You know something unprecedented is going down when Canadians are expressing open hostility.
It’s only been two days since the first shot rang out, but the tariff battle has already escalated to a full-on trade war. While today’s stock sell-off was pared back by the delay on tariffs against Mexico, the real market pain may have only just begun.
Lower bottom lines
Goldman Sachs Chief US Equity Strategist David Kostin argued that corporations now find themselves between a rock and a hard place. They can either absorb the extra costs of tariffs themselves or pass along the additional costs to customers—both of which will hurt their bottom lines.
“If company managements decide to absorb the higher input costs, then profit margins would be squeezed. If companies pass along the higher costs to its end customers, then sales volumes may suffer,” Kostin wrote in a note published Sunday.
Today’s market reaction is largely just that: a reaction. The S&P 500’s valuation has been high for a while now—its forward P/E stood at 22 this weekend, well above its 10-year average of 18—and any bad news had the potential to send stocks tumbling. But if these tariffs stay in place and take their toll on company earnings, which are what ultimately underpin the market, then stocks may continue to sink.
“We estimate that every 5pp increase in the US tariff rate would reduce S&P 500 EPS by roughly 1-2%,” wrote Kostin. “As a result, if sustained, the tariffs announced this weekend would reduce our S&P 500 EPS forecasts by roughly 2-3%.”
“Combining these modeled EPS and valuation sensitivities suggests near-term downside of roughly 5% to S&P 500 fair value if the market prices the sustained implementation of the newly-announced tariffs,” Kostin warned.
Tanked by trade
The stocks that are most likely to struggle under the weight of higher tariffs are obviously those with direct exposure to China, Canada, and Mexico.
Making sense of market moves
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Automakers, homebuilders, agriculture, and consumer goods companies will be hit particularly hard. Clean energy companies, basic materials manufacturers, and semiconductor stocks also sit squarely in the crosshairs.
“Key categories of exposure by country, per Bloomberg, include: Canada -- Oil, passenger cars and parts, aluminum, petroleum products; China -- Cellphones, household items, toys & sporting goods, electric apparatus; Mexico -- Vehicle parts, vehicles, computers, electric apparatus, and agriculture,” Bank of America analysts wrote today.
Maybe the better question is, which sectors won’t be hurt by tariffs? “We have a relative preference for services (Financials, Software, Media & Entertainment, and Consumer Services) over Consumer Goods for a number of reasons,” explained Morgan Stanley Chief Investment Officer Mike Wilson. “Goods-oriented industries with stronger pricing power (Multi-industry/Cap Goods) are better positioned to manage this than industries without it (Consumer Discretionary Goods).”
What to watch for: Today’s sell-off was just a knee-jerk reaction, but to gauge long-term impact, investors need to closely listen for how corporations plan to handle the extra costs of tariffs.
Luckily for us, we’re at the peak of corporate earnings season, which gives companies a chance to explain to investors what they’ll do about tariffs. While earnings calls are not known for their exhilarating entertainment value, this quarter they may make for some seriously riveting listening.—LB