Market Outlook
February 1, 2025
Tariffs May Be Yesterday’s News As Earnings Come Into View
As you read this, a portion of President Trump’s trifecta of tariffs have already been stalled owing to Mexico’s willingness to negotiate. That impeded Monday morning’s stock slide, as investors bet that Canada and China will return to trade negotiations with hat in hand.
Moreover, if the market’s negligible decline last Friday is any indication of how concerned Wall Street is about a trade war, perhaps there are bigger things to worry about.
So far, the possible imposition of tariffs on Canadian, Chinese and Mexican imports resembles a milder version of the days-earlier shock triggered by DeepSeek. Immediately seen as a significant threat to America’s AI complex of industries, about a trillion dollars of stock value quickly vaporized on Monday January 27.
But after a good night’s sleep, cooler heads prevailed on Tuesday, which saw the tech sector (and, therefore, the Nasdaq Composite) start to recover. That’s the good news. The worrisome news is that in coming weeks, there may be more unwelcome surprises, this time in the form of earnings.
Only Spectacular May Do
But wait, aren’t earnings supposed to be accelerating thanks to our unstoppable economy? Indeed they are. Careful readers may recall my writing this last month: "2024’s estimated earnings growth rate may reach 11.8%, with tech the largest contributor." And, I added, "If forecasts hold, 2025 may not only see earnings rise 14.8%, but growth should broaden to other sectors."
With fourth-quarter earnings season taking flight this week (131 S&P 500 companies are set to report, including Amazon and Google, which may set the pace for the Magnificent Seven), expectations are high. Actually, they now look exuberant from a month ago precisely because of tariffs (which were previously seen as a bluff), DeepSeek (which wasn’t seen at all), inflation (which remains above expectations), and the Fed (which decided to sit on its hands because of the former).
And while not a new concern, January’s rotation away from higher-priced growth stocks and into value stocks and even cheaper Euro shares, may be the canary in a coal mine. At the very least, it’s a sign that investors have valuations on their minds.
What would salve their discomfort is not just earnings, but better-than-expected whisper-earnings.
Fortunately, earnings aggregator FactSet offers some insight.
With just over a third of S&P 500 companies having reported fourth quarter results, 77% have revealed positive earnings-per-share (EPS) surprises, and 63% positive revenue surprises.
Drilling down, there’s more good news. Consistent with the aforementioned fourth-quarter earnings forecast, a combination of actual and reported results so far point to 13.2% earnings growth — a pace that’s ahead of the prior forecast. Should that hold, that would be the S&P 500’s strongest earnings quarter in three years.
That’s the good news. The somewhat worrisome news is valuations. On that score, the S&P’s forward 12-month price-to-earnings ratio (P/E) is 22. (We reported that figure in January.) That’s above both its five- and 10-year averages of 19.8 and 18.2, respectively. Though hardly sky-high, it provides anecdotal context for companies that have so far missed analysts’ expectations.
According to FactSet, in the four-day window before and after reporting (two before, two after), downside surprises resulted in share prices retreating an average of 2.2%. (The good news there is that change is in line with the five-year average.)
At the same time, stocks that exceed expectations are enjoying average increases of 1.5%, which is above the 5-year average of 1.0%. While these preliminary figures are largely in line with recent history, it must be emphasized that the last week of January may have seen a significant shift in market sentiment. Notably, the Vix (the so-called fear index), jumped about 10%.
While robust earnings should help to keep share prices aloft, one possible after-effect of DeepSeek is investors reconsidering the extensive (multi-hundred-billion-dollar) CapEx spending that Big Tech and others have committed to compete. And, earlier arguments by tech that their investments are already paying off is likely to get more scrutiny in the days and weeks ahead.
Finally, a word about DOGE. Even if its cost-cutting recommendations don’t need bi-partisan support, the next debt ceiling arrives around June 16; that’s when the Treasury runs out of money. With financial markets now justifiably focused on U.S. indebtedness, past games of "chicken" are unlikely to be ignored.
— John Bonnanzio