Tariffs: The Impact on Earnings and Stock Prices

Despite Tariffs, US Stock Market Continues to Trade Near Record Highs

Impact of Tariffs on Earnings

The looming threat of tariffs has raised concerns about their potential impact on corporate earnings. Morgan Stanley estimates that a 5% increase in tariffs could reduce S&P 500 earnings per share (EPS) by approximately 1-2%. Goldman Sachs forecasts that announced tariffs could decrease S&P 500 EPS by 2-3%. BofA Merrill Lynch predicts an 8% earnings hit due to tariffs on goods from China, Canada, and Mexico.

Uncertainty and Volatility

Even if tariffs are not ultimately imposed, the uncertainty and volatility caused by their threat can have significant consequences. Importers may adjust their purchasing schedules, leading to increased storage costs and inventory risk.

Earnings Performance and Impact

Despite tariff concerns, earnings performance remains robust. S&P 500 companies reporting Q4 results are on track for a 16.4% year-over-year EPS growth, exceeding initial analyst expectations of 11.8%. This suggests that the potential downside of tariffs could be offset by positive earnings surprises.

Importance of Earnings for Stock Prices

Earnings are the primary driver of stock prices. Goldman Sachs emphasizes the tight correlation between earnings and market performance. Rising sales and earnings typically lead to higher profit margins and stock prices.

US Equity Market Dominance

The growing dominance of the US equity market is attributed to its superior profit growth compared to non-US markets.

Market Reaction

Despite tariff concerns, the stock market continues to trade near all-time highs. Investors appear to be betting that tariffs will not materialize or will have a limited impact.

Macroeconomic Overview

* Labor Market: Strong job growth continues, with 143,000 jobs added in January. Unemployment remains low at 4.0%.
* Wage Growth: Average hourly earnings rose by 0.48% month-over-month in January. Year-over-year growth is now at 4.1%.
* Job Openings: Job openings declined slightly in December to 7.6 million, but remain elevated compared to pre-pandemic levels.
* Layoffs: Layoffs remain depressed at historic lows.
* Hiring: Hiring activity is still strong, but the rate of hiring has slowed.
* Quits Rate: The quits rate has ticked up but remains below pre-pandemic levels.
* Labor Productivity: Labor productivity increased by 1.2% in the fourth quarter of 2024.
* Unemployment Claims: Unemployment claims increased slightly to 219,000 during the week ending February 1.
* Job Switchers: Pay growth for job switchers was 6.8% in January, compared to 4.7% for those who stayed at their jobs.
* Consumer Sentiment: Consumer sentiment has declined for two consecutive months, with concerns about inflation and tariffs playing a role.
* Consumer Spending: Card spending data suggests that consumer spending remains resilient.
* Gas Prices: Gas prices have increased slightly to $3.13 per gallon.
* Supply Chain Pressures: Supply chain pressures have eased significantly from their highs in December 2021.
* Business Investment: Core capex orders increased by 0.4% in December, signaling continued economic strength.
* Services Growth: Business activity in the services sector grew at a slower pace in January, but hiring activity remains strong.
* Manufacturing Growth: Manufacturing surveys indicate improved sentiment and growth in January.
* Construction Spending: Construction spending increased by 0.5% in December.
* Mortgage Rates: Mortgage rates declined slightly to 6.89%.
* Office Occupancy: Office occupancy remains below pre-pandemic levels but is increasing.
* GDP Outlook: The Atlanta Fed's GDPNow model predicts real GDP growth of 2.9% in Q1.

Long-Term Outlook

Despite near-term concerns, the long-term outlook for the stock market remains positive due to expectations for ongoing earnings growth. The economy is supported by strong consumer and business balance sheets, positive demand, and a supportive Federal Reserve. Investors should be aware of potential risks, such as political uncertainty, geopolitical turmoil, and economic downturns, but the long-term trend of stock market growth is expected to continue.