The S&P 500 index experienced a 16% increase throughout 2025, continuing a streak of three consecutive years with returns surpassing 10%. Despite this robust performance, various economic indicators associated with President Trump’s tariff policy suggest a potentially more difficult environment ahead in 2026.
In 2025, President Donald Trump implemented substantial tariffs on imported goods, elevating the average tax rate on U.S. imports to 16.8%, the highest since 1935 according to research by the Budget Lab at Yale. These trade policies diverged from historical norms and were promoted vigorously by the administration, which regarded tariffs positively. Nonetheless, the anticipated benefits touted by President Trump have not materialized as stated.
The administration predicted that foreign exporters would bear the cost of tariffs to maintain access to the U.S. market. However, analysis by Goldman Sachs revealed that U.S. businesses and their consumers absorbed the majority of these tariffs, with consumers expected to bear approximately 67% of the burden by mid-2026.
Further claims that tariffs would rejuvenate domestic manufacturing and create millions of American jobs have not aligned fully with economic data. The Institute for Supply Management reported that manufacturing activity in the U.S. declined for nine consecutive months amid tariff-driven uncertainty. Concurrently, unemployment rates reached a four-year peak, and hiring slowed considerably in 2025, excluding pandemic-related effects, marking the most subdued pace since the 2009 Great Recession, as per the Bureau of Labor Statistics.
Additionally, consumer sentiment plunged to its lowest annual average since records began in 1960 at the University of Michigan, contradicting assertions that tariffs would enhance general prosperity and satisfaction.
While the U.S. gross domestic product (GDP) grew at an annualized rate of 4.3% in the third quarter of 2025—the strongest growth in two years—the expansion was influenced partly by diminished imports. Imports were artificially suppressed because businesses accelerated inventory purchases ahead of tariff implementations, inflating GDP figures. Although the administration credited tariffs for fostering economic vitality, this growth does not fully reflect underlying economic conditions.
Historic analyses from the Federal Reserve Bank of San Francisco, examining data spanning 150 years, indicate that tariffs typically correspond with increases in unemployment and slower economic growth rates. Such economic headwinds create challenges for broader market performance and investor returns.
From a market valuation perspective, economist Robert Shiller, known for pioneering the cyclically adjusted price-to-earnings (CAPE) ratio, provides a framework for assessing market risk. Unlike traditional price-to-earnings (PE) ratios based on trailing-year earnings, the CAPE ratio averages inflation-adjusted earnings over the past decade, smoothing the effects of business cycle volatility.
In December 2025, the S&P 500’s average monthly CAPE ratio reached 39.4, a level last observed during the dot-com bubble peak in October 2000. Historically, monthly CAPE values exceeding 39 are rare, occurring only 25 times, and subsequent market returns following such peaks tend to be negative.
Reviewing the performance data on the S&P 500 after periods with CAPE ratios above 39 reveals the following:
| Time Frame | Best Return | Worst Return | Average Return |
|---|---|---|---|
| 1 Year | +16% | -28% | -4% |
| 2 Years | +8% | -43% | -20% |
| 3 Years | -10% | -43% | -30% |
It is important to note that while a CAPE above 39 does not guarantee an immediate market crash—with returns ranging from positive 16% to negative 28% over the ensuing year—it signals elevated risk, especially over longer durations. After such valuation spikes, average returns turn increasingly negative at two- and three-year horizons, with the S&P 500 never securing a positive three-year return following these peaks historically.
This combination of elevated market valuations and economic strain associated with tariffs underscores a cautionary outlook. The potential impact of tariffs on economic growth presents a tangible risk to the equity market. Investors might consider this a signal to reassess their portfolios, prioritizing positions in which they maintain strong conviction and possibly increasing liquidity by augmenting cash holdings.