Financial markets had been betting that President Trump was bluffing about his latest round of tariffs on Mexico and Canada. That bet didn’t pay off. Last week, he doubled down, confirming that a 25% tariff on imports from these countries would take effect immediately. Simultaneously, tariffs on Chinese goods have jumped another 10%. The market did not take the news well, with US equities down.
The core concern about tariffs is their potential to slow economic growth. Tax Foundation estimates that the newly imposed tariffs on Mexico and Canada could shave off 0.4% from long-term US GDP growth. Some analysts at the Brookings Institution argue that the impact could be even greater, depending on how these trading partners retaliate.
However, the broader fear is that this is just the beginning. Trump has shown a preference for unpredictability in his trade policies, often leveraging it as a negotiation tactic. If he’s willing to impose a 25% tariff on Canada and Mexico, there’s little reason to believe he won’t target the European Union next, a trade bloc he has frequently criticised. Given that the EU, Mexico, and Canada collectively account for nearly two-thirds of US goods imports, valued at roughly $3 trillion in 2024, the implications for industries reliant on imported goods, such as automotive and chemicals, could be significant.
One of the biggest challenges in evaluating the market reaction to tariffs is the difficulty in precisely assessing their impact on corporate earnings.
Even companies directly affected by these tariffs struggle to estimate the net impact on their revenues and profit margins. The uncertainty surrounding these questions was evident in yesterday’s stock sell-off.
Rather than targeting specific industries reliant on imports, investors appeared to be offloading risk across the board, last week. Defensive stocks, sectors that typically perform well during economic downturns, saw gains, while cyclical stocks suffered losses.
Defensive sectors such as consumer staples (Hershey, Campbell’s) and real estate (helped by falling interest rates) saw gains.
Technology stocks took the biggest hit. Nvidia and other major tech firms fell, not necessarily because they are more exposed to global trade, but likely because they had been on an extended rally, making them an easy target for portfolio managers looking to reduce risk.
US-based suppliers who compete with tariffed imports, such as Weyerhaeuser (a domestic timber producer), saw their stocks rise.
Energy stocks also took a hit, but this was likely due to OPEC’s production increases rather than the tariff news.
A common belief among investors has been that markets will ultimately restrain aggressive trade policies. That theory is now being put to the test. As tariff rhetoric turns into concrete policy, investors will be closely watching whether market turmoil forces a shift in Trump’s stance. Historically, his administration has responded to sharp stock market declines, but whether that pattern holds remains to be seen.
Despite the unsettling market and economic news, there is one major positive development: corporate earnings growth. The S&P 500 has reported an impressive 18% year-over-year earnings increase, the strongest growth since the post-pandemic rebound in 2021. This growth significantly outpaced analyst expectations.
However, this surge is primarily a result of widening profit margins rather than extraordinary revenue growth. According to FactSet, S&P 500 revenues grew at a more modest 5%, aligning with expectations. The key driver was a 1.3 percentage point increase in net profit margins, bringing the overall margin to 12.6%.
While the current earnings reports have been strong, expectations for 2025 are being revised downward. A report from Citi highlights that estimates for next year’s earnings, particularly in cyclical sectors such as materials, have been cut. The financial sector remains the only industry where expectations have improved, and even that increase is minimal.
These lowered expectations stem from cautious commentary by corporate leadership during earnings calls. Given economic uncertainty and policy unpredictability, companies prefer to under-promise and over-deliver. This cautious outlook stands in contrast to strong recent performance and encapsulates the current market sentiment: resilient earnings today but increasing uncertainty about the future.
While tariffs and trade policy uncertainty dominate the headlines, earnings growth remains a strong market pillar. Tariffs will remain something to watch closely, but earnings performance is more important, and should remain the focus of investors.
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