TKer: Even with tariffs looming, the stock market continues to trade near record highs

For now, earnings continue to perform remarkably well.

Nearly two thirds of the S&P 500 companies have reported Q4 earnings. According to FactSet, EPS growth is on track to grow by 16.4% year-over-year, the highest growth rate since Q4 2021. This is significantly higher than the 11.8% growth expected by analysts at the beginning of the year.

If this pattern of better-than-expected earnings were to continue — which by the way is one of the most consistent trends in stock market history — then it’s possible that the downside of any tariffs could be at least partially offset by what would be upside surprises in reported earnings.

As I laid out in TKer Stock Market Truth No. 5: “News about the economy or policy moves markets to the degree they are expected to impact earnings. Earnings (a.k.a. profits) are why you invest in companies.”

As TKer readers understand, earnings are the most important driver of stock prices. Earnings and prices have one of the tightest correlations of any two variables in markets.

Goldman Sachs explained: “The close relationship between the economy and market performance is largely driven by earnings. Because corporations are paid in nominal dollars, their sales and earnings tend to track nominal GDP growth over time. Rising sales typically boost profit margins as well, since companies often have some fixed costs that do not scale with higher revenues. As a result, margins historically expanded about two-thirds of the time during past periods with positive sales growth. … Given these linkages, the S&P 500 has closely followed the path of earnings over time. Even with significant expansion in the P/E ratio over the last decade, earnings and dividends still contributed three-fourths of the S&P 500’s total return.”

That last point is an important one. As much as we all obsess over P/E ratios, the dominant driver of prices has been earnings not valuations. (Indeed, in the Feb. 07, 2024 TKer, I said that moves in the P/E ratio just reflect the margin of error in what is a very tight relationship between prices and earnings.)

And by the way, earnings explain why U.S. stocks have smoked non-U.S. stocks.

“The growing dominance of the US equity market has simply mirrored its relative profit growth since the financial crisis,” Goldman Sachs’ Peter Oppenheimer wrote.

It’s worth stating that tariffs also hurt the countries on which tariffs are being imposed.

If the trajectory of earnings were to shift due to tariffs, we should expect prices to follow.

Because tariffs are almost universally considered negative for all of the economies involved, their implementation would mean earnings estimates will come down.

For now, most companies and analysts appear to be waiting for something firm before they make any revisions.

The stock market, meanwhile, continues to trade near all-time highs. This seems to reflect investors and traders wagering that new tariffs either won’t come to fruition or they will be benign.

Maybe the market is right to be trading high, and maybe companies and analysts won’t have to cut their earnings estimates. After all, there’s a case to be made that policymakers don’t want to tank the stock market.

In any case: Investing in the stock market would be a whole lot easier if we knew what was to come.

There were several notable data points and macroeconomic developments since our last review:

The labor market continues to add jobs. According to the BLS’s Employment Situation report released Friday, U.S. employers added 143,000 jobs in January. The report reflected the 49th straight month of gains, reaffirming an economy with growing demand for labor.

Total payroll employment is at a record 159.1 million jobs, up 6.8 million from the prepandemic high.

The unemployment rate — that is, the number of workers who identify as unemployed as a percentage of the civilian labor force — ticked down to 4.0% during the month. While it continues to hover near 50-year lows, the metric is near its highest level since October 2021.

While the major metrics continue to reflect job growth and low unemployment, the labor market isn’t as hot as it used to be.

Wage growth ticks higher. Average hourly earnings rose by 0.48% month-over-month in January, up from the 0.25% pace in December. On a year-over-year basis, this metric is up 4.1%.

Job openings fall. According to the BLS’s Job Openings and Labor Turnover Survey, employers had 7.6 million job openings in December, down from 8.16 million in November.

During the period, there were 6.88 million unemployed people — meaning there were 1.1 job openings per unemployed person. This continues to be one of the more obvious signs of excess demand for labor. However, this metric has returned to prepandemic levels.

Layoffs remain depressed, hiring remains firm. Employers laid off 1.77 million people in December. While challenging for all those affected, this figure represents just 1.1% of total employment. This metric remains at pre-pandemic levels.

Hiring activity continues to be much higher than layoff activity. During the month, employers hired 5.46 million people.

That said, the hiring rate — the number of hires as a percentage of the employed workforce — has been trending lower, which could be a sign of trouble to come in the labor market.

People are quitting less. In December, 3.2 million workers quit their jobs. This represents 2% of the workforce. While the rate ticked up last month, it continues to trend below prepandemic levels.

A low quits rate could mean a number of things: more people are satisfied with their job; workers have fewer outside job opportunities; wage growth is cooling; productivity will improve as fewer people are entering new unfamiliar roles.

Labor productivity inches up. From the BLS: “Nonfarm business sector labor productivity increased 1.2% in the fourth quarter of 2024 … as output increased 2.3% and hours worked increased 1.0%. (All quarterly percent changes in this release are seasonally adjusted annualized rates.) From the same quarter a year ago, nonfarm business sector labor productivity increased 1.6% in the fourth quarter of 2024. Annual average productivity increased 2.3% from 2023 to 2024.”

Unemployment claims tick up. Initial claims for unemployment benefits fell to 219,000 during the week ending February 1, up from 208,000 the week prior. This metric continues to be at levels historically associated with economic growth.

Job switchers still get better pay. According to ADP, which tracks private payrolls and employs a different methodology than the BLS, annual pay growth in January for people who changed jobs was up 6.8% from a year ago. For those who stayed at their job, pay growth was 4.7%

Consumer vibes deteriorate. From the University of Michigan’s February Surveys of Consumers: “Consumer sentiment fell for the second straight month, dropping about 5% to reach its lowest reading since July 2024. The decrease was pervasive, with Republicans, Independents, and Democrats all posting sentiment declines from January, along with consumers across age and wealth groups. Furthermore, all five index components deteriorated this month, led by a 12% slide in buying conditions for durables, in part due to a perception that it may be too late to avoid the negative impact of tariff policy.”

Relatively weak consumer sentiment readings appear to contradict resilient consumer spending data.

Politics clearly plays a role in peoples’ perception of the economy. Notably, expectations for inflation appear to be a partisan matter.

Card spending data is holding up. From JPMorgan: “As of 31 Jan 2025, our Chase Consumer Card spending data (unadjusted) was 2.7% above the same day last year. Based on the Chase Consumer Card data through 31 Jan 2025, our estimate of the US Census January control measure of retail sales m/m is 0.54%.”

From BofA: “Total card spending per HH was up 0.9% y/y in the week ending Feb 1, according to BAC aggregated credit & debit card data. Spending in the South seems to have recovered from the snowstorms driven decline we saw in the last month. Within sectors we report, online electronics saw the biggest y/y rise since last week & lodging saw the biggest decline.”

Gas prices tick up. From AAA: “Amid the threat of tariffs, the national average for a gallon of gas ticked up two cents from last week to $3.13. According to new data from the Energy Information Administration (EIA), gasoline demand increased from 8.30 million b/d last week to 8.32. Total domestic gasoline supply rose from 248.9 million barrels to 251.1, while gasoline production decreased last week, averaging 9.2 million barrels per day.”

Supply chain pressures remain loose. The New York Fed’s Global Supply Chain Pressure Index — a composite of various supply chain indicators — ticked lower in January and remains near historically normal levels. It’s way down from its December 2021 supply chain crisis high.

Business investment activity trends at record levels. Orders for nondefense capital goods excluding aircraft — a.k.a. core capex or business investment — increased 0.4% to $74.7 billion in December.

Core capex orders are a leading indicator, meaning they foretell economic activity down the road. While the growth rate has leveled off a bit, they continue to signal economic strength in the months to come.

Services surveys signal growth. From S&P Global’s January U.S. Service PMI: “Service sector businesses reported a slowdown at the start of 2025, with activity levels growing at a reduced pace compared to the robust gains seen late last year. … However, at least some of this cooling off seems to be related to disruptions caused by unusually adverse weather, hinting that growth in the services sector could revive in February. A marked upturn in hiring further supports the view that robust growth should resume.”

The ISM’s January Services PMI made a similar move.

Manufacturing surveys improved. From S&P Global’s January U.S. Manufacturing PMI: “A new year and a new President has brought new optimism in the US manufacturing sector. Business confidence about prospects for the year ahead has leaped to the highest for nearly three years after one of the largest monthly gains yet recorded by the survey. Over the past decade, only two months during the reopening of the economy from pandemic lockdowns have seen business sentiment improve as markedly as recorded in January.”

The ISM Manufacturing PMI improved and signaled growth in January for the first time since 2022.

Keep in mind that during times of perceived stress, soft survey data tends to be more exaggerated than actual hard data.

Construction spending ticks higher. Construction spending increased 0.5% to an annual rate of $2.19 trillion in December.

Mortgage rates tick lower. According to Freddie Mac, the average 30-year fixed-rate mortgage declined to 6.89% from 6.95% last week. From Freddie Mac: “Mortgage rates have been stable over the last month and incoming data suggest the economy remains on firm footing. Even though rates are higher compared to last year, the last two weeks of purchase applications are modestly above what was seen a year ago, indicating some latent demand in the market.”

There are 147 million housing units in the U.S., of which 86.6 million are owner-occupied and 34 million (or 40%) of which are mortgage-free. Of those carrying mortgage debt, almost all have fixed-rate mortgages, and most of those mortgages have rates that were locked in before rates surged from 2021 lows. All of this is to say: Most homeowners are not particularly sensitive to movements in home prices or mortgage rates.

Offices remain relatively empty. From Kastle Systems: “Peak day office occupancy was 63.4% on Tuesday last week, up 18 points from the previous week as many workers returned to the office. Houston and Austin experienced the greatest increases, rising more than 70 points to 74.8% and more than 50 points to 68.3%, respectively. Other significant changes included Chicago, up nearly 28 points to 70.4%, and Washington, D.C., up more than 10 points to 61.7%. The average low was on Friday at 36.7%, up 2.3 points from last week.”

Near-term GDP growth estimates remain positive. The Atlanta Fed’s GDPNow model sees real GDP growth climbing at a 2.9% rate in Q1.

The long-term outlook for the stock market remains favorable, bolstered by expectations for years of earnings growth. And earnings are the most important driver of stock prices.

Demand for goods and services is positive, and the economy continues to grow. At the same time, economic growth has normalized from much hotter levels earlier in the cycle. The economy is less “coiled” these days as major tailwinds like excess job openings have faded.

To be clear: The economy remains very healthy, supported by strong consumer and business balance sheets. Job creation remains positive. And the Federal Reserve — having resolved the inflation crisis — has shifted its focus toward supporting the labor market.

We are in an odd period given that the hard economic data has decoupled from the soft sentiment-oriented data. Consumer and business sentiment has been relatively poor, even as tangible consumer and business activity continue to grow and trend at record levels. From an investor’s perspective, what matters is that the hard economic data continues to hold up.

Analysts expect the U.S. stock market could outperform the U.S. economy, thanks largely due to positive operating leverage. Since the pandemic, companies have adjusted their cost structures aggressively. This has come with strategic layoffs and investment in new equipment, including hardware powered by AI. These moves are resulting in positive operating leverage, which means a modest amount of sales growth — in the cooling economy — is translating to robust earnings growth.

Of course, this does not mean we should get complacent. There will always be risks to worry about — such as U.S. political uncertainty, geopolitical turmoil, energy price volatility, cyber attacks, etc. There are also the dreaded unknowns. Any of these risks can flare up and spark short-term volatility in the markets.

There’s also the harsh reality that economic recessions and bear markets are developments that all long-term investors should expect to experience as they build wealth in the markets. Always keep your stock market seat belts fastened.

For now, there’s no reason to believe there’ll be a challenge that the economy and the markets won’t be able to overcome over time. The long game remains undefeated, and it’s a streak long-term investors can expect to continue.