Zacks Investment Management

Policy Uncertainty and Market Volatility

Investors, business leaders, and U.S. consumers are unsure what tariff policy in the U.S. is going to look like over the short-, medium, and perhaps long-term. It also remains unclear to many market participants which tariffs have been implemented, which have been postponed and for how long, and what goods are affected.

For markets, this is clearly a problem.

As it stands today, the tariffs in place include a 25% broad-based duty on steel and aluminum, a 20% increase on Chinese imports, and a 10-25% tariff on certain Canadian and Mexican goods that do not comply with the United States Mexico Canada Agreement (USMCA). These measures have collectively raised the U.S. effective tariff rate by roughly 3%, which while not ideal, is also not necessarily a big risk to total U.S. economic output, in my view. The economy can absorb new trade terms and businesses can adjust accordingly, with perhaps only minor price increases here and there.¹

But the story here is not really about tariffs and their economic impact. It’s about uncertainty and negative surprises. Not knowing what tariffs will be announced tomorrow or next month is creating challenges for corporations and markets in the near term. As seen in the chart below, the last time economic policy uncertainty was this high was in the early days of the Covid-19 pandemic.

Economic Policy Uncertainty Index for the U.S.

Looking back on history, we know that when economic policy uncertainty goes up, investors tend to demand higher risk premiums for owning stocks, which can have the effect of squeezing valuations and increasing market volatility. In my view, that’s what we’re seeing now. Rising uncertainty about tariff policy and its economic impact is colliding with a fully valued stock market, which has a multiple being pulled higher by a few key stocks in the Technology sector. With this recent selling pressure, we’re seeing some ‘steam being released.’

Does this mean the possibility of future uncertainty and volatility gives investors a sound rationale for shifting into a defensive posture now? Not in my view.

Market volatility can be unsettling, but making knee-jerk investment decisions based on short-term swings often leads to greater risk and missed opportunities. Right now, investor sentiment has reached deeply pessimistic levels, typically seen near short-term market bottoms. The CNN Fear & Greed Index sits at 20, signaling “Extreme Fear,” while the AAII Bullish sentiment reading has dropped to 19—its lowest in nearly five years. Historically, markets tend to rally when fear is at its highest, climbing the “wall of worry” in the process. If an investor shifts away from stocks now, it could mean getting whipsawed when markets rally—which can happen at any time.

Bottom Line for Investors

Uncertainty is not what businesses and investors want. Indeed, many executives have expressed that while higher tariffs are not ideal, they would be more manageable if there were greater clarity on long-term policy direction. So far, that clarity has not arrived.

For investors, the key takeaway is that tariff policy remains fluid. If tariffs are primarily being used as a bargaining tool and are eventually reduced or eliminated—similar to the earlier 25% tariffs on Canada and Mexico—markets could respond positively. Likewise, if the strategy results in other nations lowering their trade barriers on U.S. goods, the long-term outcome could also favor market growth. Ultimately, the market needs reassurance that current trade policies do not mark a fundamental shift away from the pro-growth, pro-business stance that many expected from the administration. With deregulation efforts and tax cuts still on the agenda, mitigating policies could be in the offing. It’s also important to remember that the administration can adjust its approach if economic risks intensify, meaning investors should remain cautious but avoid overreacting to short-term policy shifts.

Disclosure