Despite looming tariffs, the stock market continues to trade near record highs. This is puzzling since tariffs would hurt earnings, which are the primary driver of stock prices. The market may be betting that any tariffs will be short-lived or less severe than feared. However, companies and investors should be aware of the potential consequences of tariffs.
Goldman Sachs estimates that a 5% increase in U.S. tariff rates would reduce S&P 500 EPS by roughly 1-2%. BofA's Savita Subramanian estimates that China, Canada, and Mexico tariffs could reduce EPS by up to 8%. JPMorgan's Dubravko Lakos-Bujas estimates that the announced tariffs could impact up to two-thirds of S&P 500 EPS growth this year.
Even if tariffs are not ultimately imposed, the uncertainty and volatility caused by the threat could be costly.
On the positive side, earnings continue to perform well. FactSet data shows that S&P 500 EPS growth is on track to grow by 16.4% year-over-year, the highest growth rate since Q4 2021. This could partially offset the negative impact of tariffs on earnings.
Historically, earnings have been the primary driver of stock prices. The correlation between earnings and prices is among the strongest in markets.
It's worth noting that tariffs also harm the countries on which they are imposed. If the trajectory of earnings shifts due to tariffs, we can expect prices to follow.
Currently, most companies and analysts are waiting for more concrete information before making revisions to earnings estimates. The stock market continues to trade near all-time highs, reflecting investors' optimism that tariffs will not materialize or will be benign.
However, if tariffs are implemented, earnings estimates will likely be revised down, which could impact stock prices. There is a case to be made that policymakers would prefer to avoid a stock market decline.
Despite the uncertainty, the long-term outlook for the stock market remains favorable, supported by expectations for years of earnings growth. Demand for goods and services is positive, and the economy continues to grow, albeit at a more normalized pace than earlier in the cycle.
Consumer and business sentiment has been relatively poor, likely influenced by the threat of tariffs and other factors. However, tangible consumer and business activity continue to trend at record levels.
Analysts predict that the U.S. stock market could outperform the U.S. economy, partly due to positive operating leverage. Companies have adjusted their cost structures to optimize their operations.
While investors should remain vigilant regarding potential risks, the long-term game in the stock market has historically been victorious, and investors can expect that trend to continue.