Tariffs pose hidden risks to richly valued stocks, experts warn

The US stock market's recent rally could quickly turn bearish due to the impact of tariffs on corporate profits and economic data. Duties on imports have jumped to an average rate of over 13%, slashing 5% or more from corporate earnings growth. With the S&P 500 Index trading at rich valuations, any disappointments could cause stocks to re-rate, leading to a true bear market. Some prominent voices on Wall Street are bracing for turbulence, acknowledging the risk of near-term corporate guidance turning out worse than expected.

Title: Tariff Threats Loom Over US Stock Market

The recent rally of the US stock market, marked by record-breaking highs, is under threat from rising tariffs on imports. According to Bloomberg, the average tariff rate has surged to over 13%, more than five times the rate from last year [1]. This significant increase has the potential to slash corporate earnings growth by 5% or more, as highlighted by Alastair Pinder, head of global equity strategy at HSBC [2].

The S&P 500 Index is currently trading at about 22 times forward earnings, near its richest valuations in the post-Covid era. This valuation level has led some market strategists to compare the market to a balloon floating above Wall Street, vulnerable to being popped by a single pin, such as disappointing economic data or corporate earnings reports [3]. Any deviation from the high expectations could lead to a re-rating of stocks, potentially triggering a true bear market.

Prominent voices on Wall Street are bracing for turbulence as the tariffs start to impact companies' bottom lines. Mike Wilson, Morgan Stanley's Chief US Equity Strategist, acknowledges the risk that near-term corporate guidance could turn out worse than expected, potentially causing a market correction of 5-10% [2]. Companies such as General Mills Inc., Tommy Bahama owner Oxford Industries Inc., and Fedex Corp. have already felt the pinch of tariffs, with General Mills forecasting a 1-2% hit to its cost of goods sold and Oxford Industries slashing its profit outlook due to additional tariff costs [1].

The US economy is expected to be 1.6% smaller over the next two to three years due to the current tariff rates, according to Bloomberg Economics estimates [1]. Consumer prices are projected to end up 0.9% higher, which could dash hopes for interest-rate cuts this year, regardless of the Federal Reserve Chair's public statements.

While some bulls remain optimistic about stocks due to declining interest rates, low unemployment, and elevated corporate profitability, the unpredictable nature of President Trump's tariff policies means that any estimates of their financial impact should be treated with caution. The threat of further tariffs, such as those on Brazil, Canada, Mexico, Japan, and the European Union, remains, and the IMF has warned that trade tensions continue to cloud the global economic outlook [3].

Investors should remain vigilant as the second-quarter earnings season provides more insights into the impact of tariffs on corporate earnings. The market's steady upward climb may be masking vulnerabilities, and any setbacks in tariff negotiations or earnings guidance could lead to a market correction.

References:
[1] https://finance.yahoo.com/news/priced-perfection-tariffs-loom-over-130000402.html
[2] https://www.ainvest.com/news/tariff-threats-loom-overvalued-stocks-investors-underestimate-risks-experts-warn-2507/
[3] https://www.ainvest.com/news/stock-market-faces-5-10-correction-risk-tariff-uncertainty-2507/