Over the last five weeks, Wall Street has reminded investors that stocks can move in both directions. Although the widely followed Dow Jones Industrial Average (DJINDICES: ^DJI), broad-based S&P 500 (SNPINDEX: ^GSPC), and innovation-inspired Nasdaq Composite (NASDAQINDEX: ^IXIC) are still firmly in respective bull markets, there was a brief period where the S&P 500 and Nasdaq Composite dipped into correction territory — i.e., a decline of at least 10% from a recent high.
While there are a few concerns that have investors’ attention at the moment, including a forecasted contraction in first-quarter gross domestic product, along with the historic priciness of stocks, perhaps the prevailing issue for the stock market is President Donald Trump’s tariff policy.
Trump has touted what he calls “Liberation Day” as a key milestone for the U.S. in its fight to make foreign trade fair. The question is: Will the president’s tariff proposals perpetuate a stock market crash?
Interestingly enough, history offers a clear answer.
What, exactly, is Liberation Day?
Before digging into a data-driven analysis of how stocks perform when tariffs are implemented, let’s lay the foundation of what tariffs are, why they’re being leaned on by President Trump, and what Liberation Day might entail.
Put simply, a tariff is a tax added to an imported or exported good. Tariffs are commonly placed on imports from foreign countries, with the goal to protect domestic jobs and/or make domestically manufactured goods more price-competitive. If finished goods imported into the U.S. become notably pricier, it might encourage businesses to shift their manufacturing to the U.S., or at the very least entice consumers to buy American-made goods.
In a March 21 post to his social media platform Truth Social, President Trump stated:
April 2nd is Liberation Day in America!!! For DECADES we have been ripped off and abused by every nation in the World, both friend and foe. Now it is finally time for the Good Ol’ USA to get some of that MONEY, and RESPECT, BACK. GOD BLESS AMERICA!!!
Thus, Liberation Day (April 2) represents the date where Trump will institute potentially broad-ranging tariffs on countries that have persistent trade imbalances with the U.S.
As of this writing in the early morning hours of March 25, the details of which goods or countries will be subject to tariffs via Liberation Day remain fluid. While April 2 was initially viewed as a date that sweeping global tariffs might take effect, weekend reports from The Wall Street Journal and Bloomberg intimate that tariffs will be far more targeted than initially anticipated.
Will Liberation Day allow the bears to run wild on Wall Street?
Considering how volatile the Dow Jones, S&P 500, and Nasdaq Composite have been during the early innings implementation of tariffs on China, as well as aluminum and steel imports, it raises questions about what might happen to stocks when Liberation Day arrives.
Thankfully, history provides a very big clue.
In December, four economists at Liberty Street Economics — Liberty Street provides research and analysis for the New York Federal Reserve — published a report (Do Import Tariffs Protect U.S. Firms?) that examined the various impacts Trump’s China tariffs had on stocks and publicly traded companies during his first term in office.
Perhaps the least-surprising of all takeaways is that public companies exposed to Trump’s China tariffs in 2018-2019 did worse than those not exposed on the days these duties were announced. Wall Street likes predictability, and there’s no telling what impact an added tax could have on a company’s margins or demand for its products.
Additionally, Liberty Street Economics observed an adverse correlation between tariffs and future outcomes for public companies with exposure to the U.S.-China trade war. In particular, companies that fared poorly on tariff announcement days, on average, saw their profits, employment, sales, and labor productivity all decline from 2019 to 2021.
Lastly, the four economists were quick to point out the difference input versus output tariffs had on U.S. businesses during the U.S.-China trade war. “Output” tariffs are duties placed on finished goods imported into the U.S. While this type of tariff often leads to reciprocal duties from other countries, it’s as straightforward as it gets.
Meanwhile, an “input” tariff is an added tax placed on an imported good used to manufacture a finished product in the U.S. This type of tariff can make domestic goods pricier and hurt U.S. businesses. President’s Trump’s tariff policy hasn’t historically paid much attention to this difference between output and input tariffs.
Based on Liberty Street Economics’ data-driven analysis, a stock market crash isn’t likely. However, the uncertainty created by tariffs does tend to lead to modest weakness in the equities exposed to said tariffs. In other words, the Dow, S&P 500, and Nasdaq could all take the escalator lower.
Uncertainty begets opportunity on Wall Street
If history were to rhyme for the stock market, a heightened period of volatility and weakness have arrived. Until there’s clarity from President Trump on tariffs and/or trade deals in place, it’s not far-fetched to expect uncertainty to drive equity valuations lower.
But it’s important to note that, when given ample time, uncertainty begets opportunity on Wall Street.
Inclusive of the latest 10.1% peak-to-trough decline in the benchmark S&P 500, it’s endured 40 corrections of at least 10% since the start of 1950, based on data from Yardeni Research. This works out to a correction occurring, on average, every 1.88 years. In short, downturns are probably more common than you might realize.
Something else that’s incredibly common but might be flying under the radars of investors is the undeniable nonlinearity of investing cycles.
In June 2023, the analysts at Bespoke Investment Group published a data set on social media platform X that explored the length of every bull and bear market in the S&P 500 dating back to the start of the Great Depression (September 1929). What this data set depicted was the night-and-day difference between optimism and pessimism on Wall Street.
On one hand, the average 20% (or greater) downturn in the broad-based index lasted for 286 calendar days. Further, no S&P 500 bear market endured longer than 630 calendar days, with only nine out of 27 bear markets topping one year (365 calendar days) in length.
On the other side of the coin, the typical bull market stuck around for a considerably longer 1,011 calendar days. Additionally, a third of these 27 bear markets spanning 94 years ranged from 1,324 calendar days to 4,494 calendar days in length.
Even without ever knowing ahead of time when stock market corrections will begin, how long they’ll last, or where the bottom will be, this data set from Bespoke demonstrates the power of optimism and patience on Wall Street.
If President Donald Trump’s Liberation Day tariffs sink the stock market, it would represent the perfect opportunity for long-term investors to pounce.
