Stock Market Remains Resilient Despite Threat of Tariffs

Earnings Growth as Primary Driver

The stock market continues to trade near record highs despite the looming threat of tariffs. This discrepancy stems from the belief among investors that any tariffs will either be short-lived or less impactful than anticipated. However, analysts should remain cognizant of their potential consequences.

Goldman Sachs estimates that a 5% increase in U.S. tariff rates would reduce S&P 500 EPS by 1-2%, resulting in a reduction of its EPS forecasts by 2-3% if sustained. BofA estimates an 8% reduction in EPS from tariffs imposed on China, Canada, and Mexico.

Tariff Impact on Earnings

Tariffs not only directly impact production costs and demand prices but also make estimating their full impact on earnings challenging. Goldman Sachs' Kostin suggests a potential $7.50 EPS headwind from Mexico, $6.10 from Canada, and $2.60 from China, totaling $16.20 for announced tariffs.

Even if tariffs are ultimately not implemented, the uncertainty and volatility they cause can still have detrimental effects, including affecting importers' purchasing decisions and increasing storage and inventory risks.

Earnings Performance & Market Disconnect

Despite tariff concerns, earnings continue to perform well. Nearly two-thirds of S&P 500 companies have reported strong Q4 earnings, with EPS growth expected to reach 16.4% year-over-year. This outpaces the 11.8% growth initially anticipated by analysts.

Earnings are the most crucial driver of stock prices, as they directly impact corporate valuations. This relationship is evident in the close correlation between earnings and market performance.

Outlook and Potential Risks

While the long-term outlook for the stock market remains favorable due to anticipated earnings growth, investors should be aware of potential risks, including geopolitical tensions, energy price volatility, and the threat of recession.

However, the current economic data remains solid, with positive demand for goods and services, job creation, and support from the Federal Reserve. The economy has normalized from earlier "coiled" conditions, with tailwinds such as excess job openings diminishing.

Despite the disconnect between sentiment-oriented and economic data, investors should focus on the resilience of the underlying economy and the potential for U.S. stock market outperformance due to positive operating leverage.

While the long-term investment approach has historically yielded positive results, investors should remain alert to risks and be prepared for short-term market volatility and economic downturns.