For the stock market, it's not bad unless it's bad for earnings 💰
Plus a charted review of the macro crosscurrents 🔀
📉The stock market fell last week, with the S&P 500 shedding 0.2% to close at 6,025.99. It’s now up 2.5% year to date and up 68.5% from its October 12, 2022 closing low of 3,577.03. For more on recent market moves, read: Investing in the stock market is an unpleasant process 📉 and 5 outstanding issues as President Trump threatens the world with tariffs 😬
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Despite the looming threat of tariffs, the stock market continues to trade near record highs.
This is a bit confounding since tariffs would be bad for earnings, and earnings are the most important driver of stock prices.
Perhaps the market is betting that any tariffs will either be short-lived or less burdensome than feared.
Standing by to revise earnings estimates lower 📉
As we discussed on Monday, the effects of new tariffs on goods imported from Mexico, Canada, and China have not been factored into a lot of companies’ earnings guidance.
“Of the S&P 500 companies that discussed tariffs in conjunction with any type of guidance or outlook for Q1 2025 or CY 2025, 30 companies excluded the impact of tariffs from their guidance or outlook while 21 companies included the impact of tariffs in their guidance or outlook,” FactSet’s John Butters observed on Friday.
While the tariffs on Mexico and Canada have been delayed for a month, they very much remain on the table. So investors should be aware of their potential consequences.
Unfortunately, their consequences go beyond just the direct effects of higher costs on production and higher prices on demand. This makes estimating their full impact on earnings difficult to pinpoint.
“We estimate that every 5pp increase in the U.S. tariff rate would reduce S&P 500 EPS by roughly 1-2%,” Goldman’s Kostin said. “As a result, if sustained, the tariffs announced [on February 1] would reduce our S&P 500 EPS forecasts by roughly 2-3%, not taking into account any additional impact from major financial conditions tightening or a larger-than-expected effect of policy uncertainty on corporate or consumer behavior.“
BofA’s Savita Subramanian estimates: “China+Canada+Mexico tariffs could be as much as an 8% hit to EPS.”
According to FactSet, analysts estimate S&P 500 EPS will grow 13.0% to $272 in 2025 and 13.8% to $309 in 2026. So the announced tariffs could have a meaningful impact on earnings. And keep in mind that President Trump has discussed imposing tariffs beyond what’s been announced.
"We estimate that the current tariffs explicitly mentioned could result in an EPS headwind from first order effects of $7.50, $6.10 and $2.60 from Mexico, Canada and China tariffs, respectively,” JPMorgan’s Dubravko Lakos-Bujas wrote. “If we were to presume that Europe would face a 10% tariff, that would be another $3.60. In short, this could impact up to 2/3 of S&P 500 EPS growth this year from just the currently announced tariffs."
Even if tariffs ultimately aren’t imposed, the uncertainty and volatility caused by the threat of tariffs could prove costly. Among other things, it’s already affecting how importers time their purchases, which can come with higher storage costs and increased risk of inventory held or sold at a loss.
The good news 👍
For now, earnings continue to perform remarkably well.
Nearly two thirds of the S&P 500 companies have reported Q4 earnings. According to FactSet, EPS growth is on track to grow by 16.4% year-over-year, the highest growth rate since Q4 2021. This is significantly higher than the 11.8% growth expected by analysts at the beginning of the year.
If this pattern of better-than-expected earnings were to continue — which by the way is one of the most consistent trends in stock market history — then it’s possible that the downside of any tariffs could be at least partially offset by what would be upside surprises in reported earnings.
It’s all about earnings 💰
As I laid out in TKer Stock Market Truth No. 5: “News about the economy or policy moves markets to the degree they are expected to impact earnings. Earnings (a.k.a. profits) are why you invest in companies.“
As TKer readers understand, earnings are the most important driver of stock prices. Earnings and prices have one of the tightest correlations of any two variables in markets. Just look at the chart below from Goldman Sachs.
Goldman Sachs explained: “The close relationship between the economy and market performance is largely driven by earnings. Because corporations are paid in nominal dollars, their sales and earnings tend to track nominal GDP growth over time. Rising sales typically boost profit margins as well, since companies often have some fixed costs that do not scale with higher revenues. As a result, margins historically expanded about two-thirds of the time during past periods with positive sales growth. … Given these linkages, the S&P 500 has closely followed the path of earnings over time. Even with significant expansion in the P/E ratio over the last decade, earnings and dividends still contributed three-fourths of the S&P 500’s total return.”
That last point is an important one. As much as we all obsess over P/E ratios, the dominant driver of prices has been earnings not valuations. (Indeed, in the Feb. 07, 2024 TKer, I said that moves in the P/E ratio just reflect the margin of error in what is a very tight relationship between prices and earnings.)
And by the way, earnings explain why U.S. stocks have smoked non-U.S. stocks.
“The growing dominance of the US equity market has simply mirrored its relative profit growth since the financial crisis,” Goldman Sachs’ Peter Oppenheimer wrote.
It’s worth stating that tariffs also hurt the countries on which tariffs are being imposed.
If the trajectory of earnings were to shift due to tariffs, we should expect prices to follow.
Market standoff 😰
Because tariffs are almost universally considered negative for all of the economies involved, their implementation would mean earnings estimates will come down.
For now, most companies and analysts appear to be waiting for something firm before they make any revisions.
The stock market, meanwhile, continues to trade near all-time highs. This seems to reflect investors and traders wagering that new tariffs either won’t come to fruition or they will be benign.
Maybe the market is right to be trading high, and maybe companies and analysts won’t have to cut their earnings estimates. After all, there’s a case to be made that policymakers don’t want to tank the stock market.
In any case: Investing in the stock market would be a whole lot easier if we knew what was to come.
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Related from TKer:
5 outstanding issues as President Trump threatens the world with tariffs 😬
Stock market vigilantes could prompt trade war de-escalation 🏳️
The business community's 2-part plan for addressing tariffs 📋
Review of the macro crosscurrents 🔀
There were several notable data points and macroeconomic developments since our last review:
👍 The labor market continues to add jobs. According to the BLS’s Employment Situation report released Friday, U.S. employers added 143,000 jobs in January. The report reflected the 49th straight month of gains, reaffirming an economy with growing demand for labor.
Total payroll employment is at a record 159.1 million jobs, up 6.8 million from the prepandemic high.
The unemployment rate — that is, the number of workers who identify as unemployed as a percentage of the civilian labor force — ticked down to 4.0% during the month. While it continues to hover near 50-year lows, the metric is near its highest level since October 2021.
While the major metrics continue to reflect job growth and low unemployment, the labor market isn’t as hot as it used to be.
For more on the labor market, read: The labor market is cooling 💼 and 9 once-hot economic charts that cooled 📉
💸 Wage growth ticks higher. Average hourly earnings rose by 0.48% month-over-month in January, up from the 0.25% pace in December. On a year-over-year basis, this metric is up 4.1%.
For more on why policymakers are watching wage growth, read: Revisiting the key chart to watch amid the Fed's war on inflation 📈
💼 Job openings fall. According to the BLS’s Job Openings and Labor Turnover Survey, employers had 7.6 million job openings in December, down from 8.16 million in November.
During the period, there were 6.88 million unemployed people — meaning there were 1.1 job openings per unemployed person. This continues to be one of the more obvious signs of excess demand for labor. However, this metric has returned to prepandemic levels.
For more on job openings, read: Were there really twice as many job openings as unemployed people? 🤨 and Revisiting the key chart to watch amid the Fed's war on inflation 📈
👍 Layoffs remain depressed, hiring remains firm. Employers laid off 1.77 million people in December. While challenging for all those affected, this figure represents just 1.1% of total employment. This metric remains at pre-pandemic levels.
For more on layoffs, read: Every macro layoffs discussion should start with this key metric 📊
Hiring activity continues to be much higher than layoff activity. During the month, employers hired 5.46 million people.
That said, the hiring rate — the number of hires as a percentage of the employed workforce — has been trending lower, which could be a sign of trouble to come in the labor market.
For more on why this metric matters, read: The hiring situation 🧩
🤔 People are quitting less. In December, 3.2 million workers quit their jobs. This represents 2% of the workforce. While the rate ticked up last month, it continues to trend below prepandemic levels.
A low quits rate could mean a number of things: more people are satisfied with their job; workers have fewer outside job opportunities; wage growth is cooling; productivity will improve as fewer people are entering new unfamiliar roles.
For more, read: Promising signs for productivity ⚙️
💪 Labor productivity inches up. From the BLS: “Nonfarm business sector labor productivity increased 1.2% in the fourth quarter of 2024 … as output increased 2.3% and hours worked increased 1.0%. (All quarterly percent changes in this release are seasonally adjusted annualized rates.) From the same quarter a year ago, nonfarm business sector labor productivity increased 1.6% in the fourth quarter of 2024. Annual average productivity increased 2.3% from 2023 to 2024.”
💼 Unemployment claims tick up. Initial claims for unemployment benefits rose to 219,000 during the week ending February 1, up from 208,000 the week prior. This metric continues to be at levels historically associated with economic growth.
For more on the labor market, read: The labor market is cooling 💼
📈 Job switchers still get better pay. According to ADP, which tracks private payrolls and employs a different methodology than the BLS, annual pay growth in January for people who changed jobs was up 6.8% from a year ago. For those who stayed at their job, pay growth was 4.7%
For more on why policymakers are watching wage growth, read: Revisiting the key chart to watch amid the Fed's war on inflation 📈
👎 Consumer vibes deteriorate. From the University of Michigan’s February Surveys of Consumers: “Consumer sentiment fell for the second straight month, dropping about 5% to reach its lowest reading since July 2024. The decrease was pervasive, with Republicans, Independents, and Democrats all posting sentiment declines from January, along with consumers across age and wealth groups. Furthermore, all five index components deteriorated this month, led by a 12% slide in buying conditions for durables, in part due to a perception that it may be too late to avoid the negative impact of tariff policy.”
Relatively weak consumer sentiment readings appear to contradict resilient consumer spending data. For more on this contradiction, read: What consumers do > what consumers say 🙊 and We're taking that vacation whether we like it or not 🛫
Politics clearly plays a role in peoples’ perception of the economy:
Notably, expectations for inflation appear to be a partisan matter.
For more on how politics affects sentiment, read: Beware how your politics distort how you perceive economic realities 😵💫
💳 Card spending data is holding up. From JPMorgan: “As of 31 Jan 2025, our Chase Consumer Card spending data (unadjusted) was 2.7% above the same day last year. Based on the Chase Consumer Card data through 31 Jan 2025, our estimate of the US Census January control measure of retail sales m/m is 0.54%.”
From BofA: “Total card spending per HH was up 0.9% y/y in the week ending Feb 1, according to BAC aggregated credit & debit card data. Spending in the South seems to have recovered from the snowstorms driven decline we saw in the last month. Within sectors we report, online electronics saw the biggest y/y rise since last week & lodging saw the biggest decline.”
For more on the consumer, read: Americans have money, and they plan to spend it 🎁
⛽️ Gas prices tick up. From AAA: “Amid the threat of tariffs, the national average for a gallon of gas ticked up two cents from last week to $3.13. According to new data from the Energy Information Administration (EIA), gasoline demand increased from 8.30 million b/d last week to 8.32. Total domestic gasoline supply rose from 248.9 million barrels to 251.1, while gasoline production decreased last week, averaging 9.2 million barrels per day.”
For more on energy prices, read: Higher oil prices meant something different in the past 🛢️
⛓️ Supply chain pressures remain loose. The New York Fed’s Global Supply Chain Pressure Index — a composite of various supply chain indicators — ticked lower in January and remains near historically normal levels. It's way down from its December 2021 supply chain crisis high.
For more on the supply chain, read: We can stop calling it a supply chain crisis ⛓
🏭 Business investment activity trends at record levels. Orders for nondefense capital goods excluding aircraft — a.k.a. core capex or business investment — increased 0.4% to $74.7 billion in December.
Core capex orders are a leading indicator, meaning they foretell economic activity down the road. While the growth rate has leveled off a bit, they continue to signal economic strength in the months to come.
For more, read: 'Check yourself' as the data zig zags ↯ and 9 once-hot economic charts that cooled 📉
👍 Services surveys signal growth. From S&P Global’s January U.S. Service PMI: “Service sector businesses reported a slowdown at the start of 2025, with activity levels growing at a reduced pace compared to the robust gains seen late last year. … However, at least some of this cooling off seems to be related to disruptions caused by unusually adverse weather, hinting that growth in the services sector could revive in February. A marked upturn in hiring further supports the view that robust growth should resume.“
The ISM’s January Services PMI made a similar move.
👍 Manufacturing surveys improved. From S&P Global’s January U.S. Manufacturing PMI: “A new year and a new President has brought new optimism in the US manufacturing sector. Business confidence about prospects for the year ahead has leaped to the highest for nearly three years after one of the largest monthly gains yet recorded by the survey. Over the past decade, only two months during the reopening of the economy from pandemic lockdowns have seen business sentiment improve as markedly as recorded in January.”
The ISM Manufacturing PMI improved and signaled growth in January for the first time since 2022.
Keep in mind that during times of perceived stress, soft survey data tends to be more exaggerated than actual hard data.
For more on this, read: What businesses do > what businesses say 🙊
🔨 Construction spending ticks higher. Construction spending increased 0.5% to an annual rate of $2.19 trillion in December.
🏠 Mortgage rates tick lower. According to Freddie Mac, the average 30-year fixed-rate mortgage declined to 6.89% from 6.95% last week. From Freddie Mac: “Mortgage rates have been stable over the last month and incoming data suggest the economy remains on firm footing. Even though rates are higher compared to last year, the last two weeks of purchase applications are modestly above what was seen a year ago, indicating some latent demand in the market.”
There are 147 million housing units in the U.S., of which 86.6 million are owner-occupied and 34 million (or 40%) of which are mortgage-free. Of those carrying mortgage debt, almost all have fixed-rate mortgages, and most of those mortgages have rates that were locked in before rates surged from 2021 lows. All of this is to say: Most homeowners are not particularly sensitive to movements in home prices or mortgage rates.
For more on mortgages and home prices, read: Why home prices and rents are creating all sorts of confusion about inflation 😖
🏢 Offices remain relatively empty. From Kastle Systems: “Peak day office occupancy was 63.4% on Tuesday last week, up 18 points from the previous week as many workers returned to the office. Houston and Austin experienced the greatest increases, rising more than 70 points to 74.8% and more than 50 points to 68.3%, respectively. Other significant changes included Chicago, up nearly 28 points to 70.4%, and Washington, D.C., up more than 10 points to 61.7%. The average low was on Friday at 36.7%, up 2.3 points from last week.”
For more on office occupancy, read: This stat about offices reminds us things are far from normal 🏢
📈 Near-term GDP growth estimates remain positive. The Atlanta Fed’s GDPNow model sees real GDP growth climbing at a 2.9% rate in Q1.
For more on the economy, read: 9 once-hot economic charts that cooled 📉
Putting it all together 🤔
The long-term outlook for the stock market remains favorable, bolstered by expectations for years of earnings growth. And earnings are the most important driver of stock prices.
Demand for goods and services is positive, and the economy continues to grow. At the same time, economic growth has normalized from much hotter levels earlier in the cycle. The economy is less “coiled” these days as major tailwinds like excess job openings have faded.
To be clear: The economy remains very healthy, supported by strong consumer and business balance sheets. Job creation remains positive. And the Federal Reserve — having resolved the inflation crisis — has shifted its focus toward supporting the labor market.
We are in an odd period given that the hard economic data has decoupled from the soft sentiment-oriented data. Consumer and business sentiment has been relatively poor, even as tangible consumer and business activity continue to grow and trend at record levels. From an investor’s perspective, what matters is that the hard economic data continues to hold up.
Analysts expect the U.S. stock market could outperform the U.S. economy, thanks largely due to positive operating leverage. Since the pandemic, companies have adjusted their cost structures aggressively. This has come with strategic layoffs and investment in new equipment, including hardware powered by AI. These moves are resulting in positive operating leverage, which means a modest amount of sales growth — in the cooling economy — is translating to robust earnings growth.
Of course, this does not mean we should get complacent. There will always be risks to worry about — such as U.S. political uncertainty, geopolitical turmoil, energy price volatility, cyber attacks, etc. There are also the dreaded unknowns. Any of these risks can flare up and spark short-term volatility in the markets.
There’s also the harsh reality that economic recessions and bear markets are developments that all long-term investors should expect to experience as they build wealth in the markets. Always keep your stock market seat belts fastened.
For now, there’s no reason to believe there’ll be a challenge that the economy and the markets won’t be able to overcome over time. The long game remains undefeated, and it’s a streak long-term investors can expect to continue.
For more on how the macro story is evolving, check out the previous review of the macro crosscurrents »
Key insights about the stock market 📈
Here’s a roundup of some of TKer’s most talked-about paid and free newsletters about the stock market. All of the headlines are hyperlinked to the archived pieces.
10 truths about the stock market 📈
The stock market can be an intimidating place: It’s real money on the line, there’s an overwhelming amount of information, and people have lost fortunes in it very quickly. But it’s also a place where thoughtful investors have long accumulated a lot of wealth. The primary difference between those two outlooks is related to misconceptions about the stock market that can lead people to make poor investment decisions.
The makeup of the S&P 500 is constantly changing 🔀
Passive investing is a concept usually associated with buying and holding a fund that tracks an index. And no passive investment strategy has attracted as much attention as buying an S&P 500 index fund. However, the S&P 500 — an index of 500 of the largest U.S. companies — is anything but a static set of 500 stocks.
The key driver of stock prices: Earnings💰
For investors, anything you can ever learn about a company matters only if it also tells you something about earnings. That’s because long-term moves in a stock can ultimately be explained by the underlying company’s earnings, expectations for earnings, and uncertainty about those expectations for earnings. Over time, the relationship between stock prices and earnings have a very tight statistical relationship.
Stomach-churning stock market sell-offs are normal🎢
Investors should always be mentally prepared for some big sell-offs in the stock market. It’s part of the deal when you invest in an asset class that is sensitive to the constant flow of good and bad news. Since 1950, the S&P 500 has seen an average annual max drawdown (i.e., the biggest intra-year sell-off) of 14%.
High and rising interest rates don't spell doom for stocks👍
Generally speaking, rising interest rates are not welcome news for the economy and the stock market. They represent higher financing costs for businesses and consumers. All other things being equal, rising rates represent a hindrance to growth. However, the world is complicated, and this narrative comes with a lot of nuance. One big counterintuitive piece to this narrative is that historically, stocks have actually performed well during periods of rising interest rates.
How the stock market performed around recessions 📉📈
Every recession in history was different. And the range of stock performance around them varied greatly. There are two things worth noting. First, recessions have always been accompanied by a significant drawdown in stock prices. Second, the stock market bottomed and inflected upward long before recessions ended.
In the stock market, time pays ⏳
Since 1928, the S&P 500 generated a positive total return more than 89% of the time over all five-year periods. Those are pretty good odds. When you extend the timeframe to 20 years, you’ll see that there’s never been a period where the S&P 500 didn’t generate a positive return.
What a strong dollar means for stocks 👑
While a strong dollar may be great news for Americans vacationing abroad and U.S. businesses importing goods from overseas, it’s a headwind for multinational U.S.-based corporations doing business in non-U.S. markets.
Economy ≠ Stock Market 🤷♂️
The stock market sorta reflects the economy. But also, not really. The S&P 500 is more about the manufacture and sale of goods. U.S. GDP is more about providing services.
Stanley Druckenmiller's No. 1 piece of advice for novice investors 🧐
…you don't want to buy them when earnings are great, because what are they doing when their earnings are great? They go out and expand capacity. Three or four years later, there's overcapacity and they're losing money. What about when they're losing money? Well, then they’ve stopped building capacity. So three or four years later, capacity will have shrunk and their profit margins will be way up. So, you always have to sort of imagine the world the way it's going to be in 18 to 24 months as opposed to now. If you buy it now, you're buying into every single fad every single moment. Whereas if you envision the future, you're trying to imagine how that might be reflected differently in security prices.
Peter Lynch made a remarkably prescient market observation in 1994 🎯
Some event will come out of left field, and the market will go down, or the market will go up. Volatility will occur. Markets will continue to have these ups and downs. … Basic corporate profits have grown about 8% a year historically. So, corporate profits double about every nine years. The stock market ought to double about every nine years… The next 500 points, the next 600 points — I don’t know which way they’ll go… They’ll double again in eight or nine years after that. Because profits go up 8% a year, and stocks will follow. That's all there is to it.
Warren Buffett's 'fourth law of motion' 📉
Long ago, Sir Isaac Newton gave us three laws of motion, which were the work of genius. But Sir Isaac’s talents didn’t extend to investing: He lost a bundle in the South Sea Bubble, explaining later, “I can calculate the movement of the stars, but not the madness of men.” If he had not been traumatized by this loss, Sir Isaac might well have gone on to discover the Fourth Law of Motion: For investors as a whole, returns decrease as motion increases.
Most pros can’t beat the market 🥊
According to S&P Dow Jones Indices (SPDJI), 59.7% of U.S. large-cap equity fund managers underperformed the S&P 500 in 2023. As you stretch the time horizon, the numbers get even more dismal. Over a three-year period, 79.8% underperformed. Over a 10-year period, 87.4% underperformed. And over a 20-year period, 93% underperformed. This 2023 performance follows 13 consecutive years in which the majority of fund managers in this category have lagged the index.
Proof that 'past performance is no guarantee of future results' 📊
S&P Dow Jones Indices found that funds beat their benchmark in a given year are rarely able to continue outperforming in subsequent years. For example, 334 large-cap equity funds were in the top half of performance in 2021. Of those funds, 58.7% came in the top half again in 2022. But just 6.9% were able to extend that streak through 2023. If you set the bar even higher and consider those in the top quartile of performance, just 20.1% of 164 large-cap funds remained in the top quartile in 2022. No large-cap funds were able to stay in the top quartile for the three consecutive years ending in 2023.
The odds are stacked against stock pickers 🎲
Picking stocks in an attempt to beat market averages is an incredibly challenging and sometimes money-losing effort. In fact, most professional stock pickers aren’t able to do this on a consistent basis. One of the reasons for this is that most stocks don’t deliver above-average returns. According to S&P Dow Jones Indices, only 24% of the stocks in the S&P 500 outperformed the average stock’s return from 2000 to 2022. Over this period, the average return on an S&P 500 stock was 390%, while the median stock rose by just 93%.
Congrats!
Well deserved.