The S&P 500 (^GSPC -0.23%) has fallen 11% from its record high as of April 3, erasing over $5 trillion from the U.S. stock market. Investors have become increasingly unsettled by the abrupt and radical shift in U.S. trade policy orchestrated by President Donald Trump.
His first few months in the White House have been a whirlwind of executive orders. Before April, Trump had already imposed tariffs on goods from China, Canada, and Mexico and announced duties on steel, aluminum, and auto imports. But his most alarming proclamation came on April 2:
- Effective April 5, most U.S. imports will be subject to a 10% tariff.
- Effective April 9, higher reciprocal tariffs will be applied to goods from dozens of countries.
Wedbush Securities analyst Dan Ives said the tariffs President Trump outlined were "worse than the worst case scenario." Likewise, many economists now expect a downturn. "Many countries will likely end up in a recession," commented Olu Sonola, head of U.S. economic research at Fitch Ratings.
Here's what investors should know.
Image source: Official White House Photo by Joyce N. Boghosian.
History says President Trump's tariffs could sink the U.S. stock market
In general, the average tax on U.S. imports has declined in the past century as the nation has embraced free trade and globalization. Below, I'll examine instances when import taxes increased in order to make an educated guess about how President Trump's tariffs might impact the S&P 500, the best benchmark for the U.S. stock market.
1955 to 1962: The average tariff rate on U.S. imports increased from 5.9% in 1955 to 7.6% in 1962. That 1.7 percentage-point increase was spread across seven years but contributed to several sharp declines in U.S. stocks. The S&P 500 fell into four corrections and two bear markets during those years, the worst of which involved a 28% decline.
1980 to 1983: The average tariff rate on U.S. imports increased from 3.1% in 1980 to 3.7% in 1983. That 0.6 percentage-point increase was spread across three years but contributed to two corrections and one bear market. The S&P 500 suffered a 27% decline in 1980.
2017 to 2019: The average tariff rate on U.S. imports increased from 1.4% in 2017 to 2.7% in 2019. That 1.3 percentage-point increase was spread across two years and contributed to two market corrections, the worst of which involved the S&P 500 declining more than 19% from its high.
To summarize, relatively small bumps in the average tax on U.S. imports (no more than 2 percentage points over a few years) have historically correlated with sharp declines in the U.S. stock market. That's concerning, because the tariffs outlined by President Trump on April 2 will increase the average tax rate on U.S. imports by 19 percentage points to 22%, a level not seen since around 1910, according to Fitch Ratings.
If smaller increases in the past have correlated with substantial stock market drawdowns, then the impact this time around could be correspondingly larger.
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History says the U.S. stock market will eventually recover
David Kelly, the chief global strategist at JPMorgan Chase, recently explained why trade wars tend to have devastating economic consequences. "The trouble with tariffs, to be succinct, is that they raise prices, slow economic growth, cut profits, increase unemployment, worsen inequality, diminish productivity and increase global tension."
Unfortunately, it's impossible to know how the current situation will evolve. The European Union, China, and Canada have promised retaliatory tariffs in response to duties imposed by the Trump administration. More countries may follow suit. That means the coming months could be particularly challenging for investors.
However, the fact remains that every past drawdown has ultimately been an opportunity to buy stocks because the S&P 500 has never failed to recoup its losses. There's no reason to believe the current market correction will be any different. Indeed, Warren Buffett has urged investors to "be fearful when others are greedy, and be greedy when others are fearful."
With that advice in mind, the best decisions investors can make today are to (1) avoid panic selling, and (2) steadily buy high-conviction stocks as the market falls.
