related supply disruptions and stimulus measures, price pressures have moderated toward the Federal Reserve’s target. This improvement has enabled the central bank to begin easing monetary policy.
However, the sustained market rally since late 2022 has pushed valuations significantly above historical averages across multiple asset classes. The S&P 500’s price-to-earnings ratio is approaching levels last seen during the dot-com era peaks.
Market history demonstrates how sentiment can swing between extremes as investors respond to positive and negative developments. Similar patterns emerged after the 2016 election – initial enthusiasm gave way to volatility in 2018, followed by strength in 2019 before the pandemic shock of 2020. These cycles reinforce that markets rarely move uniformly upward, regardless of how favorable conditions may appear.
During uncertain times, valuation metrics serve as a reliable compass for investors. Over extended periods, few factors correlate more strongly with returns than whether markets are expensive or inexpensive relative to corporate earnings. While valuation metrics have shown not to be a reliable market timing tool, they do help set realistic long-term expectations.
Returns tend to be lower when valuations are elevated
Current market optimism reflects anticipated policy shifts including potential tax reforms, trade measures, regulatory changes and infrastructure spending. Similar enthusiasm drove markets higher after the 2016 election as investors anticipated pro-growth initiatives.
As renowned investor Benjamin Graham noted, “in the short run, the market is a voting machine but in the long run, it is a weighing machine.” This insight is particularly relevant now, as many richly valued assets like technology stocks and cryptocurrencies are susceptible to dramatic swings. While strong performance can make valuation concerns seem excessive, careful analysis remains vital precisely because picking individual winners is challenging.
The data shows that historically, high valuations often precede periods of muted or negative returns, especially when they occur late in economic cycles. While optimists hope for continued steady growth, even in positive scenarios, recent market gains may represent more muted returns being pulled forward.
Diversification remains important as multiple asset classes show strength
Rather than avoiding stocks, elevated valuations suggest taking a balanced approach. Careful portfolio construction using effective diversification into areas of the market where valuations are more favorable is a prudent approach. While the largest U.S. stocks have performed well, various other asset classes have also delivered positive results this year.
The valuation spread between small and value-oriented stocks compared to the overall market is close to its all-time high, informing investors that small value stocks look historically cheap. Further, International stocks continue offering more attractive valuations compared to U.S. markets. Despite recent pressure from rising rates, bonds maintain their role in providing income and portfolio stability during volatile periods. Rest assured; all of these asset classes are included in your evidence-driven portfolio.
The bottom line? Long-term investment success depends more on fundamental economic trends than short-term market movements. History shows the importance of maintaining balanced portfolios that can capture upside while providing for potential downside protection.
For informational and educational purposes only and should not be construed as specific investment, accounting, legal, or tax advice. Certain information is based upon third party data which may become outdated or otherwise superseded without notice. Third party information is deemed to be reliable, but its accuracy and completeness cannot be guaranteed. Data and analytics provided by Clearnomics, Inc. Neither the Securities and Exchange Commission (SEC) nor any other federal or state agency have approved, determined the accuracy, or confirmed the adequacy of this article.
