The Stock Market Flashes a Warning as Investors Get Bad News About President Trump’s Economy. History Says This Will Happen Next.

The U.S. stock market has overcome economic headwinds to deliver solid returns this year. The S&P 500 (SNPINDEX:^GSPC) and the Nasdaq Composite (NASDAQINDEX:^IXIC) have advanced 14% and 18%, respectively. But investors recently got bad news about the economy, and the blame lies with inflationary pressure created by President Trump's tariffs and his decision to launch military operations in Iran.

Consumer sentiment continued to decline in October, reaching its second-lowest level in history. Meanwhile, the S&P 500 is sounding an alarm for the first time since the dot-com crash in 2000. Here's what it means for the stock market.

President Donald J. Trump speaks from a podium. Image source: Official White House Photo.

Consumer sentiment continued to fall in October, reaching its second-lowest level on record

Each month, the University of Michigan publishes the Index of Consumer Sentiment (ICS), a metric based on a 50-question survey covering personal finances, business conditions, and buying conditions. Higher scores indicate that consumers are more confident in their financial situation and the overall economy, while lower scores indicate a more pessimistic outlook.

Consumer sentiment fell to 46.3 in October 2026, the second-lowest reading since the University of Michigan began collecting data in 1952. Persistent inflation was the primary reason for the drop. The latest survey results show consumers think inflation will reach 4.7% in the next year. Year-ahead inflation expectations have risen substantially from 3.4% in February because the Iran war has disrupted global oil supplies.

Low consumer sentiment is bad news for investors because consumer spending accounts for two-thirds of gross domestic product (GDP), making it the primary engine of economic growth. The stock market is forward-looking, meaning share prices reflect expectations concerning future corporate financial results. A decline in consumer sentiment can pressure stocks by raising concerns about slower economic growth and weaker corporate earnings.

Historically, weakening consumer sentiment has often been a precursor to stock market losses. Here are two recent examples:

• Consumer sentiment peaked at 96.9 in January 2007, then fell to 55.3 by November 2008. Meanwhile, the S&P 500 peaked in October 2007, then dropped 57% by March 2009.
• Consumer sentiment peaked at 88.3 in April 2021, then fell sharply to 50 by June 2022. Meanwhile, the S&P 500 peaked in January 2022, then dropped 25% by October 2022.

In short, consumer sentiment has historically peaked and bottomed ahead of the stock market. That makes the recent weakness particularly concerning: Since Donald Trump returned to the White House in January 2025, consumer sentiment has averaged 54.7, down from 74 in December 2024. That persistent pessimism hints at a potential stock market downturn.

The stock market flashes a warning last seen during the dot-com bubble

The S&P 500 had a cyclically-adjusted price-to-earnings (CAPE) ratio of 40.6 in September. That is well above the 20-year average of 27.8. In fact, excluding the current year, the stock market has not been so expensive since the dot-com crash in September 2000.

More alarmingly, the S&P 500's CAPE ratio has only topped 40 in 26 months since the index was created in January 1957, meaning the stock market has only been more expensive 3% of the time throughout history. And past incidents have generally preceded big losses.

The chart below shows the S&P 500's best, worst, and average returns over different time periods after recording a monthly CAPE ratio of at least 40.

Data source: Robert Shiller, YCharts.

There are two noteworthy data points in the chart. First, the S&P 500 has generally declined over the one-year and two-year periods after a monthly CAPE ratio of at least 40. Second, the S&P 500 has never delivered a positive three-year return following a monthly CAPE ratio of at least 40. In short, history says the S&P 500 could decline 30% by October 2029.

Of course, past performance is never a guarantee of future results, and the chart above is based on a relatively small data set. Additionally, the CAPE ratio is a backward-looking indicator, meaning it does not account for the possibility that S&P 500 earnings could grow faster in the future as artificial intelligence drives efficiency and productivity gains.

Nevertheless, the stock market is historically expensive, so investors should be cautious in the current environment. That means focusing on quality stocks and never purchasing any stock you aren't prepared to hold through volatility.

Trevor Jennewine has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.