3 Reasons a Bear Market Could Be on the Way and How President Trump Could Accelerate Its Arrival

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3 Reasons a Bear Market Could Be on the Way and How President Trump Could Accelerate Its Arrival

watchlist :: 2025-03-03 :: source - motley fool

By Keith Speights

The first time Donald Trump served as U.S. president, the stock market enjoyed a strong bull market until the COVID-19 pandemic hit. Even then, stocks fell only briefly before quickly rebounding.

This time could be different. There are already concerning signs only weeks into the second Trump administration. Here are three reasons why a bear market could be on the way -- and how President Trump could accelerate its arrival.

1. Resurging inflation

The last S&P 500 (SNPINDEX: ^GSPC) bear market occurred in 2022. Skyrocketing inflation was the primary cause of the index's steep drop. Inflation became so high that the Federal Reserve increased interest rates 11 times beginning in March 2022. If there's anything that makes investors jittery, it's aggressive rate hikes.

Fortunately, the Fed's actions seemed to work. Inflation first peaked and then began a rapid decline. By the fourth quarter of 2024, the Fed was comfortable enough that inflation was under control that it cut interest rates twice.

US Inflation Rate data by YCharts

However, inflation is now rising again. The Fed's comfort level with further rate cuts has diminished significantly. And President Trump's actions could spark a resurgence in inflation that just might hasten the next bear market.

The president is a big fan of tariffs. He has already levied a 10% tariff on imports from China and wants to soon double the amount. His administration plans to soon impose previously delayed 25% tariffs on imports from Canada and Mexico, with Canadian energy imports having a lower tariff rate of 10%. Trump intends to place a 25% tariff on all imports of aluminum and steel as well as on all products imported from the European Union. He's also seeking reciprocal tariffs on all imports from other countries.

Most economists believe that tariffs will lead to higher inflation. U.S. trading partners don't pay the tariffs; importers do. Many of those importers will pass along their increased costs to American consumers.

Overall, the tariffs President Trump has said he would impose affect imports that comprise 4.8% of U.S. GDP, according to the Peterson Institute for International Economics. By comparison, the Smoot-Hawley tariff of 1930, which many economists think worsened the Great Depression, affected 1.4% of GDP.

It's possible that any tariffs President Trump imposes could be temporary. But tariffs aren't the only way he could cause inflation to rise. The White House's plans to deport millions of undocumented immigrants could also be inflationary. So could tax cuts which lead to higher budget deficits.

2. Rapidly declining consumer sentiment

Worries about inflation appear to be a primary reason behind The Conference Board's U.S. consumer sentiment index falling 10% in February. This is the steepest one-month decline since August 2021 and the lowest level for the index since 2022 (when the S&P 500 was in its last bear market).

Consumers aren't just worried about inflation, though. Stephanie Guichard, Senior Economist, Global Indicators at The Conference Board, said, "Consumers became pessimistic about future business conditions and less optimistic about future income. Pessimism about future employment prospects worsened and reached a ten-month high."

If consumers aren't confident about the future, they could curtail spending. This would, in turn, impact the sales and earnings of many companies. Ultimately, declining consumer confidence could (although not always) presage a bear market. Again, the Trump administration's actions that negatively impact consumer confidence could accelerate a stock market decline.

3. Sky-high market valuation

We should also keep in mind that the stock market's valuation is sky-high right now. The S&P 500 Shiller CAPE ratio, a widely followed valuation metric, is near its second-highest level ever. The last time it was higher was in early 2022 when the S&P 500 entered a bear market.

S&P 500 Shiller CAPE Ratio data by YCharts

Granted, stock valuations can remain at elevated levels for long periods. However, with the potential impact of tariffs coupled with declining consumer confidence, the chances of a bear market are arguably increased when stocks are trading at a steep premium.

What should investors do?

Maybe a bear market is on the way; maybe not. Either way, investors shouldn't panic. The best strategy is to focus on the long term. Only invest money you won't need for the next five years or more. This will provide plenty of time for your portfolio to recover if stocks fall.

The good news is that bear markets on average last less than 10 months. Even if the S&P 500 enters a bear market during President Trump's second term, the index could be in another strong bull market before he leaves office.

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Keith Speights 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.

3 Reasons a Bear Market Could Be on the Way -- and How President Trump Could Accelerate Its Arrival was originally published by The Motley Fool