Will the Stock Market Crash if President Trump's Tariffs Cause a Recession? History Gives a Clear Answer.

The S&P 500 (^GSPC +0.84%) has declined 7% from its high as the Trump administration has imposed tariffs on goods from several countries. The president has also outlined plans for more aggressive reciprocal tariffs scheduled to take effect on April 2. That shift in U.S. trade policy has rattled Wall Street.

In March, J.P. Morgan raised its recession probability forecast to 40%, up from 30% in January. Economist Bruce Kasman said, "We see a materially higher risk of a global recession due to U.S. trade policy." Similarly, 32 fund managers and strategists surveyed by CNBC raised their aggregate forecast to 36% in March, up from 23% in January.

History says the S&P 500 would fall much further if the U.S. economy does indeed suffer a recession. Here's what investors should know.

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Tariffs are already taking a toll on the U.S. economy

Tariffs are typically bad news for the economy and stock market. "They raise prices, slow economic growth, cut profits, increase unemployment, worsen inequality, diminish productivity and increase global tensions," according to David Kelly, Chief Global Strategist at J.P. Morgan.

Not surprisingly, forecasts have become increasingly gloomy since the Trump administration began imposing tariffs in February. J.P. Morgan strategists have cut their U.S. gross domestic product (GDP) growth outlook by three-tenths of a point and increased their inflation outlook by two-tenths of a point. Goldman Sachs and Morgan Stanley strategists have made similar revisions to their outlooks.

U.S. consumers are also more pessimistic. Consumer spending fell 0.2% in January, the first month-on-month decline in nearly two years. Additionally, consumer sentiment has now worsened in three straight months, and it reached a two-year low in March amid rising uncertainty about U.S. trade policy.

Finally, a modeling tool from the Federal Reserve Bank of Atlanta shows U.S. GDP is on pace to decline at an annual rate of 1.8% in the first quarter of 2025. Importantly, that is an early estimate -- an official number will not be published until April 30 -- but the U.S. is currently headed for its first economic contraction in three years and its worst contraction in nearly five years.

Image source: Getty Images.

History says the S&P 500 will fall much further if the U.S. suffers a recession

The S&P 500 is regarded as the best benchmark for the overall U.S. stock market. The index has historically fallen sharply during recessions. The chart below lists each recession since the S&P 500 was created in March 1957. It also shows the peak-to-trough decline in the index during each event.

Data source: Truist Advisory Services.

As shown above, the S&P 500 has declined by an average of 31% during past recessions. Past performance is never a guarantee of future results, but we can apply that data to the current situation to make an educated guess about what may happen if tariffs tip the U.S. economy into a recession.

Specifically, the S&P 500 earlier this year peaked at 6,144. The benchmark index would fall 31% to 4,239 during a recession if its performance aligned with the historical average. That projection implies 26% downside from its current level of 5,700.

Readers may wonder if now is a good time to exit the stock market. The answer is no, and I say that for two reasons. First, tariffs imposed by the Trump administration may be temporary negotiating tools, in which case they would have no lasting impact. "The threat of tariffs can be used as a way to open up foreign markets to U.S. exports and, if they work in this way, no harm is done," according to Kelly.

Second, even if U.S. trade policy pushes the economy into a recession, predicting the duration and severity of the stock market decline would be impossible. The S&P 500 in past recessions has usually bottomed about five months before GDP. In other words, the stock market is typically several months into a rebound by the time official economic data shows the recession has ended.

Here's the big picture: The near-term outlook for the U.S. stock market is currently clouded by economic uncertainty. However, the S&P 500 has recovered from every past drawdown, so investors should treat the current one as a buying opportunity. That does not mean the stock market will recover anytime soon. But history says investors who patiently hold high-quality stocks will be well rewarded in the long run.