Tariffs Threaten to Derail the Early 2025 'Santa Rally'

Tariffs Could Undermine Potential 'Santa Rally' in Early 2025, Saxo Bank Says
The recent rally in stocks has investors optimistic about the start of 2025, but the specter of tariffs looms large, threatening to dampen the festive spirit. Saxo Bank, a leading financial services provider, has warned that President-elect Donald Trump's renewed threats to impose tariffs on key trading partners could undermine the potential 'Santa Rally' in early 2025.

The 'Santa Rally' is a phenomenon where stock markets tend to rise during the last few days of December and the first days of January. Historically, it occurs about 80% of the time, providing a cheerful end to the year for investors. However, the potential for increased tariffs and retaliatory measures from targeted countries could cast a shadow over this traditional rally.

Trump's renewed threats to impose tariffs on China, Canada, Mexico, and other U.S. trading partners have raised concerns about the impact on corporate earnings and the broader economy. Economists' worst-case forecasts paint a worrisome picture, with world trade shrinking as much as 10% and U.S. economic growth about 1% below current expectations. Tariffs will hit corporate earnings, particularly in the retail, industrials, and materials sectors, while stoking inflation, other forecasts show.

Barclays strategists estimated that proposed tariffs on Canada, Mexico, and China, along with any retaliatory actions, could drag S&P 500 earnings down by 2.8%. The materials and consumer discretionary sectors could face double-digit earnings declines, due to their significant supply and production presence in Mexico and Canada. Retaliatory tariffs by targeted countries would exacerbate any earnings fallout.

BofA Global Research expects a 1% hit to S&P 500 earnings if tariffs on China double to 40% while they rise to around 8% for the rest of the world, excluding Mexico and Canada. But with retaliatory tariffs, which hurt foreign sales, the earnings hit would rise to 5%, the bank's strategists wrote.

Tariffs may also increase the core measure of the personal consumption expenditures price index, a widely used inflation gauge, to around 2.5% from 2.3% next year, according to Deutsche Bank economists.

The materials and industrial sectors were the market's worst performers during the U.S.-China trade war in 2018, both falling more than 5% over a nine-month period, according to RBC Capital Markets. Defensive stocks, popular during uncertain times, posted the strongest returns, with utilities and real estate both rising more than 10%.

RBC's strategists earlier this month downgraded the materials sector to "market weight" from "overweight," citing its poor performance in that 2018 period as one factor. The sector has fallen 3% since Trump's election victory, versus a 4% gain for the S&P 500 over the same time.

The tech sector tended to underperform on days of announced U.S. tariffs or China retaliations in 2018 and 2019, with particular weakness in hardware and semiconductors, a Citi analysis showed. However, given they remain at the forefront of the AI story and may benefit from a front-loading of orders if tariffs are announced, Citi strategists are less concerned on the immediate risk.

Higher tariffs on China could put retailers, industrial companies, and tech hardware firms in the crosshairs, said David Lefkowitz, head of U.S. equities at UBS Global Wealth Management. Popular U.S. brands such as Apple, Starbucks, and Nike could face retaliatory measures, Lefkowitz said. Automakers manufacturing in Canada and Mexico could feel the heat from any tariffs, Lefkowitz said. General Motors and other auto shares sold off after Trump's tariff pledges last month.

Bullish investors point to various parts of Trump's economic platform, including tax cuts and deregulation, that could potentially offset tariffs. Trump's choice of prominent investor Scott Bessent to be U.S. Treasury Secretary, essentially the highest-ranking U.S. economic official, was also well received by Wall Street.

However, the potential for increased tariffs and retaliatory measures could dampen the enthusiasm for the early 2025 'Santa Rally.' Investors should closely monitor the developments in trade policies and adjust their portfolios accordingly to mitigate the risks associated with tariffs.

In conclusion, while the 'Santa Rally' has historically been a reliable phenomenon, the potential for increased tariffs and retaliatory measures from targeted countries could threaten the festive spirit in early 2025. Investors should be mindful of the risks associated with tariffs and consider diversifying their portfolios to reduce exposure to vulnerable sectors. By doing so, investors can better position themselves to weather the potential storm and capitalize on the opportunities that may arise in the new year.