Despite ongoing tariff threats, the stock market remains resilient, holding steady near record highs. This is puzzling, given that tariffs typically harm earnings, which are considered the primary driver of stock prices. One possible explanation for this market behavior could be the expectation that any new tariffs will either be short-lived or less damaging than initially anticipated.
Potential Earnings Impact from Tariffs
As mentioned earlier, the looming tariffs on imports from China, Mexico, and Canada have yet to be fully incorporated into the earnings forecasts of many companies. While the tariffs on Mexico and Canada were delayed for a month, they remain a significant concern for investors.
The potential consequences of these tariffs go beyond direct cost increases. The ripple effects, including higher production costs and reduced demand, complicate efforts to accurately estimate their full impact on earnings. Goldman Sachs analyst Kostin estimates that a 5 percentage-point increase in the U.S. tariff rate could reduce S&P 500 earnings per share (EPS) by 1-2%. If sustained, the tariffs announced on February 1 could lower EPS estimates by 2-3%, excluding any additional impact from tightened financial conditions or policy-induced uncertainty affecting consumer and corporate behavior.
BofA’s Savita Subramanian has warned that the combined tariffs on China, Canada, and Mexico could cut EPS by as much as 8%. Meanwhile, analysts at FactSet predict a 13% increase in S&P 500 EPS to $272 in 2025, and 13.8% growth to $309 in 2026, suggesting that tariffs could have a notable impact on earnings.
The Uncertainty of Tariffs
Even if the tariffs are not implemented, the uncertainty surrounding them could still cause significant disruption. Importers are already adjusting their strategies, which could result in higher storage costs and increased risks of inventory losses. Market watchers, including JPMorgan’s Dubravko Lakos-Bujas, estimate that the current tariffs could reduce EPS by up to $7.50, $6.10, and $2.60 for tariffs on Mexico, Canada, and China, respectively. If tariffs on Europe were added, this could further impact 2/3 of S&P 500 EPS growth this year.
Earnings Resilience Amid Market Uncertainty
Despite these potential headwinds, earnings have shown remarkable resilience. According to FactSet, nearly two-thirds of S&P 500 companies have reported Q4 earnings, with a projected year-over-year growth rate of 16.4%, the highest since Q4 2021. This exceeds the 11.8% growth analysts had predicted at the start of the year.
If this trend of better-than-expected earnings continues, it could help offset any negative effects from tariffs, creating upside surprises in corporate earnings.
Earnings Remain the Key Driver of Stock Prices
Earnings remain the most significant factor in determining stock prices. As highlighted by Goldman Sachs, the close relationship between earnings growth and stock market performance is a key feature of market behavior. Historically, earnings have contributed the lion’s share of returns in the S&P 500, even amid fluctuations in price-to-earnings (P/E) ratios.
While the focus often shifts to P/E ratios, earnings have consistently been the dominant driver of stock prices, as rising sales typically lead to improved profit margins. This is a primary reason the U.S. stock market has outperformed global markets in recent years.
Tariffs and Their Broader Impact
The introduction of tariffs could harm not only the countries being targeted but also the broader economy, including U.S. companies. Should earnings projections shift due to tariffs, stock prices are expected to follow suit. For now, however, many analysts and businesses are withholding significant revisions to earnings estimates, awaiting clearer guidance on the fate of the tariffs.
The market’s continued high performance may reflect investor optimism that the worst impacts of tariffs will either not materialize or will be less severe than expected.
The Outlook for the Economy and Labor Market
Looking at the broader economy, several key indicators point to steady growth. The U.S. labor market added 143,000 jobs in January, marking the 49th consecutive month of gains. The unemployment rate is near 50-year lows, though it ticked up slightly to 4.0%. Wage growth has also accelerated, with average hourly earnings increasing by 0.48% month-over-month in January, up from 0.25% in December.
Despite some signs of cooling, the labor market remains robust, with low levels of layoffs and strong hiring activity. However, the number of job openings decreased in December, signaling a return to pre-pandemic levels.
Mixed Consumer Sentiment
Consumer sentiment, on the other hand, is showing signs of strain. The University of Michigan’s February survey revealed a 5% decline in sentiment, driven by concerns over the potential impact of tariffs on purchasing conditions for durable goods. Despite this, consumer spending remains resilient, with credit card spending growing 2.7% year-over-year as of January 31.
Economic Data Remains Strong
Key economic data, including GDP growth, construction spending, and business investment, continues to suggest a healthy economy. Business investment in core capital goods remained strong, signaling future economic expansion, and the manufacturing sector showed improvement in January. While consumer sentiment remains weak, actual economic activity continues to grow at a steady pace.
Navigating Uncertainty
Looking ahead, the outlook for the stock market remains positive, supported by strong earnings growth expectations. While concerns about tariffs and other risks loom, the resilience of earnings and the broader economy suggests that any short-term market disruptions will likely be temporary. Despite uncertainties, the long-term trajectory of the market remains favorable, especially as businesses benefit from positive operating leverage and continued investment in productivity-enhancing technologies.
However, investors must remain cautious, acknowledging the inherent risks in the market, including potential geopolitical tensions and economic volatility. As always, the long-term perspective remains key, and investors should be prepared for both market ups and downs in their wealth-building journey.
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