History Says This Is How Tariffs Will Impact Stocks After the Initial Dip

The markets were taking it on the chin after President Donald Trump's "Liberation Day" tariff announcement. While investors were expecting the president to initiate some new tariffs, the size and breadth of them were much, much worse than expected.

Not surprisingly, this led to a big decline in the stock market immediately after the announcement, with the S&P 500 (SNPINDEX: ^GSPC) falling more than 4% during the next trading session.

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Now that the initial blow has been felt by stocks, though, the question for investors is where do stocks head from here and when will the market recover?

What history tells us about stocks and tariffs

Tariffs are generally not a good thing for the stock market. They increase the cost of goods for consumers, while often reducing the flow of trade. They can also be met with retaliatory tariffs, which can exacerbate the situation.

How big and long-lasting the impact of tariffs is on the stock market usually depends on a few factors, such as the scale of the tariffs, the state of the economy, and whether other countries react with retaliatory tariffs.

From a historical perspective, the biggest tariff impact on stocks occurred in the 1930s with the Smoot-Hawley Tariff Act of 1930, which increased duties on already high tariff rates. Smoot-Hawley is often blamed for helping prolong the Great Depression. The stock market had already crashed in 1929, the year before Smoot-Hawley was signed into law, but the tariffs deepened the depression, sending stocks even lower. The market would not recover until years later as trade tensions eased and the New Deal kicked in.

More recent examples of tariffs include the George W. Bush administration's steel tariffs in 2002 and the Trump administration's trade war from 2018 to 2019. The market recovered pretty quickly following the Bush steel tariffs because, despite retaliatory tariffs from the European Union, the U.S. economy chugged along with the help from the recovery from the dot-com bust. Stocks recovered in only a few months after the initial hit.

The Trump trade war, meanwhile, began in January 2018 with tariffs on solar panels and washing machines and then was later expanded to steel and aluminum in March. In July 2018, Trump enacted 25% tariffs on $34 billion of Chinese products, which China then matched. Increased tariffs on Chinese goods further escalated throughout 2019. The market saw some notable short-term dips throughout the trade war, including the S&P falling into a bear market in December of 2018. However, the S&P 500 rose 28.8% in 2019, helped by the Fed lowering rates.

Image source: Getty Images.

The 2025 tariffs

History shows that it can take between a few months to a few years for stocks to rebound from the impact of tariffs. Where stocks go from here will largely depend on the economic impact caused by the tariffs and whether the U.S. dives further into isolationism. How the Fed reacts and any potential tax cuts could also play a role.

Trump's 2025 tariffs are very broad-based and quite high. The big tariffs on goods from countries like Vietnam, meanwhile, are a big blow to companies that tried to broaden their manufacturing and supply chain away from China to other countries. Nike, for example, which had already been struggling with a turnaround, manufactures 25% of its footwear products in Vietnam and another 25% in China.

In terms of the U.S. economy, lower-income households will be affected the most by Trump's actions. This demographic had already been struggling due to the prior high inflationary environment, and now it will just get worse for them. Meanwhile, the tax cuts being proposed by the Trump administration won't provide relief to this income class (some could actually end up paying more federal income taxes as a result of proposed legislation).

The pricing pressures on lower-income households are likely to lead to less spending. That could hurt retailers and fast-food restaurant chains that cater to this demographic, such as Dollar Tree and Jack in the Box.

If the tariffs lead to a recession, I would expect the market indices to enter a bear market (the Russell 2000 is already trading in bear market territory). A typical bear market lasts roughly nine months. However, whether the tariffs stick is also uncertain. President Trump can be unpredictable, so there is no telling if he will decide to remove them at some point.

What should investors do?

Right now, there is a lot of uncertainty in the market. What the ultimate duration and depth of the market pullback will be is unknown, as is how fast the market will recover once it rebounds. For example, the COVID-19 bear market was short and steep, but stocks recovered to new highs very quickly.

As such, the best strategy that investors can employ in times like this is to look to dollar-cost average into a solid exchange-traded fund (ETF) like the Vanguard 500 ETF (NYSEMKT: VOO). This strategy involves taking market timing out of the equation and buying the ETF at set dollar amounts at set times. You're not going to pick a bottom in the market using this strategy, but it's going to give you an attractive cost basis and set you up for when the market rebounds.

Bull markets tend to make their largest gains early at the start of a new bull run, so you don't want to miss these gains by just sitting back.

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Geoffrey Seiler has positions in Vanguard S&P 500 ETF. The Motley Fool has positions in and recommends Nike and Vanguard S&P 500 ETF. The Motley Fool has a disclosure policy.