The 'Trump Bump' in the Stock Market Could Become a 'Trump Dump'

Since Inauguration Day 2021, the S&P 500 has risen roughly 51%. Yet, many people seem certain that these substantial gains will continue under Donald Trump's second term, as if this success can be easily replicated. This optimism may partly stem from the rally seen in the week following his victory, though it's important to remember that a single week, even a strong one, doesn't guarantee future trends.

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To those optimistic about a continued “Trump bump,” here’s something to consider: Warren Buffett, the legendary investor and CEO of Berkshire Hathaway, has been selling shares of companies like Bank of America and Apple while building Berkshire’s cash reserves to an impressive $325 billion. Buffett’s recent moves raise the question: why are others buying when one of the most respected figures in finance is offloading stocks? What insights might Buffett have that others are overlooking?

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Buffett, now 94 and still an avid student of market history, likely recognizes some concerning signals that respected market indicators are flashing. For example, the Shiller CAPE ratio—a valuation metric that compares stock prices to the average inflation-adjusted earnings over the past decade—is higher than it’s been 97% of the time since the 1880s. This level of elevation was also seen before the major crashes in 1929 and 2008. Such an inflated CAPE ratio suggests that stocks may be significantly overvalued, a warning sign Buffett, a value investor known for avoiding overpaying, does not ignore.

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Another key measure, aptly named the “Buffett Indicator,” compares the total market value of U.S. stocks to the country’s GDP. Currently, this ratio is higher than it’s been in over fifty years. Buffett himself has often described this indicator as the best gauge of overall market valuation. Given Buffett's track record of achieving a 19.8% annualized return from 1965 to 2023—almost double the S&P 500’s 10.1%—his cautious shift towards cash could be wise. Buffett’s well-known advice, “Be greedy when others are fearful, and fearful when others are greedy,” may sound like a cliché, but it holds true when assessing potential risks.

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However, just because these historical indicators suggest that stocks are overvalued doesn’t mean a market downturn is imminent. As another respected value investor, Seth Klarman, CEO of the Baupost Group, has pointed out, overvaluation is not always immediately clear to everyone in the market. Klarman notes that stock prices often reflect perceptions rather than reality, meaning that inflated valuations can persist for extended periods.

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But looking ahead, 2025 could bring challenges, especially with Trump’s continued focus on tariffs. While Trump and his advisers may support a trade war, few believe it will benefit American consumers. Trade conflicts can lead to inflationary pressures, which in turn harm consumer purchasing power. Additionally, a tariff war could introduce tensions with major trading partners in Europe and Asia.

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Since over 41 million American jobs rely on international trade—a figure that has nearly tripled since 1992 due to trade liberalization policies—the potential impact of trade restrictions is a point of concern. The U.S. Chamber of Commerce, a pro-business organization, has highlighted the substantial role that trade plays in American employment. Furthermore, Trump’s earlier tariff policies did not yield the expected results, as studies show his tariffs actually cost the U.S. approximately 250,000 jobs and increased the trade deficit.

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What could drive stocks higher in Trump’s second term? Corporate profits, which have surged in recent years, could continue to grow, especially if tax cuts from Trump’s first term are extended. However, any potential economic growth from tax cuts might be offset by a swelling deficit and rising interest rates, according to many economists.

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Trump’s promises to reduce regulatory burdens might provide some economic lift, as was seen in his first term, but the impact of such measures on the stock market and individual portfolios is difficult to quantify.

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Another Trump policy that has piqued investors’ interest is his vow to shrink the federal government, which is widely seen as overextended. Yet, this perception may not reflect reality. According to the St. Louis Federal Reserve, the federal workforce stands at about 3 million employees—nearly the same number as in 1989 at the end of Ronald Reagan’s presidency, despite the population growth. Back then, those 3.1 million workers accounted for 1.2% of the U.S. population, whereas today, they make up only about 0.9%.

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Despite the establishment of significant federal departments like Homeland Security, the federal workforce has slightly decreased both in absolute and relative terms. When it comes to government spending, as a share of GDP, net federal expenditure is only marginally above its historical average, with some increase during Trump’s first term due to pandemic relief efforts.

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If reducing government size is truly the goal, state and local governments might be a better target. Their combined workforce is approximately 20.5 million—seven times larger than the federal workforce. However, complaints about “big government” are often aimed at the federal level, despite the substantial presence of state and local employees. So, if downsizing government is on the agenda, perhaps focusing on state and local levels would yield more impact.

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Given these various factors, it’s worth questioning whether Trump’s second term will indeed boost the stock market as many expect. While stocks performed well during his first term, they also thrived under Biden, and they achieved even higher returns during Obama’s administration. Investors who choose to “back up the truck” and invest heavily in stocks during this period of uncertainty might do so confidently, but they should remember that seasoned investors like Buffett, Shiller, and Klarman may not be following that same course.

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