In recent trading days, global stock markets have seen massive losses in the wake of US President Donald Trump’s announcement of tariffs on almost every country in the world.
The announcement of America’s new approach to trade policy obliterated over $6 trillion in the first trading days afterward.
We examine the current landscape and historical precedents to see whether the stock market is likely to get worse and how bad it could get if it does.
What Is the Average Decline Going Into a Bear Market?
While a bear market is defined as a decline of more than 20%, the average bear market sees the S&P 500 drop by about 28%.
Each of the last four bear markets has seen a decline of 25% or more, and three of the four have been in excess of 30%.
Given that the S&P is “only” down about 18.4% at the time of this writing, history suggests that there could be considerably more room for stocks to slip if the index crosses the line into a true bear market.
Parallels to Smoot-Hawley the Nixon Shock
Two instances of sweeping tariffs in American economic history stand out as possible models.
The first is the infamous Smoot-Hawley tariff enacted at the beginning of the Great Depression, and the second is the less-remembered tariff regime placed on imports by Richard Nixon.
The Smoot-Hawley Tariff Act of 1930 hiked the average tariff on imported goods in the United States to about 40% in response to growing agricultural competition from abroad and the stinging effects of the first year of the Depression.
It’s worth noting, however, that America already had high tariffs by today’s standards in place before the act went into effect.
In the case of Smoot-Hawley, it’s difficult to put an exact number on the effects of tariffs on the US stock market. That’s because the market was still reeling from the crash of 1929 less than a year earlier.
What is generally agreed upon by economic historians, though, is that the tariff and the retaliatory trade actions taken by other countries in response to it made the Depression far worse than it otherwise would have been.
Another parallel of blanket tariffs can be seen in 1971 and labled the Nixon Shock. While transitioning the U.S. off of the gold standard that had been agreed upon under the Bretton Woods agreement, then-president Richard Nixon imposed a 90-day wage and price freeze and placed an extra 10% tariff on all imports in order to stem temporary inflation.
Interestingly, the Nixon Shock didn’t lead to an immediate stock market selloff. The S&P 500 returned 14.3% in 1971 and 19.0% in 1972. Some believe the short-lived nature of Nixon’s tariff policy explains this.
The shock began in August of 1971, and Nixon removed the additional 10% tariff surcharge in December of the same year. Though a particularly bad bear market in which the S&P 500 lost 48.2% of its value began in 1973, Nixon’s tariffs were solidly in the rearview mirror by then.
One lesson that modern investors may take away from these two examples is that the damage tariffs do to the stock market seems strongly tied to how long they remain in force.
In Smoot-Hawley, tariffs were used as a long-term structural mechanism to protect American industries from competitors overseas. By contrast, tariffs employed by President Nixon were short-lived and designed to combat inflation during a period of currency disruption. The standout feature was Nixon made it clear from at the outset that tariffs were temporary and not directed against other countries.
And what did countries do? Smoot-Hawley led to retaliatory tariffs from other countries, setting off a trade war that deepened the Depression and disrupted financial institutions all over the world. Nixon’s tariffs, likely thanks to the fact that he was very clear about their temporary nature, didn’t meet with the same level of organized international backlash.
Will the Fed Rescue the Market?
Many investors are currently pinning their hopes on an accelerated schedule of rate cuts from the Federal Reserve to breathe new life into the stock market. Traders are currently pricing five rate cuts into their 2025 expectations, including one as soon as May. A rate cut, many believe, would counteract some of the worst impacts of the tariffs.
These hopes, however, may be misplaced. The Federal Reserve is publicly taking a wait-and-see approach to rate cuts, saying that it will wait for concrete data in order to calibrate whatever cuts it may make in accordance with its dual mandate for managing inflation and unemployment through monetary policy.
The Fed may not have the ability to fully blunt the impact of these tariffs on the stock market. Cutting rates drastically could cause a market bounce, but the inflation it would likely allow to run rampant could cause declines further down the road. Even with a significant program of cuts, the damage done to the economy by tariff policy in the short term may be too much for the Fed to alleviate by lowering interest rates.
Are Trump’s Tariffs Temporary Pain or Permanent Damage?
Right now, much still seems to depend on whether these tariffs are a temporary action meant to encourage the negotiation of more favorable trade agreements or a permanent feature of the American economic landscape. If they’re temporary, the tariffs may only put the stock market through a brief, albeit painful, spasm of selling.
If they remain on for a prolonged period of time, though, the effects would likely be far more negative and long-lasting. The idea of leaving tariffs in place was aptly described by the noted economist Thomas Sowell in an interview last week as a “a ruinous decision from back in the 1920s being repeated,” a view that seems to be echoed by many other prominent economists.
So far, the Trump administration has shown little interest in backing away from its position on tariffs. Trump himself has largely brushed aside the sharp market selloff and described his tariffs as “medicine” for the American economy. He has even increased the stakes, threatening to raise the total tariff on Chinese goods by a further 50% in response to China’s own retaliation against his initial tariff.
Large banks are also increasingly expecting a recession, a development that could contribute to further selling. JPMorgan is now actively forecasting a recession, and Goldman Sachs has raised its perceived chances of a recession this year twice in the last week alone. A combination of higher inflation caused by tariffs and slowing growth could even lead to stagflation, a difficult economic cycle that can last for years at a time under the wrong circumstances.
So, How Bad Could the Stock Market Get?
Given the fact that tariffs are shaping up to be more than just a blip on the radar, it seems quite likely that stocks could still extend their losses. This is especially true in light of how bear markets have played out in the past few decades, with most causing dips far in excess of 20%.
Considering the extreme volatility of the market and ongoing day-to-day developments around the tariffs, it’s very difficult to put an exact number on how much farther stocks could drop. We can get some idea of where they might go given what we already know. Goldman Sachs estimates that for every 5% US tariffs increase, the S&P 500’s earnings drop by 1-2%. Following the April 2nd announcement of the new exhaustive tariff program, America’s effective tariff rate jumped from 2.4% to 25.5%.
Using Goldman’s rough rule of thumb, we would expect to see S&P 500 earnings fall by around 4-8% as a direct result of the tariffs.
It’s also important to remember that the tariffs won’t be a one-time hit to growth, but an ongoing drag on the American economy. As such, stocks will likely settle at appreciably lower P/E ratios to reflect lower growth expectations going forward. The market could also suffer further losses if tariffs are gradually escalated. The 25.5% used for the assumption above, for instance, doesn’t take into account the additional 50% on Chinese goods Donald Trump proposed to punish China for retaliating against the first slate of tariffs.
Given that a bear market seems very likely, a further drop of 10% would only bring the current market decline to about the historical average. That may still be a fairly optimistic scenario though if tariffs are put on permanently and kick off a global trade war. As such, a more pessimistic scenario could see stocks continue to drop by another 15% or more depending on how long the tariffs stay in place and how much retaliation and escalation takes place.
Times of extreme volatility like this can see large upswings as well as large downswings. Despite the indications that permanent tariffs could be deeply negative for the market and for the economy at large, there could also be temporary uptrends associated with price action, rate cuts and the news cycle. For the stock market to rebound fully in the near future, however, the government will likely need to back away from its bellicose trade policy.
The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.
