Despite the economic uncertainty brought forth by the tax and trade policies of the Trump administration, the U.S. stock market is enjoying a great 2025.
The benchmark S&P 500 (SNPINDEX: ^GSPC) has gained 16% so far this year, which is almost twice as much as the average.
But the Federal Reserve recently issued a "silent warning" to investors over the state of the economy, and high stock market values have raised worries about an artificial intelligence (AI) bubble. In light of this, historical data indicates that the stock market will tumble in 2026 possibly substantially.
When the Federal Open Market Committee (FOMC) convened in December, an odd thing occurred. As anticipated, officials lowered interest rates by 25 basis points, but their opinions on the matter were noticeably divided. Three members of the FOMC dissented, and they did so in opposing ways.
Disagreements are rare. From October 2005 to November 2024, a span of 19 years, there was no dissent among FOMC members.
It is uncommon in recent memory to have three dissents at the same meeting. According to Torsten Slok, chief economist at Apollo Global Management, it last occurred in June 1988.
Theoretically, the stock market is negatively impacted by multiple dissents. The stock market detests ambiguity, and disagreements among experts over the best monetary policy indicate that economic conditions are hard to understand.
In this instance, the Federal Reserve's divide stems from President Donald Trump's tariffs. Since the average tax on U.S. imports has increased to its greatest level since the 1930s due to the combination of baseline and reciprocal tariffs, there is essentially no historical data at least not recent data to inform policy decisions.
Fed officials are in a challenging situation because tariffs have been linked to increased unemployment and inflation. If interest rates are too low, inflation will get worse, but if they are too high, unemployment will get worse. To put it briefly, policymakers cannot deal with both issues at the same time.
Inflation usually decreases as unemployment increases (and vice versa), but Trump's tariffs have caused economic distortion.
Three policymakers dissent at the most recent FOMC meeting is a "silent warning" because it highlights the uncertainty brought about by that economic distortion.
The last time three FOMC members dissented at the same meeting, readers might be wondering how the stock market did. Very nicely. Over the next year, the S&P 500 increased by 16%. But there was one crucial difference between that tragedy and this one: stock prices were more affordable in 1988.
In fact, Fed Chairman Jerome Powell stated in September that the Fed does not formally take a position regarding the appropriate value of any financial asset. "By many measures equity prices are fairly highly valued." And since he said that, valuations have simply continued to rise.
In November, the S&P 500's cyclically adjusted price-to-earnings (CAPE) ratio was 39.2, the highest level since the late 2000 dot-com bubble.
Since its creation in 1957, the index has only recorded a monthly CAPE ratio above 39 25 times, or roughly 3% of the time, and it has generally performed poorly during the following year.
Following a monthly CAPE rating above 39, the table displays the S&P 500's average return over the course of a year, along with its best and worst returns.
When the S&P 500's monthly CAPE ratio surpassed 39 in the past, the index experienced returns of up to 16% and declines of up to 28% during the following year. However, in those circumstances, the index fell by an average of 4%.
In summary, history indicates that the S&P 500 may rise or fall next year, but a slight dip is the most likely result. Naturally, past success should never be used as a predictor of future outcomes, but 2026 looks to be more difficult than 2025. Investors ought to get ready for that result.
