Tariffs: They're the centerpiece of Donald Trump's second-term agenda, they're controversial, and they raise the price of imported goods. But until recently, their effect on the stock market was mostly a topic for dusty old economics textbooks. They just haven’t been all that impactful since the Great Depression era.
That changed in 2025. President Trump’s “Liberation Day” tariffs led to an immediate two-day, 11% drop in the S&P 500. But why is that? What was it about the tariffs that led to the selloff?
The answer is complex because there are a lot of moving parts. Let's try to make it as simple as possible.
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
How do tariffs work?
Let's go over the basics. A tariff is a tax on imported goods. Contrary to popular belief, the tax is paid by the importer, not the exporter.
Let’s use Trump’s recently announced 46% tariff on Vietnamese goods as an example. The Vietnamese government doesn’t pay that, and neither do the local manufacturers. It’s the American companies who import the merchandise that get stuck paying the tax bill.
Thus, shares of Nike (NKE) tumbled following the new tariff announcement because Nike manufactures about half of its shoes in Vietnam. Every shoe Nike imports just got 46% more expensive. That means that Nike has the unpleasant choice of either passing the price hike on to consumers or eating the costs itself, taking a major hit to profits.
Tariffs are going to affect companies differently. Retail operations such as Home Depot, Walmart (WMT), Amazon.com (AMZN) and even mom-and-pop shops will be affected negatively. Logistics and shipping companies could also take a hit because demand for imports falls when tariffs are high.
On the flip side, domestic producers such as steel or lumber mills mostly benefit from reduced competition. The same would be true for an automaker like Tesla (TSLA) that manufactures substantially all of its vehicles in the United States.
However, these benefits are partly offset by increases in component costs. For example, Tesla might enjoy a pricing advantage over automakers that produce a large chunk of their cars overseas, but they are also paying more for imported aluminum and steel.
Are tariffs normally good or bad for the stock market?
From a macro view, the economic impact of tariffs tends to be negative. But the specific tie to the stock market is harder to measure except in extreme circumstances, such as Trump’s "Liberation Day" tariffs. Most tariffs don’t normally result in an immediate 11% repricing of the stock market.
So what is normal, and why is this time different?
Free trade allows for specialization and creates a more efficient economy with lower prices and greater consumer choice. This has been a core belief of virtually all economists since Adam Smith first penned The Wealth of Nations. Tariffs disrupt free trade in goods and can lead to higher prices and lower consumer choice.
Conceptually, it's easy to grasp that we are all a little poorer if we have to pay an extra $10 for a toaster. But how exactly does that flow through to gross domestic product (GDP) or to the aggregate profits of the S&P 500? Some companies gain, others lose, but the net results aren’t generally going to move the market as a whole.
Another factor to consider is that the United States is primarily a services and information economy with world-leading tech, financial and health care firms. This means they stand to absorb the costs of tariffs but with no benefits to compensate, as tariffs are levied on goods, not services.
Tariffs will potentially increase a service company's expenses, meaning they will pay more for imported electronics and equipment, but they won't get any pricing advantage over foreign rivals.
Under normal conditions, tariffs might be a mild negative for the market but not enough on their own to move the needle much.
Why did the market react so much to Trump's tariff announcement?
So, why was this time different?
It comes down to size. The "Liberation Day" tariffs were massive, significantly larger than the infamous Smoot-Hawley tariffs that plunged the world far deeper into the Great Depression. The tariff on Chinese goods as I write this is a shocking 104%. The very real likelihood is that we will have a spike in inflation and a recession at the same time... something we haven’t seen since the 1970s.
Did the market overreact?
That depends on how serious Trump is about keeping tariffs at current levels. If 104% tariffs are the new normal, then it’s entirely possible the stock market didn’t react negatively enough.
Trying to price a market like this is virtually impossible because there are simply too many moving parts.
What should investors do about tariffs?
What is an investor to do: Buy the dip? Sell everything and hide?
Perhaps the best bet is to simply stick to your investment plan. If you own good stocks at good prices, you probably shouldn’t rush to dump them.
But you should use this time to evaluate your position sizes and the overall level of risk you’re taking. And if you’re nervous, there’s nothing wrong with rebalancing to a slightly more conservative portfolio or trimming back some of your appreciated positions a little.
Related content
-
5 Historic Philadelphia Homes for Sale NowPhiladelphia is a goldmine of historic properties that rival the best in New York, London and Paris for charm and opulence. Here are five gems you can own.
-
When to Sell Your StockKnowing when to sell a stock is a major decision investors must make. While there's no one correct answer, we look at some best practices here.
-
When to Sell Your Stock
Knowing when to sell a stock is a major decision investors must make. While there's no one correct answer, we look at some best practices here.
-
Within Five Years of Retirement? Five Things to Do NowIf you're retiring in the next five years, your to-do list should contain some financial planning and, according to current retirees, a few life goals, too.
-
The Home Stretch: Seven Essential Steps for Pre-RetireesThe decade before retirement is the home stretch in the race to quit work — but there are crucial financial decisions to make before you reach the finish line.
-
Stock Market Today: Great Power Affairs Mesmerize MarketsThe U.S. and China are at least talking about talking about tariffs, and investors, traders and speculators are showing a little less fear.
-
Three Options for Retirees With Concentrated Stock PositionsIf a significant chunk of your portfolio is tied up in a single stock, you'll need to make sure it won't disrupt your retirement and legacy goals. Here's how.
-
Four Reasons It May Be Time to Shop for New InsuranceYou may be unhappy with your insurance for any number of reasons, so once you've decided to shop, what is appropriate (or inappropriate) timing?
-
Stock Market Today: Stocks Rise on Good VolatilityInvestors, traders and speculators continue to process the "known unknown" of global tariff-and-trade war negotiations.
-
Before You Invest Like a Politician, Consider This DilemmaAs apps that track congressional stock trading become more popular, investors need to take into consideration some caveats.
