The Big Picture
Column Summary:
*The escalating U.S-China trade war, marked by reciprocal tariffs exceeding 100%, has disrupted global trade and heightened economic uncertainty.
*Stock market volatility reflects diminished confidence in earnings forecasts due to tariff impacts, with recession fears influencing investor behavior.
*The S&P 500 remains overvalued at 19.1x forward earnings despite tariff-induced selloffs, raising concerns about sustainability amid the trade dispute.
We are about to embark on the first quarter earnings reporting period, and we are left wondering if it is over before it even begins. We say this knowing that market participants are expecting little in the way of full-year guidance because it is impossible for companies to forecast a distant future in the fog of a trade war.
Shots Fired
Make no mistake about it. The Trump administration has started a trade war. One can agree or disagree about the reasons why the administration did what it did and what its aims are, but the writing is on the wall.
Tariff actions are flying back and forth between the U.S. and -- well, just about everyone else.
The U.S. and China are effectively embroiled in a nuclear trade war. Things started in a more conventional manner when the U.S. imposed a 20% tariff on China for its part in aiding the fentanyl epidemic in the U.S. Then, a 34% reciprocal tariff rate was announced (54% in total) that China didn't like, so it responded with its own 34% tariff rate on goods imported from the U.S. President Trump wasn't having it when China didn't retract that tariff, so he announced an additional 50% tariff rate for China (104% in total).
China hasn't shown any willingness to negotiate on trade differences with the U.S., so President Trump increased the reciprocal tariff rate to 125% (145% in total) while simultaneously announcing a 90-day pause on reciprocal tariffs for other countries that expressed an interest in negotiating with the U.S. There is still a 10% baseline tariff for those countries while negotiations take place.
The EU subsequently said that it will pause countermeasures planned for the U.S. for 90 days as well. China, meanwhile, has raised its tariff rate on U.S. goods to 125% from 84% in response and declared that if the U.S. continues to impose tariffs on Chinese goods exported to the U.S., China will ignore it. And around and around we go.
What happens at the end of 90 days is anyone's guess, which is exactly the problem from a forecasting standpoint. Global trade will be disrupted by the tariff actions and already has been, with businesses ramping up orders to try to get ahead of the onerous tariff rates. That approach will result in payback later when companies, sitting on excess inventory, decrease orders for new goods that will be subject to higher tariff rates.
At a minimum, it sounds like the baseline 10% tariff rate is here to stay in most cases. NEC Director Kevin Hassett said it will take an "extraordinary deal" for President Trump to lower that.
Lacking Vision
It will take extraordinary vision for CFOs to put out a full-year forecast that isn't defined by aberrantly wide guidance ranges. Amazon.com (AMZN) has made a practice of doing that, but it has always been the exception and not the rule when it comes to such things.
The difficulty in forecasting earnings was at the heart of the selloff following the April 2 reciprocal tariff announcement. Investors simply did not have confidence in earnings forecasts, knowing full well that they would be subject to downward revision because of the tariffs and the attendant effects of those tariffs.
The willingness to pay up for every dollar of earnings was greatly diminished because there was no confidence in prevailing earnings estimates being met and little confidence in knowing just how significant the downward revisions would be.
The price action in the stock market was governed by a recession trade, as investors were pricing in downside earnings risk before earnings estimates even got cut. In our column "How bad can a recession be?" that was posted on March 14, we pointed out that the average peak-to-trough earnings drop in a recession since 1960 has been about 31%, according to Yale University Professor Robert Shiller's data.
There is some renewed hope, with the reciprocal tariff pause, that the U.S. economy can avoid a recession, yet it stands to reason that full-year consensus earnings estimates will get marked down because of the tariffs and the hit to consumer and business confidence that has been a casualty of the stock market selloff and the policy volatility.
Briefing.com Insight
Strikingly, the forward 12-month earnings estimate has increased 2.0% since the start of the year, whereas the calendar year 2025 estimate has slipped 1.8%. In other words, the downward revisions haven't really hit yet.
The other reality of this tariff mess is that the market still isn't "cheap" in spite of the recent selloff. The S&P 500 is trading at 19.1x forward 12-month earnings (which haven't been cut), which is a slight premium to the 10-yr average of 18.3, according to FactSet.
If one allows for a 10% cut to the forward estimate, the S&P 500 at its current price would really be trading at 21.1x forward earnings. That is a rich multiple for an environment in which the global trade order is being disrupted, the world's biggest geopolitical rivals are embroiled in a trade/ideological war, and inflation expectations are rising along with Treasury yields.
And now we enter the first quarter earnings reporting period. Estimates for this quarter have been cut. The blended growth rate has been trimmed to 6.7% from 11.7% on December 31, according to FactSet. The calendar year earnings growth estimate is 10.7% now versus 12.7% on December 31.
Double-digit earnings growth this year, however, is sounding more and more like a stretch given the backdrop, which is why it remains a stretch right now to pay, arguably, more than 20x earnings for entry to a market that is losing confidence in the growth outlook.
That is why the previously unbeatable buy-the-dip approach has been supplanted by an inclination to sell into strength. There isn't any confidence in earnings estimates -- certainly full-year estimates -- because visibility has been clouded by the fog of a trade war that is just getting started along with the earnings reporting.
