The main reason for the stock market rally — the stupendous rise in corporate earnings due to the global economic expansion and tax cuts — is now under threat.
Now that President Donald Trump has threatened to dramatically ramp up the tariff pressure on China, traders are being forced to confront an unpleasant reality: The main reason for the stock market rally — the stupendous rise in corporate earnings due to the global economic expansion and tax cuts — is now under threat.
“Earnings estimates have been going up in the third and fourth quarter, and the market is now speculating that these numbers are under risk,” Earnings Scout’s Nick Raich told CNBC.
Stocks have held up well this year, and analysts have been consistently raising earnings estimates for all quarters, which are now expected to pass 20 percent growth for every quarter.
Q1: up 26.6 percent
Q2 (est.): up 20.3 percent
Q3 (est.): up 23.1 percent
Q4: (est.) up 20.1 percent
Source: Thomson Reuters
Third quarter estimates, already at 23.1 percent growth, will likely increase and pass Q1’s record 26.6 percent. Unfortunately, the sectors most exposed to a global trade war, as well as a stronger dollar, are also those that are the biggest contributors to earnings growth.
Energy: up 102.7 percent
Materials: up 32.5 percent
Industrials: up 19.6 percent
Technology: up 16.6 percent
Source: Thomson Reuters
Given the sky-high estimates for earnings growth for the rest of the year and the exposure of key sectors to trade tariffs and a stronger dollar, it’s little wonder that the market is anticipating earnings cuts even though analysts and strategists do not have any firm numbers to plug into their models yet.
Some strategists appear to be clinging to the hope that Trump’s get-tough policies on immigration and trade are designed to appeal to voters in the midterm election and that with a strong economy, he can afford to press the issue for a few months, then compromise.
“We believe it is important to remember that there is a process for these tariffs to go into effect and most of them take 60 days from the start of the process,” Strategas’ Daniel Clifton told investors Tuesday morning.
Clifton said he believes it is “significant” that some of the tariffs will likely not take effect until after the midterm election, implying Trump’s main objective is to get to that point, and then he may relent soon after.
But Clifton acknowledges the risks are now much higher: “The stakes have been raised,” he said.
