Why is the S&P 500 at risk of a crash? CAPE ratio, Fed rates and Trump policies raise concerns

The S&P 500 faces a crash risk as its Shiller CAPE ratio rises above 41, while inflation, Fed rate hike fears, Trump tariffs and bond volatility add pressure.

Updated on: Sep 6, 2026, 18:26:08 IST

Prefer HTon Google

Share via
Copy link

The S&P 500 is close to a record high, but investors may have a reason to be careful. The index is near its all-time high and could be heading for a fourth straight year of double-digit gains. But the strong performance may hide risks underneath the market.

One major warning sign is how expensive the S&P 500 has become. The S&P 500 Shiller CAPE ratio is now slightly above 41.The CAPE ratio has crossed 35 only twice before in the past 155 years. That makes the current level unusual.

The first warning came during the dot-com bubble. The CAPE ratio first crossed 35 in late 1999 and early 2000, when investors were paying extremely high prices for companies linked to the internet boom, according to The Motley Fool.

The CAPE ratio crossed the 35 mark for the second time in 2021, rising to above 38 by the end of that year. Stocks were again trading at very high valuations. Then rising interest rates hit the stock market. After the pandemic, inflation surged. The Federal Reserve then moved to sharply increase interest rates. Higher borrowing costs put pressure on stocks, sending the S&P 500 into a bear market in 2022.

Trump's policies add another layer of risk

President Donald Trump's policies could make the situation more complicated. Trump has introduced steep tariffs during his second term. Even after the US Supreme Court struck down Trump’s tariffs imposed under the International Emergency Economic Powers Act (IEEPA), he used other legal powers to bring in new tariffs, according to The Motley Fool.

Trump has said foreign countries pay these tariffs. However, several studies have found that US businesses and consumers bear most of the extra costs. These higher costs could also push inflation higher.

When American businesses face higher costs because of tariffs, some of those costs can be passed on to consumers through higher prices. This could push inflation higher, at least temporarily. Higher inflation could create a problem for interest rates.

If inflation stays high, the Federal Reserve could have less room to cut interest rates. Investors are also increasingly worried that rates could move higher instead. The Iran war has added another inflation risk. Trump also initiated the US attack on Iran. The conflict caused oil prices to jump, which pushed energy costs higher for Americans.

Markets are now pricing in a high chance of a Fed rate hike by year-end.According to The Motley Fool, CME Group’s FedWatch tool now puts the chances of a Federal Reserve rate hike by the end of the year at 87%, as concerns over inflation grow.

Higher interest rates are particularly dangerous when stock valuations are already high. When rates rise, borrowing becomes more expensive and bonds can become more attractive compared with stocks. That can put pressure on highly valued companies and the broader market.

This is similar to what happened in 2022. The Fed's aggressive rate increases in response to inflation helped trigger the 2022 bear market. A similar rate shock could create pressure again if inflation remains difficult to control.

US Treasury moves are another concern

The US Treasury is also creating uncertainty in the bond market. It has been buying back older, long-term bonds while issuing newer bonds with shorter maturities. This strategy has created volatility in long-term bond yields. Changes in Treasury borrowing can affect bond yields, and large movements in long-term yields can influence how investors value stocks.

That matters because stock valuations already have very little room for disappointment. With the CAPE ratio above 41, stocks are already expensive by historical standards. Higher and more volatile bond yields could therefore create another headwind for stock prices.

But a crash is NOT guaranteed

The warning signs do not mean that an S&P 500 crash is certain. The Motley Fool points out that investors should be careful about assuming that history will automatically repeat itself. Strong corporate earnings could change the picture. One major difference today is that companies could continue to deliver strong earnings growth. If profits rise quickly enough, today's expensive stock prices could become more reasonable.

FactSet found an important trend in the market. Strong earnings growth has been pushing the S&P 500's forward price-to-earnings multiple lower, rather than higher. In simple terms, companies earning more money can make their stock valuations look less expensive even when share prices remain high.

But history shows why investors should not ignore the warning. The CAPE ratio has crossed 35 only twice before, and both times were followed by major market downturns. Today's reading above 41 makes the warning particularly important.

The S&P 500 is not necessarily about to crash, but its historically high CAPE ratio is flashing a warning. Investors may want to pay close attention to earnings growth, inflation, interest rates and Treasury yields before assuming the current rally can continue indefinitely.

See Less