The Stock Market Flashes a Warning Seen Twice in 40 Years, and the Federal Reserve Has Bad News About President Trump's Tariffs

The S&P 500 is up ~16% YTD in 2025 but faces rising macro risk: a Federal Reserve Bank of San Francisco study (and other academic estimates) finds President Trump’s tariffs are likely to raise unemployment and shave about 0.5 percentage points off GDP growth in 2025–26, which would curb corporate earnings momentum. That vulnerability comes as the index trades at a forward P/E of 22.4 (Dec. 5), above 5- and 10-year averages and at valuation levels that, excluding the past year, have preceded two major drawdowns in the last 40 years; although 2025 earnings estimates have been revised higher (LSEG now sees roughly 13% growth vs. 8.5% in July), elevated multiples leave the market exposed to disappointing economic or earnings news. Practical takeaways for institutional investors: consider trimming low-conviction positions and building cash buffers given the asymmetric downside risk.

Analysis

The S&P 500 has gained roughly 16% year-to-date in 2025 even as macro risk from President Trump’s tariffs has risen; a Federal Reserve Bank of San Francisco study and Yale’s Budget Lab project tariffs will raise unemployment and shave about 0.5 percentage points off GDP growth in 2025–26, which would mechanically slow corporate earnings growth. The index traded at a forward price-to-earnings multiple of 22.4 as of Dec. 5, above the five-year average of 20 and the ten-year average of 18.7, leaving valuations elevated relative to history.

Excluding the past year, the S&P has only been above a 22x forward P/E twice in the last 40 years; both episodes preceded large drawdowns (about a 49% decline after the dot‑com cycle and roughly a 25% drop around the COVID shock). Fed Chair Jerome Powell has acknowledged that equity prices are ‘‘fairly highly valued,’’ underscoring sensitivity to negative economic or earnings surprises.

Consensus earnings estimates have been revised higher this year—LSEG now projects ~13% S&P earnings growth for 2025 versus a July consensus of 8.5%—which can partly justify current multiples, but the article highlights that any reversion in earnings momentum or adverse tariff developments would likely amplify downside. The piece’s recommended tactical responses are to trim positions lacking conviction and build cash cushions given asymmetric downside risk from combination of slowing GDP and rich valuation.

Key Decisions for Investors

• Trim or sell low‑conviction, high‑beta positions and reduce exposure to names you would not hold through a >20% market correction
• Increase cash or short‑duration liquid reserves to step into opportunities if tariffs or earnings disappointments trigger a market drawdown
• Monitor forward earnings revisions and tariff policy developments closely—if LSEG/consensus growth reverts toward the July 8.5% figure, materially de‑risk portfolios
• Consider modest hedges or lowering portfolio beta to protect against valuation‑driven downside while preserving optionality for a selective buyback on weakness