How Do Tariffs Impact the Stock Market?

Tariffs.

They're the centerpiece of Donald Trump's second-term agenda. They're controversial, and they raise the price of imported goods. But what is their actual impact on the stock market?

The answer is complex because there are a lot of moving parts. Let's try to make it as simple as possible.

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To start, you have to remember that the stock market is a market of stocks. While macro factors affect the market as a whole, there are also company-specific factors.

The macro impacts are harder to measure and are more widely dispersed, but the micro, company-specific factors are very visible and a lot easier to quantify. Even at the individual level, tariffs can cut both ways for publicly traded companies by reducing competition while also raising costs.

What is a tariff?

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 the Trump administration's recently announced 25% tariffs on Canada and Mexico as an example. If a Canadian lumber mill sells plywood sheets to home improvement retailer Home Depot (HD), neither the Canadian mill owner nor the Canadian government pays the tariff. Home Depot or one of its domestic suppliers does.

Of course, this incentivizes them to buy from a domestic producer, and that's the rationale for the tariff. Any domestic mill now has a 25% price advantage over foreign competitors.

So, American lumber mills should enjoy fatter profits and a better-performing share price in this example.

But what about Home Depot?

Well, that's a different story. Home Depot is now stuck with the difficult decision of raising prices to maintain its profit margins … or eating the cost of the tariffs itself. All else equal, the tariffs would be damaging to Home Depot's profitability and presumably the share price of the blue chip stock.

(I say "presumably" because stocks do not always move in lockstep with earnings expectations. In the short term, there can be a lot of noise.)

So, 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 mills and automakers mostly benefit from reduced competition. However, these benefits are partly offset by increases in component costs. For example, the automakers might enjoy higher selling prices but they are also paying more for imported aluminum.

Are tariffs good or bad for the stock market?

From a macro view, the economic impact of tariffs tends to be negative. The specific tie to the stock market is harder to measure except in extreme circumstances.

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.

But again, this is hard to measure. 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? There's no easy way to measure.

Another factor to consider is that the United States is primarily a services and information economy with world-leading tech, financial and healthcare firms. This means they stand to absorb the costs but with no benefits to compensate, as tariffs are levied on goods, not services. Tariffs will potentially increase a company's expenses, meaning they will pay more for imported electronics and equipment, but they won't get the same domestic sales bump as retailers.

Think of it like this. Tariffs will likely benefit an old-economy company like General Motors (GM). But General Motors only represents a small portion of the S&P 500 Index (0.11% at last check). However, tariffs will actually hurt the bottom lines of the services and information-based Magnificent 7 stocks. And these mega-cap names – Nvidia (NVDA), Apple (AAPL), Microsoft (MSFT), Amazon, Meta Platforms (META), Alphabet (GOOGL) and Tesla (TSLA) – currently make up over 30% of the broad-market index.

The one exception to the Mag 7 stocks is Tesla, which would indeed benefit from less competition in electric vehicles.

And finally, we have to mention the elephant in the room: inflation. If inflation remains elevated due in part to the higher cost of imports, the Federal Reserve will be forced to keep interest rates higher for longer. All else equal, higher interest rates are a headwind for stock prices.

None of this means the stock market is necessarily due for a tumble, of course. And while headlines around tariffs tend to create volatility, the dips are often short-lived and the long-term trend of the market is up. For investors looking for more immediate ways to protect their portfolios, check out these ways to hedge against tariffs.

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