Will Tariffs Lead to Stagflation?
Trade headlines continue to weigh on markets as new tariffs on Canada, Mexico and China have gone into effect. Tensions are high as impacted countries are retaliating with their own tariffs.
While it is unclear how long the administration will keep tariffs in place or if compromises will eventually be made, tariffs have the potential to stoke inflation and slow economic growth. The combination of rising inflation and economic contraction is often referred to as “stagflation” by economists.
Fears of stagflation are contributing to the recent swings in the markets. While inflation is sticky and tariffs are worrisome, stagflation is by no means a foregone conclusion. Just in case, let’s take a look at the data.
In the chart below, stagflation in the U.S. economy is illustrated in the lower right quadrant where inflation is positive (x-axis) and real GDP growth is negative (y-axis).
For the period 1930 - 2024:
- The U.S economy experienced stagflation in 12 of 95 years.
- 9 of those 12 years produced positive real returns in the S&P 500.
- The average annual real return of the S&P 500 over these 12 years of stagflation was 16.4%
The data suggests that stagflation does not necessarily mean bad news for stocks over the mid- to long-term. While counterintuitive, the data illustrates that periods of stagflation actually produced better stock returns than the three other economic regimes (deflationary growth, inflationary growth, deflationary recession). That said, I do not recommend wishing for stagflation…
The tariffs imposed during President Trump’s first administration led to trade deals with Mexico, China, and other countries. This administration may see tariffs as a negotiating tactic for broader policy objectives, such as curbing unauthorized immigration and imports of illegal drugs. President Trump had success with these tactics his first time around, so it is no surprise he’s going back to his old playbook. We are already seeing compromises from the countries involved.
Given the market’s recent swings and the constant news coverage, the S&P 500 has pulled back about 6% from recent highs at the time of this writing. While this is unpleasant, the reality is that market pullbacks of this magnitude occur on a regular basis. Pullbacks of 5% or more occurred twice in both 2024 and 2023 as the S&P 500 notched back-to-back years of 20% plus returns.
From a portfolio perspective, maintaining a well thought-out, long-term investment approach remains one of the most effective strategies for navigating market volatility.
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