Why Markets Are Shrugging Off Trump’s Tariffs
Wall Street may be getting it all wrong—or perhaps investors know something economists do not
The stock market reflects the health of just one part of the US economy: the segment that supports, and is supported by, the Trump administration.
Despite dire warnings from most economists—not just in the US—about the effects of President Trump’s economic policies, especially tariffs, Wall Street continues to applaud, hitting new record highs.
Either the markets are entirely mistaken, as it has happened before, or perhaps investors know something that economists have yet to understand.
There are several hypotheses that can help reconcile the apparent contradiction between stock market exuberance and the realities of the real economy.
The first is that investors are betting on a scenario in which, beyond Trump’s declarations and threats, tariffs will only increase marginally and will have a limited impact on the US economy.
This assumption is based on what happened after the so-called Liberation Day on April 2, when a market plunge of over 10 percent prompted Trump to backtrack on most of his measures and extend the timeline for negotiations.
Expectations that Trump will retreat in the face of negative market reactions—“Trump Always Chickens Out”—explain Wall Street’s rapid rebound in the second half of April. By July, stock prices had already surpassed the levels reached right after the January 20 inauguration.
But there is no guarantee that Trump will always be willing to back down.
Recent data on customs revenue suggest that tariffs may in fact be encouraging the administration to stick to its hardline approach. In this scenario, markets may have to adjust their expectations sharply downwards, triggering a sudden correction with risks for financial stability.
A second hypothesis is that equity valuations are not correlated to the broader US economy.
Indeed, in the most recent post-pandemic period, stock market gains have outpaced nominal GDP growth by 30 percent. Looking back over the past decade, the ratio of the main stock index to GDP has increased by a staggering 300 percent. This indicates that the markets are not a reliable predictor of the real economy—except possibly during deep crises such as the 2008–09 recession and the pandemic.
There are several reasons for such a divergence. Most importantly, the US equity index is increasingly dominated by technology giants—the so-called “Magnificent Seven”—whose valuations have multiplied in recent years. Excluding this sector, the divergence is far less pronounced.
Moreover, US companies have steadily expanded their activities overseas, reaping the benefits of global—not just domestic—growth.
Another factor explaining the stock market’s outperformance is the ongoing wave of corporate buybacks, which boosted share prices.
Fundamentally, recent years have seen a pronounced shift in income distribution in favor of capital, helping to explain the widening gap between corporate valuations and US household income.
A third, related hypothesis is that equity markets care less about tariffs and their macroeconomic effects, and more about the broader sweep of the new administration’s economic policy.
As Trump himself pointed out, tariffs are not only about redressing the trade deficit, but also—perhaps above all—about boosting federal revenues to pay for the sweeping corporate tax cuts passed in the recent “Big Beautiful Bill.”
Unsurprisingly, Wall Street rallied following the bill’s approval by Congress.
The Trump administration is also rolling out broad-based deregulation, spanning all sectors—including finance and crypto—which disproportionately benefits investors.
Overall, even if Trump’s economic policies result in slower growth and higher prices over the medium term—due to both higher import costs and cuts to social spending, especially healthcare—corporate America, especially tech firms, are unlikely to be hurt. Quite the contrary: they stand to gain from lower taxes, lighter regulation, and reinforced monopoly power.
In short, the stock market reflects the health of only a segment of the US economy: the one that backs, and is backed by, the Trump administration.
A first version of this article was published in the Italian daily Il Foglio
IEP@BU does not express opinions of its own. The opinions expressed in this publication are those of the authors. Any errors or omissions are the responsibility of the authors.
Lorenzo Bini Smaghi
Lorenzo Bini Smaghi holds a degree in Economic Sciences from the Université Catholique de Louvain (Belgium) and a Ph.D in Economic Sciences from the University of Chicago. He has been Chairman of the Board of Directors of Société Générale since 2015. He is an IEP@BU non-resident fellow
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