Tariffs and Earnings: Market Uncertainty Amidst Record High Stock Prices

Tariffs and the Stock Market: Unraveling the Matrix

Despite escalating tariff threats, the stock market continues to hover near record highs. This may seem counterintuitive, given that tariffs would negatively impact earnings, which are the primary driver of stock prices.

Uncertain Impact of Tariffs

The effects of tariffs on goods imported from Mexico, Canada, and China have not been fully factored into corporate earnings guidance. While tariffs on Mexico and Canada have been delayed, the threat remains. Investors must be aware of their potential consequences.

Estimates vary on the impact of tariffs on earnings. Goldman Sachs projects a 1-2% reduction in S&P 500 EPS for every 5% increase in tariffs. BofA estimates a potential 8% hit to EPS. These estimates exclude the effects of tighter financial conditions or increased uncertainty on corporate behavior.

Uncertainty as a Burden

Even if tariffs aren't ultimately implemented, their threat can be costly. Importers may alter their purchasing patterns, leading to higher storage costs and inventory risks.

Earnings Resilience

Despite tariff headwinds, earnings continue to perform well. Nearly two-thirds of S&P 500 companies have reported strong Q4 earnings, with EPS growth exceeding expectations.

Earnings as the Keystone

Earnings, a reflection of a company's profits, are the cornerstone of stock prices. The close correlation between earnings and prices underscores their importance. Rising sales and profit margins typically drive earnings growth.

Earnings Dominate Valuations

Over the past decade, earnings and dividends have accounted for the majority of S&P 500 returns, outperforming valuations. U.S. stocks have outpaced non-U.S. stocks due primarily to superior earnings growth.

Tariffs Hurt All

Tariffs have detrimental effects on both the sender and receiver countries. If earnings trajectories are altered due to tariffs, stock prices will likely follow.

Market Standoff

Since tariffs are universally considered harmful, their implementation would prompt downward revisions to earnings estimates. Currently, companies and analysts appear to be waiting for further developments before adjusting their forecasts.

Balancing Act

Investing in the stock market would be less challenging if the future were predictable. Policymakers, wary of disrupting the market, may factor into the tariff equation.

Key Economic Trends

* Labor Market Strength: Job creation remains strong, with unemployment at low levels.
* Wage Growth: Average hourly earnings are increasing, albeit at a slower pace.
* Job Openings Decline: The number of job openings has fallen, but remains elevated compared to historical norms.
* Layoffs and Hiring: Layoffs remain low while hiring activity is robust. However, the hiring rate is trending downward.
* Productivity Gains: Labor productivity has increased slightly.
* Consumer Sentiment: Consumer sentiment has weakened, likely influenced by political factors.
* Card Spending Resilience: Card spending data suggests consumer activity remains strong.
* Gas Prices: Gas prices have risen slightly amidst tariff threats.
* Supply Chain Pressures: Supply chain pressures have eased.
* Business Investment: Business investment continues at high levels.
* Services Sector Growth: Services sector surveys indicate growth, albeit slower than late last year.
* Manufacturing Sector Optimism: Surveys point to increased optimism in the manufacturing sector.
* Construction Spending Uptick: Construction spending has increased slightly.
* Mortgage Rates Lower: Mortgage rates have declined slightly.
* Office Occupancy: Office occupancy rates remain relatively low.
* GDP Growth Projections: Near-term GDP growth estimates are positive.

Long-Term Outlook

Despite short-term uncertainties, the long-term outlook for the stock market remains positive. Earnings expectations are robust, and economic growth continues. While economic growth has slowed, the economy remains healthy, supported by strong consumer and business balance sheets.

Balancing Risks and Opportunities

While investors must remain vigilant about potential risks, they should also recognize the opportunities presented by positive operating leverage. Companies have adjusted their cost structures, resulting in strong earnings growth even in a cooling economy.

Long-Term Confidence

Economic recessions and bear markets are inevitable challenges that long-term investors should expect. However, the long-term trend of the stock market remains undefeated, providing confidence for investors who navigate the market's fluctuations wisely.