Over the past year, the S&P 500 index has advanced approximately 14%, a noteworthy achievement given the backdrop of President Trump's tariffs, which have elevated the average tax on U.S. imports to levels not seen since 1935. While the market's upward trajectory offers encouragement to investors, underlying economic and geopolitical factors prompt concerns about the sustainability of this performance.
President Trump originally asserted that exporters would bear the brunt of the tariff measures. However, research from Goldman Sachs indicates that in October 2025, American companies and consumers together absorbed approximately 82% of the tariffs imposed. Moreover, projections suggest that by July 2026, U.S. consumers alone are expected to shoulder 67% of these additional costs, underscoring the wider economic impact on the domestic population.
Efforts to revitalize domestic manufacturing through tariffs have not yielded the anticipated uptick. Data from the Institute for Supply Management (ISM) reveals that U.S. manufacturing activity has contracted for ten consecutive months, countering claims that tariffs would stimulate factory growth. In addition, President Trump's promise that tariffs would spawn new jobs in the United States has yet to materialize significantly. According to the Bureau of Labor Statistics, the economy added only 584,000 jobs in the past year. Excluding the pandemic-induced changes in 2020, this pace is weaker than any period experienced since the Great Recession.
Recently, investor concerns have intensified with developments signaling an escalation in trade tensions. The timing compounds worries, as the S&P 500 valuation levels are exhibiting warning signs reminiscent of the dot-com crash era. Understanding the details of these dynamics is crucial for evaluating potential risks to the market and economy.
Renewed Trade Frictions with Europe
President Trump has placed Greenland, a strategically significant autonomous territory owned by Denmark, at the center of a heated dispute. Despite explicit rejections from Greenlandic and Danish authorities—and the expressed desire of Greenland's residents to remain outside U.S. jurisdiction—the president has insisted that the United States should acquire Greenland due to its national security importance.
In a recent escalation, the president threatened to levy new tariffs on eight European countries allied with Denmark unless Greenland is sold to the United States. The nations opposing the sale include Denmark, Finland, France, Germany, Norway, the Netherlands, Sweden, and the United Kingdom. The president has warned that imports from these countries will be subjected to a 10% tariff starting in February, increasing to 25% in June if a transaction does not occur. This proposal links economic penalties directly to geopolitical aims focused on Greenland’s ownership.
Although detailed tariff specifics have not been released, these new charges would likely be additive to existing tariffs, which stand at 15% for most products from European Union countries and 10% for most from the United Kingdom. Economically, these threatened tariffs could inflict harm on the U.S. given that these European nations represent 13% of U.S. imports, a share comparable to that of China or Canada. Compounding the economic implications, the European Union has declared plans to retaliate with tariffs on $100 billion of U.S. exports, signalling a potential escalation in trade hostilities.
Historical Data Highlight Economic Risks of Tariffs
Recent analysis by Federal Reserve economists examining 150 years of data reinforces concerns about tariff increases. The researchers concluded that hikes in tariffs are associated with rising unemployment rates and a reduction in gross domestic product growth, highlighting the adverse macroeconomic effects of protectionist trade policies.
S&P 500 Valuations Reach Heightened Levels
The S&P 500 valuation, as measured by the cyclically adjusted price-to-earnings (CAPE) ratio, reached 39.9 in December. This valuation metric has not been recorded at such a high level since the dot-com bubble in October 2000. Since the index's establishment in 1957, the CAPE ratio has exceeded 39 during only 25 months, meaning the market is in the extreme valuation tier just 3% of the time historically.
Historically, entering periods with a CAPE ratio above 39 has corresponded with challenging market returns. For example, average outcomes following such valuation peaks show a 4% decline in the S&P 500 over the subsequent year and a more pronounced 20% reduction over the next two years. While best case scenarios have seen the market increase by up to 16% within a year, the likelihood of negative returns is substantial based on historical precedents.
While these trends highlight potential risks, some investors argue that unique factors today—such as the growth of artificial intelligence and its expected enhancement of profit margins and earnings growth—may justify higher valuations and sustain market appreciation. Nonetheless, such perspectives remain speculative, and investors may find it prudent to reassess their portfolios to mitigate downside risk. Maintaining liquidity could position investors to capitalize on potential market declines for future opportunities.