Why You Should Worry About This Market Signal

By Larry Benedict, editor, Trading With Larry Benedict

Consumer confidence soared following the election last November.

But the euphoria didn’t last long. In 2025, consumer moods have been down in the dumps.

This week, the Conference Board released its measure of consumer sentiment, the Consumer Confidence Index. It posted the largest monthly drop in over three years.

That came on the heels of the latest University of Michigan survey, the Consumer Sentiment Index. It showed consumer sentiment falling to the lowest level in 15 months.

Consumer views and feelings can impact spending habits. Plunging sentiment is already showing up in economic reports. For example, retail sales fell by 4.2% year-over-year in January.

And these consumer surveys paint a bleak picture for another economic stat.

It’s something that should concern anyone with money in the stock market. So today, let’s look at a key figure that needs to be on your radar…

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Surging Inflation Expectations

Consumer surveys ask a range of questions. That could be feelings about the present situation or how the economy might look down the road.

Critically, both of the surveys mentioned above also ask about inflation.

And this is where new concerns are growing.

The Conference Board’s measure saw inflation expectations over the next 12 months jump from 5.2% to 6%.

Michigan’s survey was even worse. The chart below shows expected inflation over the next 5–10 years:

(Click here to expand image)

Expectations rose to an annual rate of 3.5%. That might not sound like much, but it’s the highest level since 1995.

Much of the concern around the inflation outlook has to do with tariffs. Tariffs ranging from 10% to 25% could impact up to $1.3 trillion in goods.

Those extra costs will be passed along to consumers in the form of higher prices… hence the concern around the inflation outlook.

Even if tariffs don’t go through as expected, surging expectations should concern you. They can become a self-fulfilling prophecy.

If consumers expect higher prices down the road, they might pull forward future purchases. That bump in demand adds upward pressure on inflation.

That’s why economists pay so much attention to inflation expectations in these sentiment surveys.

And you should be paying close attention as well… because a bump in inflation could spell bad news for your portfolio.

Inflation’s Impact on Stocks

Higher inflation tends to hurt stock market valuations. We’ve already seen this play out in recent years.

From the start of 2021 into mid-2022, the Consumer Price Index (CPI) rose from 1.4% to 9.0%.

During 2022, the S&P 500 fell as much as 25% from its peak as inflation surged. Since then, inflation has come back in. The CPI was most recently sitting at 3.0%.

So it will be important to track CPI going forward… and watch its effect on stock market valuations.

The price-to-earnings (P/E) ratio is a popular way to measure valuations. It can show whether a company is over- or undervalued.

More specifically, it reveals how much investors will pay per dollar of earnings. If a company trades at a P/E multiple of 10x, investors are willing to pay $10 for $1 of current earnings.

With that in mind, here is how inflation can impact P/E ratios…

When inflation is running at a low range of 0% to 2%, the S&P 500 has seen an average P/E ratio of just over 18. But as inflation picks up, the average P/E starts dropping.

For example, when inflation is above 6%, the average P/E ratio gets cut by 35% or more. That’s a significant haircut on what people are willing to pay.

Now consumer surveys are pointing to higher inflation down the road. And the impact on the stock market could be severe.

That’s because stocks are trading at extreme valuations.

The S&P 500 trades at a P/E ratio of 21.9 based on expected earnings. That’s 30% higher than the long-term average.

The S&P’s P/E ratio is also near the early 2022 level… just before the last bear market set in.

So keep a close eye on inflation. If expectations come true, we could see sharp downward pressure on stock prices…

Happy Trading,

Larry Benedict
Editor, Trading With Larry Benedict