Could Tariffs and Fed Warning Trigger 2026 Stock Crash?

Understanding the Potential Risks to the Stock Market

The S&P 500 currently trades at valuations that sit near the top of their historical spectrum, raising significant concerns among investors. Recent analyses indicate that President Trump’s tariff policies could act as a substantial drag on economic expansion, amplifying these worries. At the close of January, the S&P 500 exhibited a forward price-to-earnings ratio exceeding 22, a level deemed quite elevated and one that has frequently signaled the onset of bear markets in the past.

This precarious situation draws heightened attention because multiple studies now project that the tariffs will hinder growth, contrary to some optimistic projections. While lofty valuations by themselves might prompt a downturn in stock prices, the introduction of tariffs as a genuine economic obstacle could precipitate a more dramatic fall or even a full-blown market crash.

Back in September, Federal Reserve Chair Jerome Powell explicitly cautioned market participants about the high cost of equities. Despite this advisory, the S&P 500 has managed to climb approximately 3% since that statement. Although this gain is modest, it suggests that investors have partially discounted the Fed’s concerns and continued their buying activity.

What investors need to grasp is the interplay between these elevated valuations and the emerging tariff-related challenges. These factors combined could create a perfect storm for the markets, particularly if economic indicators begin to weaken noticeably.

Tariffs Under President Trump: The True Cost to American Businesses and Consumers

President Trump’s tariff initiatives have dramatically increased the average tax levied on goods entering the United States, pushing it up roughly five times to around 13%. Some estimates vary slightly, placing it a bit higher or lower, but overall, this marks one of the steepest import tax rates seen in nearly a century.

The former president has repeatedly maintained that these tariffs bolster the domestic economy and that the financial load primarily rests on overseas producers and intermediaries, sparing American entities. Recent scholarly research, however, paints a starkly different picture, demonstrating that U.S. firms and households shoulder the vast majority of these costs.

• A study from the National Bureau of Economic Research concludes that the expenses are predominantly absorbed domestically, with foreign exporters failing to reduce their prices significantly. Researchers calculated that American companies and consumers covered 94% of the tariff burdens in 2025.
• Findings from the Federal Reserve Bank of New York reveal that most of the tariff impacts continue to hit U.S. businesses and buyers. In November, they assessed that overseas sellers offset just 14% of the costs, leaving 86% for Americans to bear.
• Analysis by the Kiel Institute emphasizes that nearly all tariff expenses land on American importers and end-users. Their data shows foreign producers absorbing only 4%, with a whopping 96% passed directly to U.S. purchasers.
• The Congressional Budget Office projects that foreign exporters will take on about 5% of the tariffs, with the balance of 95% distributed between domestic companies and consumers.

Viewed holistically, each dollar extracted via tariffs from U.S. businesses and individuals represents funds that could otherwise circulate through the economy via spending or investment. This reduction in available resources diminishes overall purchasing power, thereby dampening economic activity and growth prospects.

These tariffs effectively function as a tax on imports, redirecting money from productive uses into government coffers. The downstream effects ripple through supply chains, raising input costs for manufacturers, increasing prices for retailers, and ultimately squeezing household budgets. This chain reaction can curtail consumer spending, which forms the backbone of the U.S. economy.

The Federal Reserve’s Stark Valuation Alert for Investors

The Congressional Budget Office has forecasted that the tariffs enacted under the Trump administration will lead to a lower real gross domestic product than would occur without them. Such a projection spells trouble for equities, as subdued growth typically translates to weaker corporate profits. Stock valuations, fundamentally tied to earnings multiples, become vulnerable under these conditions.

This unfavorable outlook arrives amid a period where the S&P 500 has lingered at premium valuations for an extended stretch. Fed Chair Powell’s September remarks highlighted that equity prices appeared fairly highly valued. The Federal Reserve’s November Financial Stability Report reinforced this by noting the S&P 500’s forward price-to-earnings ratio hovered near the upper boundary of its historical distribution.

Conditions have not ameliorated since then. Closing January at a forward P/E of 22.2, the index significantly outpaces its 10-year average of 18.8. Over the past four decades, the S&P 500 has upheld comparable valuations in just two instances: the dot-com era and the COVID-19 crisis. Each episode culminated in bear markets, with the index plummeting 49% and 34%, respectively.

Importantly, forward P/E metrics rely on projected earnings, implying that even if those estimates materialize precisely, stocks remain pricey relative to history. Should tariffs erode earnings below expectations—a scenario growing more plausible—the market faces risks of a sharp correction or outright crash.

Investors might wonder if it’s time to liquidate holdings entirely. Such a move is ill-advised, as market timing often proves futile and costly. Positive developments, like productivity surges from artificial intelligence, could counteract tariff-induced slowdowns, potentially sustaining stocks despite stretched valuations. Prudence dictates entering positions gradually, favoring smaller initial allocations and selecting resilient holdings capable of weathering volatility.

Beyond immediate tactics, diversification remains key. Spreading investments across sectors less exposed to trade disruptions—such as domestic services or tech innovators—can mitigate risks. Monitoring economic data releases, earnings reports, and policy updates will be crucial for navigating this uncertain terrain.

In summary, while a 2026 crash is not inevitable, the convergence of tariff headwinds and lofty valuations warrants vigilance. History underscores that markets at these levels, facing growth impediments, have previously delivered painful lessons. Thoughtful positioning now could preserve capital through potential turbulence ahead.