The Impact of Tariffs on the Market

The Market Reaction as Tariffs Take Effect

Stocks experienced an early bout of volatility this year, as tariff tensions weighed heavily on the markets in March. Initially, the concerns around tariffs were manageable, but when coupled with weakening economic data, investors found the uncertainty too significant to overlook.

Before tariffs took center stage, the U.S. economy was already set to moderate from last year’s near-3% growth. Weak retail sales figures in January and February led LPL Research to adjust its annual growth forecast downward, from 1.9% to 1.7%, acknowledging potential downside risks if trade tensions escalate further. Currently, the likelihood of a recession within the next year sits at about 30%, driven primarily by tariff-induced pressure on economic activity.

Tariffs inevitably increase costs for businesses, squeezing profit margins and, ultimately, translating into higher prices for consumers who are already cautious about inflation. Consumer spending patterns are responding to these pressures; some people are accelerating purchases to avoid higher costs later, while others are delaying spending entirely due to uncertainty. Compounding this anxiety are falling stock prices and rising layoffs within the federal government. Businesses, too, are hesitant to commit to large capital investments or new hiring until the impacts of tariffs become clearer.

Despite these concerns, the economic outlook still includes bright spots. Consumers benefit from healthy savings, steady income growth in recent years, and significant accumulated wealth, all of which support continued economic expansion. Additionally, slower economic growth naturally dampens inflation, potentially offsetting some tariff-related price hikes. The Federal Reserve may respond by cutting interest rates further, which could keep borrowing costs favorable. Moreover, corporate America is fundamentally robust, with earnings positioned to remain solid even amid significant tariff increases.

We may currently be experiencing peak uncertainty regarding trade. Historically, markets dislike uncertainty but often rally robustly as clarity emerges. Reflecting on the 2019 trade war period, the S&P 500 gained approximately 19% from August 2019 until just before the pandemic struck in early 2020. While replicating such a significant gain in the near future might be optimistic, a double-digit recovery through year-end seems achievable as tax cut extensions and deregulation plans come into view.

Interestingly, while the overall U.S. stock market saw declines in the first quarter, sectors such as U.S. value stocks and international equities showed resilience, with seven out of 11 S&P equity sectors posting positive returns. Bonds also advanced, reinforcing the importance of diversified investment portfolios.

Market volatility may linger as policies and their implications unfold. Historically, annual returns following a challenging first quarter tend to be subdued, yet current negative sentiment could indicate we are nearing a durable market bottom. Investors should anticipate a generally positive trajectory for stocks in the coming months.

To gain deeper insights, please listen to our attached podcast discussing the detailed market outlook and strategies for navigating current economic uncertainties.