Market Beat: The effect of tariffs on earnings
August 9, 2018
Most of the market volatility that we've witnessed in the last few months has been due to concerns over the possibility of a trade war developing.
Geopolitical events can have a substantial influence on the markets and the outcome can be very difficult to predict. We must analyze the final details to see how certain companies and industries will be impacted. Sometimes the discussions can get heated, but the results aren't that bad.
One way to estimate the impact is to see how the CEOs of S&P 500 companies forecast how their corporate earnings will be affected. According to a recent analysis by FactSet, 60 percent of the companies that they analyzed said that there would be little or no impact on their earnings. Another 30 percent said the impact would be modest. That means that only about 10 percent of S&P 500 companies are concerned about a significant impact on their earnings from proposed tariffs. The greatest impact from tariffs could be on long-term capital spending which will not show up in near term earnings reports.
If the costs of raw materials increase, many companies will pass those costs on to consumers by raising their prices, which could cause some inflation. Procter and Gamble is one company that may raise the price of everyday items like diapers and paper towels. Currently inflation has been tame and is running near 2 percent, which is right where the Fed wants it to be, anything higher than that could lead to more interest rate increases by the FOMC. The CPI or consumer price index has been flat over the last year at 2.2 percent.
The greatest impact from tariffs could be on long-term capital spending which will not show up in near term earnings reports.
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Companies in the Industrials sector have expressed the most concern about tariffs, followed by Financials and Consumer Discretionary. Companies in the Energy, Real Estate, Utilities and Telecom Services sectors don't seem to be very concerned at all. Small cap stocks without much international exposure shouldn't be affected much, either.
So far, earnings for the second quarter have been coming in strong. With over 80 percent of the companies having already reported, more companies are reporting higher than expected earnings than the five-year average. Looking ahead, analysts are expecting earnings growth to be near 20 percent for the rest of this year, then slow down going into 2019. The market is fully valued now with a PE or price to earnings ratio of 16.5, which is above both the five and 10-year average.
Kenneth Roberts is a Truckee-based Registered Investment Advisor. Information is at his blog at http://www.sellacalloption.com or 775-657-8065. The mention of securities should not be considered an offer to sell or solicitation to buy investments mentioned. Consult your investment professional to understand the risks and/or how the purchase or sale of these investments may be implemented to meet your investment goals. Past performance is no guarantee of future results.