“Uncertainty” is the new buzzword. The term has been used repeatedly during earnings calls throughout the past month as company executives described the current state of the operating environment. This uncertainty is driven by the Trump Administration’s fluctuating tariff policy.
Company Earnings
During an earnings call, company executives will generally review the previous quarter’s revenue and earnings and then give guidance for the next quarter. The goal is to help investors better understand how the company has performed and how it’s likely to perform throughout the coming year. Executives want to paint their companies in the best light without overpromising, i.e., don’t say the company is going to increase revenue by 20% and then deliver 10% growth. Post earnings release, investors assess both how the company performed and how it guided for the future.
Tariff Changes
The ever-changing tariff landscape is throwing executives and investors for a loop. As of this writing, there is a universal 10% tariff on all goods, a 25% tariff on cars, steel and aluminum, and a 145% tariff on Chinese imports. China has retaliated with a 125% tariff on United States imports. The US and China have agreed to lower the tariff to 30% (Chinese goods into the US) and 10% (US goods into China) for 90 days. The United Kingdom has outlined a deal with the US, reducing auto tariffs to 10% and metal tariffs to 0%, although details are still being negotiated. The European Union is targeting autos, planes and bourbon in response to the US tariffs. The Trump administration is still planning additional tariffs on sectors such a semiconductors, pharmaceuticals and critical minerals.
This fluid situation means the first quarter’s earnings are almost irrelevant. The cost and pricing environment operated under for the first three months of the year is not applicable going forward. On Amazon’s first quarter call, CEO Andrew Jassy stated that “none of us knows exactly where tariffs will settle or when.” Aerospace and defense company RTX Corp’s stock fell after its earnings release, despite beating estimates, partially due to the estimated $850 million tariff hit to operating profits for the year. The company did its best to estimate the impact but admitted the situation remains fluid and “it's difficult to assess the impact of multiple variables,” including changes to current tariffs and countermeasures taken by other countries.
Tariff Impact on Price Elasticity
The increased costs because of tariffs will mean companies need to test the price elasticity of their products. Price elasticity refers to how much demand changes with price- the more elastic, the more demand changes. For example, demand for discretionary items like new furniture or a new television is likely to fall if price increases are enacted. On the other hand, demand for staples like bread, eggs and toilet paper is unlikely to fall because of price increases.
The price elasticity of smartphones is a question looming over Apple as well as suppliers such as Qualcomm. Qualcomm’s stock fell after its earnings release, largely due to fears that the trade war would dampen demand for new smartphones, even though first-quarter sales beat estimates. Smartphones are made through a global supply chain that includes China and is not easily shifted. As the cost of producing a phone will therefore increase, will consumers view their current phone as good enough, or will enough new features be added to drive demand regardless of price?
GDP
The uncertainty has bled into the macro environment, making the Gross Domestic Product (GDP) report, as an example, largely irrelevant. The first quarter GDP report showed negative growth of 0.3% annualized, which would normally indicate the start of a recession. But the negative number was driven by the increase in imports as companies purchased items from overseas to get ahead of pending tariffs. So perhaps it’s not a sign of a slowing economy. However, fixed investment was up as companies may have front-loaded capital spending, again to get ahead of tariffs, so the impact was not all negative. Personal Consumption, the largest component of GDP, slowed from 4% annualized in the 4th quarter to 1.8% annualized. This points to a slowing economy but perhaps not a recession.
The Fed
The Federal Reserve (Fed) is now facing tariff-driven uncertainty. The Fed met last week and held its target rate at 4.25 percent to 4.5 percent. Chair Jerome Powell stated that the Fed will not lower its target rate, i.e., the cost of money, until there is more certainty in the direction of the trade policy. He further stated it will take time for the full effect of the new tariffs to work through the economy. So, while inflation has slowed and the unemployment rate is low, the uncertainty is making that data irrelevant.
Where does this uncertainty leave an investor? While the uncertainty can mean more volatility, it doesn’t mean a falling stock market. Companies are adjusting to the new tariff environment, shifting production to different locations, and increasing prices where possible. This ultimately means stocks can still grow earnings, which is the ultimate driver of an appreciating stock market.
For informational purposes only. Opinions referenced are as of the date of the email and may be modified due to changes in the market or economic conditions and may not necessarily come to pass. All investments involve risks, including the loss of principal.
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