The Stock Market Got Crushed by President Trump's Tariffs. Is the Worst Yet to Come?

The S&P 500 (SNPINDEX: ^GSPC) tumbled 4.8% on April 3, the largest single-day decline since the stock market crashed at the onset of the COVID-19 pandemic five years ago. But the benchmark index fell even more sharply on April 4, bringing the total losses to $6.6 trillion in the last two trading days.

The S&P 500 has now dropped 17% from the record high it reached less than two months ago, putting the index deep in market correction territory. That dramatic reversal in fortune was caused by an abrupt shift in U.S. trade policy, especially the "Liberation Day" tariffs announced on April 2.

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Specifically, President Donald Trump has already implemented a minimum 10% tariff on all imports, and he plans to impose more aggressive country-specific reciprocal tariffs on April 9. Listed below are the total import taxes the U.S. will charge its six largest trading partners once the new tariffs take effect:

• The European Union: 20%
• Mexico: 25%
• China: 54%
• Canada: 25%
• Japan: 24%
• Vietnam: 46%

Trump regularly discussed reciprocal tariffs during his campaign, but the announcement nevertheless shocked the market. According to a survey from Goldman Sachs, only 65% of investors thought Trump would follow through on his threats, and only 15% expected the duties to be so aggressive. Here's what investors should know about the situation.

Wall Street was shocked by the severity of the reciprocal tariffs outlined by President Trump

Wall Street was shocked by the severity of the reciprocal tariffs. Dan Ives at Wedbush said the numbers Trump announced on April 2 were "worse than the worst case scenario." He also questioned the math involved, saying the tariffs are "so illogical and absurd" that they will be shown in classrooms and written about by economists for years to come.

Ives also called the tariffs the worst "policy mistake in the last 100 years." He not only believes the duties will set the technology industry back a decade but also thinks they will tip the U.S. into a recession and cause stagflation almost immediately. However, those predictions are only relevant if the tariffs stay in place, but he does not expect that to happen, at least not at the rates Trump quoted.

JPMorgan economist Bruce Kasman says a recession is the most likely outcome once the reciprocal tariffs take effect. He now estimates U.S. gross domestic product (GDP) will drop by 0.3% in 2025, a stark downward revision from his January forecast that said GDP would increase 2% this year. Importantly, economists at Morgan Stanley and Goldman Sachs also upwardly revised their recession probability forecasts.

Similarly, Morningstar analyst Preston Caldwell now puts the odds of a recession at 40% to 50% in 2025. He also warned that the tariffs would permanently reduce U.S. economic growth and worsen living standards for the average American. "The tariff hikes announced April 2 represent a self-inflicted economic catastrophe for the United States."

Image source: Getty Images.

History says the stock market could fall even further as President Trump's tariffs take effect

JPMorgan estimates that the reciprocal tariffs President Trump plans to implement on April 9 will increase the average tax on U.S. imports to 25%, up from 2.5% in 2024. Estimates from other institutions vary slightly. The Budget Lab at Yale says the average tax on U.S. imports will land at 22.5%. But the big picture is the same: Trump wants to impose the most severe tariffs in more than 100 years.

That is alarming because President Trump imposed a more measured slate of tariffs during his first term, yet the stock market still sold off sharply. Specifically, tariffs imposed during the first Trump administration raised the average tax on U.S. imports from 1.4% in 2017 to 2.8% in 2020. Meanwhile, the S&P 500 tumbled 19.8% over a three-month period between September 2018 and December 2018.

So, a 1.4-percentage point rise in the average tariff rate correlated with a 19.8% drop in the S&P 500 during the first Trump administration. Logically, the 20-percentage point increase (more or less) that President Trump plans to impose during his second term could have a much more severe impact on the stock market.

Here is the bottom line: President Trump's reciprocal tariffs could increase the average tax on U.S. imports to its highest level in more than a century. Additionally, they have already elicited promises of retaliatory action from Canada, China, and the European Union, and other countries may follow in the coming weeks. History suggests the stock market could fall much further if the trade war escalates.

However, the S&P 500 has recovered from every past drawdown, and there is no reason to think this correction will be different. So, looking at the situation optimistically, investors currently have an opportunity to buy their highest-conviction stocks at a discount. But the most prudent course of action is to deploy capital slowly. There is no telling how long the downturn will last or how much further the stock market will fall.

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JPMorgan Chase is an advertising partner of Motley Fool Money. Trevor Jennewine has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Goldman Sachs Group and JPMorgan Chase. The Motley Fool has a disclosure policy.