TKer: All else is never equal when it comes to markets

“The S&P 500 effective tax rate would need to rise from 20% today to roughly 28% in 20 years to offset the potential earnings boost from AI adoption, all else equal.” – Goldman Sachs, June 2023

“The impact from a 1% buyback tax is two-fold: 1) reduction in earnings from paying the new tax; 2) reduction in overall gross buybacks (all else equal) to compensate for the tax and thus a smaller reduction in ‘S’ within EPS.” – JPMorgan, September 2022

To be clear, ceteris paribus also means there could be other negative developments that aren’t being considered, not just positive ones. Again, the world is complicated.

But in recent months and years, ceteris paribus has frequently been a reminder that even though we are witnessing challenges emerge, there’s also a lot of things we’re not talking about that could go right.

I’ve made this point a couple times. (See here and here.)

Notably, see the April 10, 2022 TKer: The wrong question — and the right one — to ask about earnings headwinds. From that newsletter:

When a new headwind emerges, investors probably think to themselves: How will this hurt the earnings of the companies I’m invested in?

… The problem is we’re asking the wrong question.

… The right question is: Can the companies I’m invested in deliver on earnings?

It’s similar to the question above, but it broadens the scope of the inquiry to consider more than just the negative impacts of just the unfavorable developments.

Simply put, investors should not be thinking about the effects of some development in isolation. It needs to be considered in the context of everything that affects earnings. Because for investors, what ultimately matters is whether earnings will keep going up.

There’s been lots of news about new tariffs and the potential for more tariffs down the road. And tariffs are almost universally considered negative for all of the economies involved.

It’s a big deal, especially since many companies and analysts have yet to factor in the impact of tariffs into their earnings forecasts.

“We estimate that 25% tariffs on Canada and Mexico plus 10% incremental tariffs on China translates into a 2% hit to EPS, all else equal (1.7% from Canada & Mexico and 0.3% from China),” BofA’s Savita Subramanian wrote in a Feb. 9 note.

As Subramanian’s use of “all else equal” suggests, the situation is more complicated than simply calculating the cost of tariffs when applied to recent trade data. The ultimate effects could be much worse! And we’re not even addressing all of the other tariffs that have been threatened in recent days.

But we also know many companies have actively taken steps to blunt the incremental costs of tariffs and work around potential disruptions to global supply chains.

We also know that companies have been reporting earnings that have exceeded expectations.

As we assess the effects of tariffs and other challenges that may emerge, we should also be vigilant of the positive things going on that may help keep earnings growing — which in turn would support stock prices going higher.

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

Shopping ticks lower from record levels. Retail sales declined 0.9% in January to $723.9 billion.

Most categories fell during the period.

Wildfires in Los Angeles and harsh winter weather in other parts of the country may have disrupted January retail activity.

Card spending data is holding up. From JPMorgan: “As of 07 Feb 2025, our Chase Consumer Card spending data (unadjusted) was 3.1% above the same day last year. Based on the Chase Consumer Card data through 07 Feb 2025, our estimate of the US Census February control measure of retail sales m/m is 0.48%.”

Inflation ticks up. The Consumer Price Index (CPI) in January was up 3.0% from a year ago, up from the 2.9% rate in December. Adjusted for food and energy prices, core CPI was up 3.3%, up from the prior month’s 3.2% level.

On a month-over-month basis, CPI was up 0.5% and core CPI was up 0.4%.

Inflation expectations remain cool. From the New York Fed’s January Survey of Consumer Expectations: “Median inflation expectations were unchanged at 3.0% at both the one- and three-year-ahead horizons. Median five-year-ahead inflation expectations rose by 0.3 percentage point to 3.0% in January. This increase was driven primarily by respondents with a high-school education or less.”

Powell says Fed isn’t in a “hurry.” From Fed Chair Jerome Powell’s semiannual monetary policy report: “With our policy stance now significantly less restrictive than it had been and the economy remaining strong, we do not need to be in a hurry to adjust our policy stance. We know that reducing policy restraint too fast or too much could hinder progress on inflation. At the same time, reducing policy restraint too slowly or too little could unduly weaken economic activity and employment. In considering the extent and timing of additional adjustments to the target range for the federal funds rate, the FOMC will assess incoming data, the evolving outlook, and the balance of risks.”

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.”

Unemployment claims fall. Initial claims for unemployment benefits fell to 213,000 during the week ending February 8, up from 220,000 the week prior. This metric continues to be at levels historically associated with economic growth.

Mortgage rates tick lower. According to Freddie Mac, the average 30-year fixed-rate mortgage declined to 6.87% from 6.89% last week. From Freddie Mac: “The 30-year fixed-rate mortgage continued to inch down this week, reaching its lowest level thus far in 2025. Recent mortgage rate stability is benefitting potential buyers, as purchase demand is stronger than this time last year. This is an indication that a thaw in buyer activity could be on the horizon.”

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.

Small business optimism cools after huge spike. From the NFIB’s January Small Business Optimism Index report:

“Small business owners greeted the new year with a surge in optimism. Seventeen percent (seasonally adjusted) now view the current period as a good time to expand substantially, up from just 4 percent a few months ago. A seasonally adjusted net 20 percent expect real sales gains compared to a net negative 18 percent a few months earlier. Better business conditions were expected by a seasonally adjusted net 47 percent, up from a net negative 13 percent just four months ago (net of negative responses). Reports of unfilled job openings and plans to hire to fill them remained historically high. Owners have been unsuccessful filling them over the past four years, finding few qualified applicants while government related hiring soared. Tough competition.”

Industrial activity ticks higher. Industrial production activity in January rose 0.5% from the prior month. Manufacturing output declined 0.1%.

Offices remain relatively empty. From Kastle Systems: “Peak day office occupancy was 63.3% on Tuesday last week, down one tenth of a point from the previous week. Austin saw a 2.7-point increase in Tuesday occupancy, up to 71%, and a 7.5-point increase in Wednesday occupancy, up to 71.9%. The average low was on Friday at 35.8%, down nearly a full point from last week.”

Near-term GDP growth estimates remain positive. The Atlanta Fed’s GDPNow model sees real GDP growth climbing at a 2.3% 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.