Stock Market Soars Amidst Looming Tariffs: Earnings Growth Remains Key

Impact of Tariffs on Earnings

Despite the potential for tariffs, the stock market continues to trade near record highs. While tariffs could negatively impact earnings, analysts believe that market optimism stems from expectations that any tariffs will be short-lived or less burdensome than feared.

Analysts estimate that a 5% increase in U.S. tariff rates could reduce S&P 500 earnings per share (EPS) by 1-2%, with the announced tariffs potentially reducing EPS forecasts by roughly 2-3%. The uncertainty and volatility surrounding the threat of tariffs can also have a negative impact on businesses.

The Importance of Earnings

Earnings, or profits, are the primary driver of stock prices. The close relationship between the economy and market performance is largely driven by earnings. As companies' sales and earnings tend to track nominal GDP growth, they benefit from rising sales and profit margins. This has historically led to strong performance in the stock market.

Current Earnings Performance

Remarkably, earnings continue to perform well. Nearly two-thirds of S&P 500 companies have reported Q4 earnings, showing a year-over-year growth of 16.4%, significantly higher than analyst estimates. This suggests that the upside surprises in reported earnings could offset the downside impact of tariffs.

Economic Indicators

The labor market remains strong, with job growth continuing and unemployment near 50-year lows. Wage growth is ticking higher, but job openings are falling. Layoffs remain depressed, while hiring remains firm. Consumer sentiment has deteriorated, but card spending data indicates that spending is holding up.

Business investment activity is at record levels, and services and manufacturing surveys signal growth. Construction spending is ticking higher, and mortgage rates are edging down. Office occupancy remains relatively low, but is slowly increasing.

Long-Term Outlook

The long-term outlook for the stock market remains positive, supported by expectations for years of earnings growth. While tariffs pose a potential risk, the economy continues to grow, and the Federal Reserve is focused on supporting the labor market.

Analysts expect the U.S. stock market could outperform the U.S. economy due to positive operating leverage, where modest sales growth is translating to robust earnings growth. It's important to note that risks remain, including geopolitical turmoil, energy price volatility, and economic recessions. However, the long-term trend of stock market growth remains intact.