Will the Beat Go On?
In our last Monthly Market Perspective, we highlighted how modest inflation numbers suggested that tariffs hadn’t impacted consumer inflation … yet. Their time may have come with the release of June’s inflation data.
The annual change in consumer prices was 2.7%, an acceleration from May’s reading of 2.4%. Core inflation, which excludes volatile food and energy categories, also accelerated in June, suggesting that companies may be passing along their tariff costs to consumers.
June’s higher inflation has a couple of implications. It’s almost certain to keep the Federal Reserve from lowering its target interest rate at its meeting this month (although financial markets indicate a September cut is still in play). And higher inflation is likely to have an adverse effect on corporate profits: Companies can eat tariffs (which increases their costs), or if they pass along tariff costs, their customers might balk at paying higher consumer price tags (which decreases company sales).
We may get some insight into how this could play out for Corporate America imminently, as companies are starting to report their financial results for the second quarter. Given timing differences for all the moving parts, their second-quarter earnings may not feel the full brunt of tariffs. But according to data from Bloomberg, Wall Street already has less-than-great expectations: Wall Street analysts estimate second-quarter earnings per share for companies in the S&P 500 to rise just 2.8%, the lowest growth in two years and a marked decline from double-digit growth enjoyed in the first quarter. (See Exhibit.) Further, analysts expect six of the S&P 500’s 11 broad sectors (including Information Technology, Financials, and Consumer Discretionary) to show profit declines.
Exhibit: S&P 500 Quarterly Earnings-Per-Share Change (Year-Over-Year)
Source: Bloomberg Intelligence, Clayton Wealth Partners.
Such low expectations could set up a positive catalyst for the stock market. Every quarter, Wall Street analysts publish estimates of what they believe the companies they track will earn, often taking their cue from company-provided guidance. When actual quarterly results exceed those estimates, stocks can react favorably on those surprising earnings “beats.” Today’s expectations for second-quarter earnings are a pretty low bar, potentially making it easier for companies to surprise to the upside.
Of course, given President Trump’s aggressive and unorthodox trade policy strategy, forecasters’ crystal balls are murkier than usual. Much depends on how trade negotiations develop as we approach the new August 1 deadline for tariff implementation. For now, financial markets appear to be expecting a benign trade-policy outcome and are perhaps looking ahead to future Fed rate cuts and near-term stimulus from the One Big Beautiful Bill Act.
Bullish
- U.S.-China trade tensions have cooled with a temporary slash in tariffs.
- The Fed has made good progress in reducing inflation since 2022.
- The most attractive yields for fixed income and cash in years.
- Credit spreads remain contained.
- Consumer and corporate balance sheets generally remain healthy.
Bearish
- Slowing global economic growth.
- Trade policy uncertainty is having a negative effect on consumer and business confidence.
- Housing affordability remains at a decades-low.
- Leading indicators of unemployment are generally trending down.
- Delinquency rates on consumer loans are rising.
- Russia-Ukraine war, Middle East conflict, and other geopolitical concerns.
- China is experiencing a growth recession, with deflation fears growing.
- Federal debt and deficits have ballooned.