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The S&P 500 is up 16% in 2025, its third consecutive year of double-digit gains.
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Federal Reserve research shows President Trump’s tariffs will slow economic growth.
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The S&P 500 is trading at its most expensive valuation since the dot-com bubble burst in 2000.
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this S&P 500 Index (SNPINDEX:^GSPC) It would rise 16% in 2025, marking the benchmark index’s third consecutive year of double-digit gains. Unfortunately, investors have reason to think 2026 will be more challenging. There’s evidence that President Trump’s tariffs are hurting the economy, and the stock market just issued its last warning during the 2000 dot-com bubble collapse.
Here’s what investors should know.
In 2025, President Donald Trump broke with decades of trade policy precedent and imposed sweeping tariffs that raised the average tax rate on U.S. imports to 16.8%, the highest level since 1935, according to the Yale Budget Lab. Trump, who once called tariffs “the most beautiful word in the dictionary,” has made many misleading or inaccurate remarks to drum up support for his signature trade policies.
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Trump said foreign exporters would bear the tariffs to gain “privileged access” to the U.S. market. However, Goldman Sachs According to the report, by October 2025, U.S. businesses and consumers will jointly pay 82% of the tariffs, and by July 2026, 67% of the burden will be borne by consumers.
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Trump said the tariffs would bring manufacturing back to the United States. However, the Institute for Supply Management (ISM) said U.S. manufacturing activity has now shrunk for nine consecutive months due to economic uncertainty caused by tariffs.
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Trump said the tariffs would protect American workers and create millions of jobs. However, according to the U.S. Bureau of Labor Statistics, the unemployment rate is at its highest level in four years (excluding the pandemic) in 2025, and hiring is slowing more sharply than in any year since the Great Recession in 2009.
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Trump said the tariffs will make the United States rich again and people will be “very happy” with the results. However, consumer confidence in 2025 hit its lowest annual average since the University of Michigan began collecting data in 1960.
Importantly, U.S. GDP grew 4.3% year-on-year in the third quarter, the strongest growth in two years. President Trump attributes the booming economy to tariffs. However, because imports (deducted from GDP) are artificially low, GDP growth rates are artificially pushed up. Why is import volume low? Earlier this year, companies stocked up on inventory ahead of the tariffs.
Empirical evidence suggests that tariffs will be an economic headwind. Researchers at the Federal Reserve Bank of San Francisco reviewed 150 years of data and concluded that tariffs have historically led to higher unemployment and slower economic growth. Anything that’s bad for the economy is also bad for the stock market.
Economist Robert Shiller, Nobel Prize winner and Sterling Professor Emeritus at Yale University, proposed the cyclically adjusted price-to-earnings ratio (CAPE) as a means of determining whether an overall stock market index is overvalued. While the traditional price-to-earnings (PE) ratio is based on profits over the past four quarters, the CAPE ratio smooths out the natural fluctuations in the business cycle by averaging inflation-adjusted profits over the past ten years.
In December, the S&P 500’s average CAPE multiple was 39.4, its most expensive multiple since the dot-com bubble burst in October 2000. In fact, the S&P 500 has only had a monthly CAPE multiple above 39 25 times in its history, and the index generally declined over the following year.
The chart below shows the S&P 500’s best, worst and average returns over different periods after its monthly CAPE multiple exceeded 39.
|
time period |
S&P 500 best returns |
S&P 500’s worst return |
Average return of the S&P 500 Index |
|---|---|---|---|
|
1 year |
16% |
(28%) |
(4%) |
|
2 years |
8% |
(43%) |
(20%) |
|
3 years |
(10%) |
(43%) |
(30%) |
Data source: Robert Schiller. This chart shows the best, worst and average returns for the S&P 500 over different periods after a monthly CAPE ratio above 39.
As shown above, a monthly CAPE ratio above 39 does not mean that the S&P 500 is destined to collapse immediately. Although the index fell an average of 4% in a year following such high valuations, its returns ranged from plus 16% to minus 28% in this case.
However, as time goes by, the situation becomes more and more serious. After a monthly CAPE multiple of over 39, the S&P 500 falls an average of 20% over the next two years and 30% over the next three years. Worse, in this case, the index has never produced three years of positive returns.
Here’s the big picture: The S&P 500’s historically high valuations are a warning to investors, especially since President Trump’s tariffs could slow future economic growth. This doesn’t mean investors should sell all their stocks. But now is a good time to sell stocks in which you lack confidence. This is also a good time to build a cash position in your portfolio.
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Trevor Jennewine has no position in any of the stocks mentioned. The Motley Fool works for and recommends Goldman Sachs Group. The Motley Fool has a disclosure policy.
Stocks are sounding the alarm as investors receive bad news about President Trump’s tariffs. History suggests the S&P 500 will achieve this goal by 2026. Originally posted by The Motley Fool