Impact of Tariffs on Stock Market

Despite looming tariff threats, the stock market continues to trade near record highs. This is somewhat perplexing since tariffs are generally detrimental to earnings, which are the primary driver of stock prices. The market may be speculating that any tariffs would be short-lived or less burdensome than anticipated.

Potential Earnings Impact

Analysts have not fully factored in the effects of new tariffs on goods imported from Mexico, Canada, and China into their earnings forecasts. While the tariffs on Mexico and Canada have been postponed for a month, they remain a possibility.

Experts estimate that a 5% increase in US tariff rates could reduce S&P 500 EPS by approximately 1-2%. If the announced tariffs are sustained, they could reduce S&P 500 EPS forecasts by roughly 2-3%. FactSet analysts project a 13.0% increase in S&P 500 EPS to $272 in 2025 and a 13.8% increase to $309 in 2026, indicating that the announced tariffs could significantly impact earnings.

Market Standoff

Since tariffs are widely viewed as detrimental to all involved economies, their implementation would likely lead to downward revisions in earnings estimates. Companies and analysts are generally waiting for definitive action before making adjustments. The stock market, on the other hand, continues to trade near all-time highs, suggesting that investors are betting on the tariffs not materializing or being benign.

Earnings As the Primary Driver

Earnings are the primary driver of stock prices, with a strong correlation between earnings and prices. The close relationship between the economy and market performance is predominantly driven by earnings. Rising sales often boost profit margins since companies frequently have fixed costs that do not scale with increased revenue. Historically, margins have expanded during periods of positive sales growth.

This relationship explains why US stocks have outperformed non-US stocks. The growing dominance of the US equity market is a reflection of its relatively strong profit growth since the financial crisis.

Macroeconomic Crosscurrents

Several significant data points and macroeconomic developments have emerged since the previous review:

* The labor market continues to add jobs, with 143,000 created in January.
* Average hourly earnings rose by 0.48% month-over-month and 4.1% year-over-year.
* Job openings have declined, but remain at pre-pandemic levels.
* Layoffs remain depressed, while hiring remains steady.
* People are quitting jobs less frequently.
* Productivity has increased.
* Unemployment claims have risen slightly.
* Consumer sentiment has declined for the second consecutive month, with all index components deteriorating.
* Card spending data remains strong.
* Gas prices have ticked upwards.
* Supply chain pressures have eased.
* Business investment activity remains high.
* Services surveys indicate growth.
* Manufacturing surveys have improved.
* Construction spending has increased.
* Mortgage rates have declined slightly.
* Offices remain relatively empty.
* Near-term GDP growth estimates remain positive.

Conclusion

The long-term outlook for the stock market remains favorable, supported by expectations of earnings growth. Economic growth persists, albeit at a normalized pace. Sentiment-oriented data remains relatively pessimistic, but hard economic data continues to be strong. Analysts expect positive operating leverage to contribute to US stock market outperformance. However, risks such as political uncertainty, geopolitical turmoil, energy price volatility, and cyber attacks remain. Long-term investors should anticipate economic recessions and bear markets as part of the wealth-building journey.