The S&P 500 (SNPINDEX: ^GSPC) briefly fell into correction territory in March before recovering slightly, but it remains more than 8% below its February record high. However, an economic warning signal that has appeared only twice in the last two decades could indicate further market struggles ahead.
As of March 18, data from the Federal Reserve Bank of Atlanta projects a 1.8% annualized contraction in U.S. gross domestic product (GDP) for the first quarter of 2025. If confirmed, this would mark the steepest economic downturn since the second quarter of 2020. Historically, the S&P 500 has performed poorly when GDP contracts.
What History Tells Us About Market Performance During GDP Declines
Gross domestic product (GDP) measures the overall size and health of an economy, calculated as the sum of consumer spending, business spending, government spending, and net exports. Over the past 20 years, the U.S. has experienced quarterly GDP contractions only twice:
- 2008-2009: GDP declined 2.5% in Q4 2008 and remained negative through Q3 2009 due to the collapse of the housing market and widespread defaults on subprime mortgages, triggering the Great Recession. The S&P 500 fell 56% from its peak during this period.
- 2020: GDP shrank by 7.5% in Q2 2020 and stayed negative through Q4 2020 as the COVID-19 pandemic led to business shutdowns and global supply chain disruptions. The S&P 500 declined by 33% at the start of the crisis.
Now, with GDP on pace for a 1.8% decline in Q1 2025, the S&P 500 could once again be vulnerable to significant downside pressure. However, official GDP figures won’t be finalized until April 30, when the Bureau of Economic Analysis releases its report.
Key Economic Pressures Impacting Growth
Several factors are contributing to economic weakness, weighing on market sentiment:
- Consumer spending slowdown: Consumer spending, which makes up two-thirds of GDP, increased 4.2% in Q4 2024 but is expected to slow to just 0.4% in Q1 2025. January saw the first month-on-month decline in spending in two years, while February’s consumer sentiment hit its lowest level since November 2022.
- Record trade deficit: Despite the Trump administration’s efforts to address trade imbalances, tariffs have led to an all-time high trade deficit. In January, U.S. imports exceeded exports by the widest margin in history, significantly dragging down GDP growth.
Even if the U.S. economy avoids a first-quarter contraction, tariffs could still exert downward pressure on the stock market in the months ahead. Goldman Sachs strategists recently noted that “Tariffs on autos, critical imports, and reciprocal tariffs could raise the effective rate to about 10%, which is five times the increase in the first Trump administration.”
How Tariffs Could Affect the Stock Market
Trade tensions have historically impacted market performance. During the first Trump administration, tariffs contributed to a 19.8% decline in the S&P 500 over a three-month span in late 2018. If the current administration implements even harsher trade policies, the market reaction could be even more pronounced.
What Investors Should Do Now
Given rising trade tensions and economic uncertainty, the current market environment presents significant risks. That doesn’t mean investors should avoid stocks entirely, but it does call for a more cautious approach. Experts suggest focusing on high-conviction investments and ensuring that stocks are purchased at reasonable valuations.
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