How tariffs are forecast to affect US stocks

Financial markets have whipsawed amid tariff negotiations between the US and its major trade partners. If the US implements sustained taxes on exports similar to those that have recently been proposed, it would likely cut S&P 500 Index earnings per share by 2-3%, according to Goldman Sachs Research.

Beyond the additional 10% tariff on imports from China, the Trump administration has proposed, and since delayed, a 25% tariff on imported goods from Mexico and Canada. Tariffs on the EU have also been suggested. It remains to be seen whether the US will implement substantial export taxes or reach a compromise with its trade partners.

Our economists’ baseline tariff forecast (which includes taxes on Chinese exports, but not Mexico and Canada) estimates that the effective US tariff rate could rise by about 4.7 percentage points. If tariffs on Canada and Mexico are implemented, that would raise the effective tariff rate by an additional 5.8 percentage points.

How will tariffs impact the S&P 500?

For the stock market, every five-percentage-point increase in the US tariff rate is estimated to reduce S&P 500 earnings per share by roughly 1-2%, writes David Kostin, chief US equity strategist at Goldman Sachs Research, in the team’s report.

As a result, if sustained, the US tariffs that were recently considered — a 25% tariff on imported goods from Mexico and Canada (energy imports from Canada will be subject to an incremental 10% tariff) and an incremental 10% tariff on imports from China — would reduce Goldman Sachs Research’s S&P 500 EPS forecasts by roughly 2-3%.

“If company managements decide to absorb the higher input costs, then profit margins would be squeezed,” Kostin writes. “If companies pass along the higher costs to end customers, then sales volumes may suffer. Firms may try to push back on their suppliers and ask them to absorb part of the cost of the tariff through lower prices.”

Tariffs could also potentially drive up the value of the dollar, according to Goldman Sachs Research foreign exchange analysts. A stronger dollar could further weigh on the earnings of S&P 500 companies, which derive 28% of revenues outside the US (although they report less than 1% of revenues explicitly from each of Mexico and Canada).

For example, Goldman Sachs Research’s earnings model suggests that, holding all else equal, a 10% increase in the value of the trade-weighted dollar would reduce S&P 500 EPS by roughly 2%.

During Trump’s last presidency, the S&P 500 fell by a cumulative total of 5% on days when the US announced tariffs in 2018 and 2019, according to Goldman Sachs Research. It fell by slightly more, a total of 7%, on days when other countries announced retaliatory tariffs.

The impact of policy uncertainty on US stocks

As well as potentially hitting earnings, tariffs could impact US stocks by causing greater uncertainty. The US Economic Policy Uncertainty Index — based on newspaper coverage, reports from the Congressional Budget Office, and a survey of economic forecasters — has gyrated significantly amid trade uncertainty. Shortly before the announcement of the latest tariffs, the measure jumped to a top percentile reading relative to the last 40 years.

All else being equal, Kostin writes, the historical relationship between policy uncertainty and the premium that investors demand from S&P 500 companies in return for holding their stock in times of elevated risk suggests that the recent uncertainty increase will weigh on the value of US stocks. It could reduce the forward 12-month price-to-earnings multiple (a key measurement for a stock’s market value) by around 3%.

Kostin also notes that some investors are concerned that tariffs could lead to higher interest rates. High bond yields could weigh on equity valuations, as increasing bond yields make stocks look less attractive.

Indeed, the risk of tariffs driving up inflation could cause a short-term increase in yields, particularly on shorter-maturity bonds, according to economists in Goldman Sachs Research. However, they expect that, ultimately, the potential impact of a trade conflict on economic growth would prevent a major increase in long-term yields.

Taken together, the models for earnings-per-share and valuations indicate the fair value of the S&P 500 could decline 5% in near term, should sustained US tariffs like those recently discussed take place. A more short-term implementation of tariffs would result in a smaller impact on equity markets.

 

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