US earnings growth has been more positive than expected in the first quarter. With more than 90% of S&P 500 firms reporting, earnings per share are 4.6 percentage points above consensus. This beat is slightly larger than normal. As a result, S&P 500 profits are on pace to rise 2.5% year over year for the quarter, allaying concerns of an "earnings recession" (two consecutive quarters of year-over-year declines in profits). Encouragingly, guidance has been solid, and after dipping during the first quarter, 12-month-forward consensus earnings estimates are rising. We still expect earnings growth of 3% this year and 7% next.
But this positive outlook is contingent on a resolution of the current trade impasse between the US and China. Trade tensions have the potential to disrupt global economic and earnings growth:
- Through uncertainty: Questions related to the dispute have been partly responsible for the recent slowdown in global trade and industrial output, as companies have delayed investment. Ongoing delays in resolving it could prolong the recent soft patch in global growth and result in weaker earnings for companies producing capital goods.
- Through the scope of tariffs: Higher tariffs pose a greater risk, notably if the US imposes them on the remaining USD 325bn of Chinese imports. While companies have managed to work around the previous rounds of tariffs – tweaking supply chains and rerouting goods – this would become harder if the scope of tariffs widens. If all Chinese goods are subject to a 25% tax, US economic growth could drop by 0.75–1% and S&P 500 profits could suffer a 3% hit or more, in our view. US equity markets could fall by 10–15% in this scenario.
Our base case remains for a resolution to the trade dispute. Both sides have plenty of incentive to avoid a breakdown of talks. In addition, the direct effect of additional tariffs will take time to feed through. The increase in tariffs on USD 200bn of Chinese goods announced last week will only apply to goods shipped after 10 May, giving a grace period of about two weeks before the extra tariffs start being collected. We maintain our belief that risk-on positions should be complemented with countercyclicals given the heightened trade risk. Overall, however, we encourage investors to focus on the healthy economic fundamentals and the likelihood that the current trade spat will (ultimately) be resolved.
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