• The S&P 500 forward price-to-earnings multiple is at its highest level in decades.

• The Federal Reserve found that Donald Trump’s tariffs may lead to higher prices in the long run.

• Although inflation is cooling, US unemployment is at its highest level in four years.

• 10 stocks we like better than the S&P 500 ›

From the closing bell on December 23, the S&P 500 (SNPINDEX: ^GSPC) had gained 17% by 2025, putting the index on pace for a third straight year of double-digit percentage gains.

Similar to the last two years, one of the most important themes that fueled the stock market throughout 2025 was artificial intelligence (AI). While the technology, energy and industrials sectors continue to drive the market to new highs, there was another variable that influenced the performance of the S&P 500 this year: andinvestor sentiment around President Donald Trump rates.

As 2026 approaches, investors are surely wondering how much longer the bull market can continue to rise. Below, I’ll break down some useful metrics that should help paint a picture of where the stock market could be headed next year. From there, we’ll delve into a recent report released by the Federal Reserve to assess the success of the new tariff agenda.

The S&P 500 currently has a forward price-to-earnings (P/E) multiple of 21.8, according to FactSet Research. For context, that’s about 10% above the index’s five-year average and 18% above its 10-year average.

Before the AI ​​revolution, the only other times in recent history that the S&P 500 had similar forward P/E levels were during the COVID-19 pandemic and the height of the dot-com bubble. Based on the chart below, investors can see that in both cases, the index declined sharply after reaching peak valuation levels.

To supplement the above analysis, let’s also look at the S&P 500 Shiller CAPE ratio. This figure represents companies’ earnings over a 10-year period relative to current stock prices.

Right now, the CAPE ratio stands at 40.7. There is only one other time in history when the CAPE ratio was anywhere near these levels: 2000, at the height of the Internet euphoria.

These dynamics raise the question: How sustainable is the current rally in the S&P 500?

Over the past few years, investors and economists have zeroed in on one specific metric: inflation. In 2022, inflation in the US reached 9.1%, the highest level in more than 40 years.

During his time on the campaign trail, then-candidate Trump used the inflation narrative to his advantage, claiming to have a solution to consumer frustrations. Specifically, Trump promised that if he returned to Washington, he would quickly enact a new tariff agenda. In April, the president followed through on that promise and announced a series of sweeping tariffs on nearly every country in the world, declaring it “Liberation Day” for Americans.

Throughout 2025, inflation levels have cooled modestly. So doesn’t that mean Trump was right and his tariff agenda worked? Well, the reality is much more nuanced.

In November, the Federal Reserve Bank of San Francisco released a detailed report on the tariffs and their impact on the economy. The takeaways were fascinating.

Generally speaking, tariffs are considered inflationary because they increase the prices of imported goods, which are then passed on by businesses to consumers. However, there is another side to this equation. When prices rise, consumers begin to cut back on spending. In turn, lower spending leads to slower economic growth, which subsequently puts downward pressure on inflation.

The victim in this scenario is usually the labor market, not the consumer. As companies face tighter margins due to rising cost of goods combined with slowing sales, they are being forced to downsize.

In essence, the Fed found that, in the short run, tariffs can lead to lower inflation and higher unemployment. That’s it exactly what is happening right now Although the consumer has experienced deflation (lower inflation) since Trump took office, the US unemployment rate of 4.6% is the highest it has been since 2021.

The long-term effects of tariffs are quite simple. Naturally, companies use moments like these to reorganize supply chains, and eventually the major players can regain their pricing power. Over time, inflation begins to rise gradually. In short, tariffs may help level the economy in the short run, but in the long run, higher costs are part of the economy’s price structure.

Given the details explored here, it would seem appropriate to say that the stock market is overvalued, or at the very least, has become increasingly frothy. Also, history suggests that stocks should undergo a correction in 2026.

From this point, longer-term data suggests that prices could start to rise and accelerated inflation rates could be in store, placing another burden on consumers and investors.

If you hold individual stocks, it may be better to reduce exposure to more volatile or speculative positions and hold long-term businesses that have proven resilient over several economic cycles. Also, I think now is a wise time to start stockpiling cash. If the market goes down next year, having extra cash in your portfolio will allow you to buy down quality assets at a discount.

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Adam Spatacco has no position in any of the aforementioned stocks. The Motley Fool has positions in and recommends FactSet Research Systems. The Motley Fool has one disclosure policy.

The stock market is showing a warning last seen decades ago, and the Federal Reserve just made President Trump’s tariffs even more risky. Here’s what the story says could happen next. was originally published by The Motley Fool