Since they bottomed out during the bear market of 2022, it's been all systems go for the ageless Dow Jones Industrial Average (^DJI 0.95%), broad-based S&P 500 (^GSPC 1.33%), and growth-propelled Nasdaq Composite (^IXIC 1.59%). All three indexes have reached multiple record-closing highs and inspired confidence among bulls on Wall Street.
In terms of catalysts, there have been too many to list. Some of the more prominent positives for the stock market include:
- The artificial intelligence (AI) revolution.
- Aggressive share repurchasing activity by S&P 500 companies.
- A resilient U.S. economy, which has avoided a recession.
- Better-than-expected corporate earnings.
- A normalization of the prevailing rate of inflation.
- Excitement surrounding stock splits.
President Trump addressing reporters. Image source: Official White House photo by Shealah Craighead, courtesy of the National Archives.
However, nothing has captured the attention of investors quite like President Donald Trump's return to the White House. Trump's focus on lowering the corporate income tax rate and deregulating complex industries boded well for stocks during his first term.
But the health of the stock market may very well depend on Donald Trump's tariffs, and one oft-overlooked aspect of these tariffs that can make them incredibly dangerous for American businesses.
Why is Donald Trump leaning on tariffs?
In simple terms, a tariff is a tax placed on an imported or exported good. In the case of Trump's tariffs, most are added to goods being brought into the United States.
As of this writing on March 5, Trump had implemented a number of tariffs on key trade partners. This included a:
- 20% tariff on most goods brought in from China
- 25% tariff on select goods imported from Canada
- 25% tariff on select goods imported from Mexico
Understandably, there's some fluidity to what goods will be subject to tariffs. For instance, the auto industry earned a one-month exemption from tariffs on Canada and Mexico, for vehicles that comply with the free-trade agreement negotiated with these two countries during Trump's first term in office.
The president has also stated plans to implement tariffs on agricultural exports, which are expected to go into effect in early April. Said Trump to American farmers on social media platform Truth Social, "Get ready to start making a lot of agricultural product to be sold INSIDE of the United States."
The purpose behind tariffs is to protect domestic jobs and/or make American-made goods more price competitive with those being imported from outside our borders. But based on one economic analysis, Donald Trump's tariffs may miss the mark.
Image source: Getty Images.
This is what makes President Trump's tariffs so unpredictable and potentially dangerous
In December 2024, Liberty Street Economics, a group of economists from the Federal Reserve Bank of New York, released a research paper that examined the impact of Donald Trump's tariffs on U.S. businesses and the stock market during the U.S.-China trade war of 2018-2019.
Perhaps the least-surprising takeaway from the four authors was a decisive correlation between the announcement of new tariffs by the president and the poor performance of publicly traded companies that had exposure to the tariffs being unveiled. The uncertainty created by these tariffs, at least in the short term, caused investors to head for the exits.
Liberty Street Economics also unearthed an adverse correlation between stocks exposed to the China trade war and future outcomes. In particular, publicly traded companies that experienced worse stock market returns due to tariff announcements in 2018-2019 also saw their profits, employment, sales, and labor productivity, on average, decline between 2019 and 2021. In other words, the negative impact of tariffs lasted well after their initial shock factor.
But the historic precedent of tariffs weighing down exposed stocks isn't what's so dangerous about this tool. Rather, it's the lack of thought being given to the difference between output and input tariffs.
An output tariff is placed directly on finished goods. For example, if a ready-for-sale car is being imported into the U.S., the duty applied to it is designed to make domestically manufactured vehicles more price competitive. While this type of tariff often leads to retaliatory actions from foreign countries, it serves the purpose of what President Trump is hoping to accomplish.
On the other hand, input tariffs are a tax applied to goods imported into the U.S. that are used to manufacture products domestically. The perfect example is that automakers Ford Motor Company and General Motors import a lot of the components used to manufacture their vehicles in the U.S. Even though tariffs are also being assigned to completed vehicles entering the U.S., the cost to manufacture for Ford and GM might increase by a commensurate amount, ultimately denting margins and/or demand for new vehicles.
While the intention may be for foreign countries to pay these tariffs, input tariffs often make life more difficult for domestic manufacturers. This is what makes President Trump's approach to tariffs so unpredictable and potentially dangerous to the U.S. economy and stock market.
Don't miss the forest for the trees
There's no denying that tariff discussion is whipsawing the Dow Jones, S&P 500, and Nasdaq Composite at the moment. In just a nine-session stretch, the high-flying Nasdaq shed close to 11% of its value, based on intraday highs and lows. But it's important not to attribute too much gravity to what are effectively short-term policy moves.
At any given time, there's bound to be one or more headwinds for Wall Street. Whether it's the stock market's historically pricey valuation, the potential for an AI bubble to form, or President Trump's tariffs, there's seemingly always some adverse event waiting in the wings that could derail this epic rally.
Eventually, the Dow Jones, S&P 500, and Nasdaq Composite will succumb to a concern or headwind. Stock-market corrections are a perfectly normal and healthy part of the investing cycle.
But something else that's perfectly normal, and backed by more than a century of historic precedent, is the stock market moving higher:
^SPX data by YCharts. This return chart only goes back as far as 1950.
Every year, the analysts at Crestmont Research refresh a data set that includes the rolling 20-year total returns (including dividends) of the S&P 500, back-tested to 1900. Although the S&P didn't exist until 1923, researchers were able to track the performance of its components in other indexes to the beginning of the 20th century. This produced 106 rolling 20-year periods (1900-1919, 1901-1920, and so on, up to 2005-2024).
What Crestmont Research's data set showed was that all 106 rolling 20-year periods yielded positive total returns. Hypothetically -- since index funds didn't exist until 1993 -- if an investor had purchased an index fund that mirrored the performance of the S&P 500 at any point since 1900, and simply held onto their position for 20 years, they'd have made money every time.
Although Donald Trump's tariffs are ruffling Wall Street's feathers, history plainly suggests they won't alter the long-term growth potential of the U.S. economy or stock market.
