Why Tariffs Prove Harmful to U.S. Economy: Stock Market Signals Escalating Risks

The relationship between tariffs and economic health reveals a troubling pattern. Despite the S&P 500’s 14% gain over the past year, mounting evidence suggests that tariffs—a centerpiece of recent U.S. trade policy—are actively harming employment, manufacturing, and consumer welfare. The dangers are becoming impossible to ignore, especially as the stock market trades at valuations that historically precede significant declines.

The Tariffs Trap: When Policy Backfires on Jobs and Growth

When the Trump administration implemented aggressive tariff policies, officials promised these measures would boost American manufacturing and create jobs. Reality tells a different story. Research from Goldman Sachs reveals the fundamental problem with how tariffs function: U.S. companies and consumers, not exporters, absorb the vast majority of tariff costs. In October 2025, Goldman’s analysis showed that 82% of tariff expenses fell on domestic businesses and household consumers. More troubling still, Goldman estimates that by July 2026, consumers alone will bear 67% of the total tariff burden.

The employment situation demonstrates why tariffs produce counterintuitive results. The Institute for Supply Management reports that U.S. manufacturing activity has contracted for 10 consecutive months—directly contradicting administration promises about reviving domestic production. Meanwhile, the Bureau of Labor Statistics data for 2025 shows the U.S. economy added only 584,000 jobs throughout the year. Outside of the 2020 pandemic period, this represents the weakest job market performance since the Great Recession. These figures underscore a harsh reality: tariffs have coincided with economic weakness in the job market rather than the promised expansion.

Federal Reserve researchers examined 150 years of historical data on trade policy and reached a definitive conclusion: when governments raise tariffs, unemployment increases while GDP growth declines. This historical pattern directly undermines the core arguments for recent tariff escalation.

Trump’s European Trade War Escalates with Greenland Tariff Threat

The administration’s tariff strategy has now engulfed Europe in new trade tensions. President Trump has demanded that Denmark sell Greenland to the United States, citing national security concerns about the Arctic territory’s strategic location. When Denmark and Greenland’s leaders repeatedly refused, Trump responded with economic pressure: tariff threats.

The president threatened to impose 10% tariffs on eight European allies—Denmark, Finland, France, Germany, Norway, the Netherlands, Sweden, and the U.K.—beginning in February. If these countries don’t agree to Greenland’s sale by June, the tariff rate will automatically escalate to 25%. These new tariffs would layer onto existing duties (currently 15% for most European goods and 10% for U.K. products), potentially reaching devastating levels.

The economic stakes are substantial. These eight nations collectively account for more than 13% of U.S. imports, making them as important to American trade as China or Canada individually. The European Union has signaled it won’t accept such tariffs passively: Brussels plans to retaliate with $100 billion in tariffs on U.S. exports. This dynamic encapsulates why tariffs ultimately damage rather than help the economy. The threat of escalating trade wars creates uncertainty, disrupts supply chains, raises business costs, and pushes consumers toward higher prices—all while reducing the economic growth that governments claim to seek.

Extreme Valuation Meets Policy Uncertainty: Historical CAPE Ratios Warn of Stock Market Risk

While tariffs have stalled economic growth, stock valuations have reached concerning extremes. The S&P 500’s cyclically adjusted price-to-earnings (CAPE) ratio hit 39.9 in December 2025—the highest level since the dot-com crash of October 2000. This metric matters because it reveals what investors collectively are paying for each dollar of corporate earnings, adjusted for economic cycles.

The historical context is alarming. Since the S&P 500’s creation in 1957, the index has only recorded a monthly CAPE ratio above 39 during 25 months total—meaning it has operated at such extreme valuations just 3% of the time in its entire history. Each of those periods carried substantial risks for investors.

When examining what happened historically after the CAPE ratio exceeded 39, the data paints a cautionary picture:

One-year forward returns: The best case scenario saw 16% gains, but the worst case delivered a 28% loss. On average, the index declined by 4%.

Two-year forward returns: Best-case gains reached 8%, while worst-case losses hit 43%. The average result was a 20% decline.

Based on this historical pattern, if the market follows its previous behavior, the S&P 500 should decline approximately 4% by January 2027 and 20% by January 2028. Of course, past performance provides no guarantee of future outcomes. Some investors argue that artificial intelligence will generate sufficient profit growth to justify higher valuations, potentially allowing the index to continue rising while its CAPE ratio normalizes. However, that outcome remains speculative.

What Investors Should Do When Tariffs and High Valuations Collide

The combination of deteriorating economic conditions from tariffs and extreme stock valuations creates a uniquely challenging environment. Investors should reassess their portfolio construction with several objectives in mind.

First, review your current holdings with honest scrutiny. Identify any positions you would feel uncomfortable maintaining through a steep market decline. If a drawdown seems probable—and historical CAPE ratios suggest it is—now is the appropriate time to make defensive changes rather than waiting until losses mount.

Second, build a cash position. Having readily available capital provides optionality during market dislocations. When stock prices decline sharply, cash reserves enable investors to purchase quality assets at attractive valuations rather than being forced into passive observation.

Third, recognize that diversification beyond the broad S&P 500 warrants serious consideration. The index represents an average of current market prices and valuations; it doesn’t always prove optimal during periods of transition or stress.

The Motley Fool’s analyst team has identified securities they believe offer superior risk-adjusted returns under current conditions. Historical examples—such as Netflix recommendations made on December 17, 2004 (which would have generated $474,578 on a $1,000 investment) or Nvidia recommendations from April 15, 2005 (yielding $1,141,628 on a $1,000 position)—demonstrate the value of strategic security selection during uncertain periods.

Ultimately, tariffs have proven harmful to economic growth and employment, contradicting their intended purpose. Combined with historically elevated stock valuations, the risk environment warrants careful portfolio management and thoughtful preparation for potential downside scenarios.