Tariffs Loom, but Stock Market Remains Buoyant

Despite the looming threat of tariffs, the stock market continues to trade near record highs. This is somewhat puzzling since tariffs are generally seen as detrimental to earnings, and earnings are the primary driver of stock prices. It's possible that the market is betting that any tariffs will either be short-lived or less burdensome than feared.

Earnings Revisions Loom

The full impact of new tariffs on goods imported from Mexico, Canada, and China has not yet been factored into many companies' earnings guidance. While the tariffs on Mexico and Canada have been delayed for a month, they remain on the table. Investors should be aware of their potential consequences.

According to analysts, the announced tariffs could reduce S&P 500 EPS by anywhere from 2-8%. This could have a significant impact on earnings, especially if the tariffs are sustained.

Uncertainty and Volatility

Even if tariffs are not ultimately imposed, the uncertainty and volatility caused by the threat of tariffs could prove costly. It's already affecting how importers time their purchases, which can come with higher storage costs and increased risk of inventory held or sold at a loss.

The Good News

Despite the potential headwinds, earnings continue to perform remarkably well. Nearly two-thirds of S&P 500 companies have reported Q4 earnings, with EPS growth on track to grow by 16.4% year-over-year. This is significantly higher than the 11.8% growth expected by analysts at the beginning of the year.

Earnings Drive Prices

Earnings are the most important driver of stock prices. As a result, if the pattern of better-than-expected earnings continues, it's possible that the downside of any tariffs could be at least partially offset by what would be upside surprises in reported earnings.

Earnings Explain U.S. Outperformance

The growing dominance of the US equity market is simply mirrored its relative profit growth since the financial crisis. Earnings growth in the US has outpaced non-US markets.

Market Standoff

Since tariffs are considered negative for all involved economies, their implementation would likely lead to downward revisions in earnings estimates. However, for now, most companies and analysts seem to be waiting for something firm before making any revisions. Meanwhile, the stock market continues to trade near its all-time high.

Labor Market Strength

The labor market continues to add jobs, with unemployment hovering near 50-year lows. Wage growth is also ticking higher.

Consumer Sentiment Weakens

Consumer sentiment has fallen for the second straight month, reaching its lowest reading since July 2024. This is somewhat contradictory to resilient consumer spending data, but politics likely plays a role in people's perception of the economy.

Macroeconomic Indicators Mixed

Job openings have fallen but remain at pre-pandemic levels. Layoffs remain depressed, and hiring remains firm. Unemployment claims have ticked up but continue to be at levels historically associated with economic growth.

Supply Chain Pressures Ease

Supply chain pressures remain loose, according to the New York Fed's Global Supply Chain Pressure Index. This is a welcome sign after the supply chain crisis of 2021.

Business Investment Trends Positive

Orders for nondefense capital goods, a measure of business investment, have increased. This suggests that economic strength could continue in the months to come.

Services and Manufacturing Surveys Signal Growth

Services and manufacturing surveys indicate growth. The ISM Manufacturing PMI has improved, signaling growth in January for the first time since 2022.

GDP Growth Estimates Remain Positive

The Atlanta Fed's GDPNow model sees real GDP growth climbing at a 2.9% rate in Q1.

Conclusion

The long-term outlook for the stock market remains favorable, bolstered by expectations for years of earnings growth. Demand for goods and services remains positive, and the economy continues to grow. However, analysts expect the U.S. stock market to outperform the U.S. economy, thanks largely due to positive operating leverage. Investors should remain aware of the risks and always keep their stock market seat belts fastened, but there's no reason to believe there'll be a challenge that the economy and the markets won't be able to overcome over time.