Understanding Market Volatility: The Role of Tariffs and Policy Uncertainty in 2025

Volatility in the stock market has returned in 2025, with an 18.9 percent drawdown based on closing prices on April 8. Since then, the S&P 500 has recouped its losses but still sits roughly 4 percent below the February 19 closing high of 6144.15. In this article, we want to explore why the stock market has corrections and hopefully put some context around the volatile price movements that come with this asset class.

While sharp sell-offs in equities can occur seemingly out of nowhere, market corrections (typically defined as a decline of 10 percent or more from a recent high) tend to be triggered by similar causes. Of the 28 corrections over the last 60 years, the common thread behind each downturn boiled down to sharply higher interest rates, higher unemployment, or some sort of external shock/crisis that caused investors to be concerned that either interest rates or unemployment were likely to move abruptly higher. Unsurprisingly, we’ve also found that 1) corrections that eventually turn into bear markets (typically defined as a loss of 20 percent or more from a previous high) tend to also be associated with higher unemployment levels versus just higher interest rates and 2) bear markets are more likely to occur along with economic contractions.

During the past 60 years, corrections that didn’t come at a time of higher unemployment rates or recessions tended to last a little more than four months with an average drawdown of 16.4 percent. Corrections associated with higher unemployment are significantly more severe, as higher levels of joblessness usually point to an economy in or approaching a recession. These corrections usually evolve into bear markets lasting an average of 14 months. During the period we looked at, the average drawdown during these bear periods was 35.9 percent.

Corrections that occur absent a recession are far more common than bear markets that occur with a recession. There have been 28 sell-offs of 10 percent or more during the last 60 years, and just eight of those were driven by recessions. That leaves 71 percent of the drawdowns in correction classification, which again historically have lasted just four months on average.

Today’s Correction Environment

The 18.9 percent sell-off that occurred during the period between February 19 and April 8 is unusual in the context of prior corrections. Interest rates were not notably higher, and labor market conditions, while slowing, weren’t registering the type of deterioration consistent with the sharp sell-offs seen in the past employment-driven bear markets. This leaves an outside factor—tariffs/trade policy—as the likely reason for the most recent correction.

Investors are concerned that tariffs will cause inflation to rise and economic growth to slow as a result of levies on steel, aluminum, automobiles, and the reciprocal tariffs on goods from all trading partners that were announced April 2. While negotiations are ongoing, the change in import duties could have a significant effect on the economy if they remain anywhere near the levels initially announced. Consider the following table from one of our research providers, Cornerstone Macro, on the potential tariff impact to U.S. gross domestic product (GDP). Assuming no change to the mix of imports that the U.S. currently sees, the tariff impact alone is roughly $485 billion, or 1.63 percent of U.S. GDP. While the actual mix of imports is likely to change as a result of tariffs, the impact of the levies is still likely to be significant. Add in the potential impact from retaliatory actions and still to be announced tariffs on pharmaceuticals/semiconductors, and it’s understandable that the market is increasingly worried about rising chances of a sharp slowdown in U.S. and global economic growth in the coming months.

It’s worth reiterating that ongoing negotiations may result in vastly different tariff levels versus the current policy announcements, so the ultimate drag on economic growth could be significantly less severe.

This uncertainty in the forward outlook is also showing up in the U.S. Policy Uncertainty Index, which is higher today on a 30-day moving average basis than at any point in recorded history. Not surprisingly, prior spikes in policy uncertainty have resulted in downward pressure on consumer and business spending as individuals and companies simply wait for uncertainty to clear before moving forward with spending decisions. Time will tell if this time is different.

Final Word

As investors navigate the 28^th correction in the last 60 years, it’s worth categorizing today’s correction as driven by external factors and not yet one that coincides with a bear market driven by a spike in unemployment. From peak to trough, the recent 18.9 percent drawdown is slightly worse than the 16.4 percent correction that typically occurs without a recession. That could change if policy uncertainty and tariff headwinds translate into outright economic weakness, but so far it hasn’t happened.

Looking ahead, the labor market data as well as trade-related headlines are likely to be market-moving events as investors try to anticipate the ultimate economic outcome. An outcome that avoids a recession likely puts the April 8 levels as a trading floor in the near term, while further downside risk is possible if a recession becomes a base-case outcome. A push toward new highs likely requires tariff headwinds to dissipate together with an ongoing resilient labor market. Each one of these outcomes is possible, and we expect volatility to remain in the coming months as investors’ views on the likelihood of the two outcomes change.

With all this uncertainty, it’s important to highlight a few foundational investing concepts. Volatility is a feature of equities, not a bug. If uncertainty didn’t exist, equities would not deliver the attractive returns they have historically generated. Today’s uncertainty will eventually fade, and the best way that we’ve found to navigate uncertainty is diversification across sectors and factors with a risk management process that emphasizes diversification of our active risk exposure at the security level.

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