Will the Stock Market Crash as Tariffs Hit the Economy in 2025? History Offers an Important Clue.

The S&P 500 (SNPINDEX: ^GSPC) rocketed higher when Donald Trump won the presidential election in November. Investors assumed his administration would usher in a period of booming economic growth with tax cuts and deregulation. Instead, Trump has made changes to U.S. trade policy that numerous economists say will slow economic growth and raise prices.

The S&P 500 began falling in February when Trump fired the first salvo in the trade war: He announced tariffs on goods from China, Canada, and Mexico, followed by duties on aluminum, steel, and auto imports. But the losses accelerated in April when the president unveiled more aggressive "Liberation Day" tariffs. The news erased over $6 trillion from the U.S. stock market in two trading days.

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Surprisingly, the S&P 500 has since staged one of its greatest comebacks in history. The index is actually up 2% year to date and currently sits within striking distance of its record high. Trump softening his stance on certain trade policies has been the primary reason for the recovery, but the most aggressive tariffs are merely paused and some Wall Street analysts think investors have been lulled into a false sense of security.

Will the stock market crash (again) in 2025? Here's what investors should know.

Image source: Getty Images.

Tariffs could cause a recession, and recessions usually coincide with stock market crashes

The Budget Lab at Yale University estimates tariffs effective as of June 2 have pushed the average tax on U.S. imports from 2.5% in 2024 to 15.6% in 2025, the highest level since 1937. History offers a clue about what may happen if President Trump stays the course with the current trade war. Consider this information:

• The average tax on U.S. imports rose 14 percentage points between 1918 and 1933. That is similar to the 13-point increase this year, but the present situation is arguably more severe because of the accelerated timeline. President Trump has effected a massive tariff hike in a matter of weeks rather than over 15 years.
• The U.S. suffered five distinct recessions between 1918 and 1933, including the Great Depression. In fact, tariffs were such a persistent headwind during that 15-year period that the U.S. economy spent 95 months (about half the period) in a recession, according to the National Bureau of Economic Research.

From that perspective, President Trump's tariffs could indeed cause a recession in the coming months, and recessions have historically coincided with stock market crashes. The following chart shows the peak-to-trough decline in the S&P 500 during every recession since the index was created in March 1957.

Data source: Truist Advisory Services.

As shown in the chart, the S&P 500 has declined by an average of 32% during recessions. The least severe drawdown was 14% and the most severe drawdown was 57%.

So history says there is a very good chance the stock market will crash if tariffs imposed by President Trump cause a recession. Whether that actually happens depends on the outcome of the ongoing trade negotiations. If the U.S. strikes deals that reduce the average tariff rate to something reasonable, a recession would be less likely.

It may seem prudent to sit on the sidelines, but market timing strategies can lead to disaster

Investors concerned about a market crash may think it prudent to sell their stocks and sit on the sidelines until the economic storm clouds clear. But a market crash is not guaranteed. And even if it was, market timing strategies tend to backfire because the best and worst days often occur in close proximity.

In the last two decades, seven of the 10 best trading days happened within two weeks of the 10 worst trading days. And missing the best days led to severe underperformance. JPMorgan Chase strategists recently cited that statistic and concluded, "Market timing is futile and staying invested is paramount."

That does not mean investors should keep every stock they currently own. The S&P 500 is trading near its all-time high, so the present is an excellent time to sell any stocks where confidence is lacking. The present is also a good time for investors to stockpile some cash in their portfolios. Spare cash makes it easy to buy the dip during market corrections.

However, investors should never overlook an opportunity to buy a high-conviction stock at a reasonable price. When I say high conviction, I mean any company whose earnings are virtually certain to be much higher in five years. And when I say reasonable price, I mean a sensible valuation multiple in the context of anticipated future growth.

Here's the big picture: History says President Trump's tariffs could drag the U.S. economy into a recession, and recessions have usually coincided with steep declines in the S&P 500. So investors should be prepared for a market crash in the coming months, but they shouldn't be so consumed by the possibility that they avoid good stocks today.

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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 JPMorgan Chase. The Motley Fool has a disclosure policy.