Trade policies, inflation, and stretched market valuations are creating a fragile setup for global markets as we move into the latter half of 2025. With tariff policies once again making headlines, particularly those proposed by former President Trump, investors are watching closely. Could these tariffs act as a catalyst for a sharp market correction? Given the already high valuations in global equity markets, even a small economic shock could set off significant declines. Let’s examine how proposed tariff hikes might impact an already overheated market.
How Tariffs Could Disrupt Markets
Trade wars are not new, and history shows they come with a cost. The tariffs implemented during 2018-2019 had measurable effects on economic growth. Data from the Tax Foundation indicates that the Trump-Biden Section 301 and Section 232 tariffs trimmed long-term U.S. GDP by about 0.2% and reduced capital investment by 0.1%. These trade restrictions also contributed to the loss of approximately 142,000 full-time jobs.
The cumulative impact has been significant. Since the start of the trade war, tariffs have led to over $264 billion in customs duties collected from U.S. importers. While $89 billion of this was collected under Trump, the Biden administration accounted for the remaining $175 billion. While these numbers might seem abstract, the effects are real, households have felt the pinch through higher costs, with estimates suggesting that trade war tariffs have effectively added $200 to $300 in extra tax burdens per U.S. household.
The intersection of trade policy, inflation dynamics, and market valuations presents a concerning picture for global financial markets as we head into the latter part of 2025. Current data suggests that escalating tariff policies, particularly those proposed by President Trump, could become a significant catalyst for market corrections against the backdrop of historically elevated valuations. The combination of trade-induced inflation pressures and stretched market metrics creates a particularly vulnerable environment where even modest economic disruptions could trigger outsized market responses. The following analysis examines how proposed tariff increases might impact global markets that are already exhibiting bubble-like characteristics.
Inflationary Consequences of Trade Disruptions
Federal Reserve research provides compelling evidence of how trade disruptions translate into domestic inflation. A shock that increases trade costs of intermediate goods by 10 percentage points leads to a 0.3 percentage point increase in CPI inflation within the first year. Similarly, an equally sized shock in final goods trade costs leads to a 0.5 percentage point increase in CPI inflation. Combined, these effects can result in a 0.8 percentage point increase in inflation that takes several years to fully dissipate.
The persistence of these inflationary effects varies based on the type of goods affected. Higher costs for final goods trade, such as tariffs on consumer products like washing machines, produce larger but more short-lived effects on inflation. In contrast, higher costs for intermediate goods, like semiconductors or imported components used in manufacturing, have more persistent inflationary effects by adversely impacting firm productivity. This distinction is particularly relevant when considering the broad-based tariffs that have been proposed, which would affect both intermediate and final goods across multiple sectors.
Market Valuation Metrics: Signs of a Bubble
Elevated Shiller CAPE Ratio
The cyclically adjusted price-earnings (CAPE) ratio, developed by economist Robert Shiller, serves as a critical indicator of long-term market valuations. As of March 1, 2025, the S&P 500 Shiller CAPE ratio stands at 35.37, representing a 4.8% increase year-over-year. This level far exceeds the historical median value of 15.99 and even surpasses the typical value range of 27.06 to 34.32. While not yet at its all-time high of 44.2, the current ratio remains significantly elevated by historical standards, suggesting potential overvaluation in the market.
The Shiller CAPE ratio has historically been a reliable predictor of future returns, with higher ratios typically associated with lower returns over subsequent decades. The current ratio of 35.37 is more than twice the historical median, placing the market in territory that has historically preceded major corrections.
The Buffett Indicator: Market Cap to GDP
Perhaps even more concerning is the ratio of total market capitalization to GDP, often referred to as the “Buffett Indicator.” As of March 4, 2025, this ratio stands at 194.2%, indicating that the value of all publicly traded US stocks is nearly double the size of the entire US economy. This represents a 6.22% increase from the previous year when the ratio stood at 184.9%.
For context, the historical median value of this ratio is just 79.8%, with a typical range between 125% and 178.1%. The current level of 194.2% is approaching the all-time high of 204.9%. Warren Buffett himself has suggested that this indicator serves as a warning sign when significantly elevated, as it reflects potential disconnects between financial market valuations and underlying economic fundamentals.
Price-to-Book Ratio Escalation
The S&P 500 price-to-book ratio provides additional evidence of stretched valuations. As of Q3 2024, this ratio stands at 4.941, representing a 3.08% increase from the previous quarter and a remarkable 24.00% increase from one year earlier. This significant year-over-year expansion reflects how rapidly valuations have extended beyond historical norms and suggests potentially unsustainable momentum in market prices relative to companies’ underlying asset values.
Tariffs and Market Vulnerability
Potential Inflation Spiral
The combination of already elevated market valuations and the prospect of higher tariffs creates a particularly precarious situation. If the proposed tariffs are implemented, they would likely accelerate inflation through both direct and indirect channels. Beyond the immediate price increases for imported goods, tariffs would disrupt supply chains, increase input costs for domestic manufacturers, and potentially trigger wage pressures as companies compete for labor in a more expensive environment.
The Federal Reserve research indicating that a combination of intermediate and final goods trade cost increases could add 0.8 percentage points to inflation suggests that comprehensive tariff policies could meaningfully exacerbate existing inflationary pressures. This becomes particularly concerning when considering the already tight labor market and persistent inflation in service sectors.
Federal Reserve Policy Responses
Higher inflation stemming from tariff implementation would likely necessitate a more hawkish monetary policy stance from the Federal Reserve. This could translate into higher interest rates and extended periods of monetary tightening, directly challenging the elevated market valuations that have been supported by accommodative monetary conditions.
Higher interest rates would impact markets through multiple channels. First, they would increase the discount rate applied to future corporate earnings, reducing present valuations. Second, higher borrowing costs would dampen consumer spending and corporate investment, potentially slowing economic growth. Third, they would make fixed-income investments relatively more attractive compared to equities, potentially triggering asset reallocation away from stocks.
Concentrated Market Risks
The vulnerability of US markets is further magnified by the concentration of gains in a small number of large technology companies, the so-called “Magnificent 7.” This concentration creates asymmetric risks, as these companies have significant global exposure that makes them particularly vulnerable to trade disruptions. For example, companies like Tesla, with extensive international supply chains and export markets, could face disproportionate impacts from retaliatory tariffs imposed by other countries in response to US trade actions.
Beyond the direct impact on US markets, escalating tariff conflicts would likely trigger retaliatory measures from trading partners. Historical evidence from the 2018-2019 trade war shows that retaliatory tariffs led to reductions in US GDP and employment. The Tax Foundation estimates that retaliatory tariffs stemming from Section 232 and Section 301 actions reduced US GDP and capital stock by less than 0.05 percent and reduced full-time employment by 27,000 full-time equivalent jobs.
The global nature of supply chains means that tariff impacts would be felt across multiple economies, potentially triggering synchronized slowdowns in economic activity and corporate profitability. This synchronized nature could amplify market corrections as investors simultaneously reassess growth expectations across different regions.
What This Means for Investors in Indian Markets
The key concern for markets isn’t just the direct cost of tariffs but their ripple effects. Tariffs drive up costs for businesses and consumers, fueling inflationary pressures. This can force central banks to keep interest rates higher for longer, which in turn weighs on corporate earnings and stock market valuations. The U.S. market, already trading at historically high price-to-earnings ratios, could become especially vulnerable to any external shock.
For Indian investors, global volatility can have knock-on effects. The Indian stock market has largely decoupled from global trends in recent years, but a major U.S. correction would still impact foreign fund flows. Investors should focus on portfolios built with strong fundamentals, companies with low debt, strong cash flows, and leadership in their industries.
India faces distinctive challenges in this environment. With its already elevated tariff structure, India has less room to respond to US tariff increases through retaliatory measures without further harming its own economy. While reducing tariffs and increasing imports could help contain domestic inflation, US tariffs on Indian exports would hurt sectors dependent on access to US markets.
India’s economy, while increasingly self-sufficient, still relies heavily on global markets for key inputs and export opportunities. Any significant disruption to global trade flows would impact India’s growth trajectory, potentially leading to valuation adjustments in its equity markets as well.
How to Position Your Portfolio
Trade tensions may come and go, but markets reward disciplined investors. The best way to navigate uncertainty is to stay focused on businesses with strong fundamentals and a proven track record of growth. As Warren Buffett says, “The stock market is designed to transfer money from the Active to the Patient.”
Rather than reacting to short-term headlines, investors should take a structured approach:
- Stick to Quality Stocks – The Roots & Wings philosophy at Maxiom helps in picking companies with strong balance sheets and consistent profit growth. These are the businesses that can withstand economic disruptions.
- Diversify Smartly – Relying too much on one region or sector increases risk. A well-balanced allocation across sectors can provide stability.
- Assess Interest Rate Impact – If inflation picks up due to tariffs, rate-sensitive sectors like banking and real estate may come under pressure. Keep an eye on how central banks respond.
Conclusion
The combination of historically elevated market valuations and the prospect of escalating tariff conflicts creates a concerning backdrop for global financial markets. The S&P 500 Shiller CAPE ratio of 35.37, the US market capitalization to GDP ratio of 194.2%, and the price-to-book ratio of 4.94 all suggest that US markets are priced for perfection, leaving little room for negative surprises.
The implementation of broad-based tariffs, as has been proposed, would likely trigger inflationary pressures requiring monetary policy responses that could challenge these elevated valuations. With the Federal Reserve research indicating that trade cost increases could add 0.8 percentage points to inflation, the stage may be set for a policy-induced market correction as central banks respond to tariff-driven price pressures.
Investors would be wise to consider these interconnected risks as they position their portfolios for the remainder of 2025 and beyond. The historical precedent suggests that when markets trading at elevated valuations face policy-induced economic headwinds, the corrections that follow can be substantial and prolonged. While timing such corrections remains notoriously difficult, the confluence of trade tensions and stretched valuations merits heightened vigilance and thoughtful risk management.