Another Panic Dies in the Dow as Traders Fixate on Profit Impact

(Bloomberg) -- Overnight spectacles aside, it’s becoming a habit of weather-beaten U.S. investors to ignore Donald Trump tweet rampages on trade and wait to see if the impact ever shows up in earnings.

The ritual recurred Monday, with futures on the Dow Jones Industrial Average bouncing 500 points. Wall Street is getting used to viewing the president’s bluster as a negotiating tactic. A tariff hike on $200 billion in goods to 25 percent has been delayed before. Twice.

Not that a trade war wouldn’t hurt. UBS Group AG estimated that if talks break down and hikes materialize, U.S. profits could contract 5 percent, wiping out growth this year. Pair that with lower valuations, and U.S. stocks could be in for a worst-case decline of 15 percent, according to Mark Haefele, UBS Global Wealth Management’s chief investment officer.

“Our base case remains for a negotiated trade settlement, including select U.S. tariff rollbacks in exchange for some Chinese concessions,” said Haefele. “That said, we have continued to warn that US-China talks could still break down.”

Should they falter, an earnings picture that has grown increasingly more rosy could dim. About 76 percent of S&P 500 companies have beaten estimates this season and fears of a profits recession have dwindled, as results and forecasts now call for earnings growth in the three months ended in March. But guidance has been skeptical at best, and full-year earnings estimates are still largely dependent on a fourth quarter boost.

If the tariff rate is raised, more downward earnings revisions to forecasts could be in the cards as companies deal with inflating prices. Throughout the first quarter reporting season, companies and executives have focused less on U.S.-China trade during conference calls, data compiled by RBC Capital Markets show. A higher tariff rate could change that.

“Beyond the blow to sentiment, we also get the impression that management teams and the sell-side community have only baked in the current tariff regime to guidance and stock level forecasts, meaning that any escalation of the tariffs could spark downward revisions to earnings expectations due to higher raw material/input costs,” said Lori Calvasina, head of U.S. equity strategy at RBC.

A change could also weigh on profit margins, measures of which, while at decade-long highs, have started to come under scrutiny as strategists call for a peak. To date, highly profitable technology companies have driven earnings among S&P 500 members to levels not seen since at least 1990, but the boost could shift to a detraction in the event of higher tariffs. Of all S&P sectors, tech and consumer discretionary companies have expressed the most concern over tariffs in previous earnings season, according to data compiled by Evercore ISI.

“An exogenous event like an escalation of the trade war would put upward pressure on input costs and weigh on profitability,” said Dennis Debusschere, the firm’s head of portfolio strategy. “Profitability will suffer significantly for the largest market cap sector if U.S. tariffs increase and China responds forcefully,” he added, referring to technology.

Trump’s tweets saying that tariffs on $200 billion worth of goods could rise to 25 percent from 10 percent, and that another $325 billion in Chinese imports could be subjected to the tax, provided a harrowing if brief blow to calm Monday, in a stock market that had gone virtually nowhere but up this year.

The S&P 500 fell as much as 1.6 percent, dragged lower by trade-sensitive technology and industrials companies, before paring three-fourths of the decline by the close. The hit was harder in Asia, where Chinese stocks suffered their biggest one-day drop in three years.

Bluster is one thing, a hit to earnings are another. And Wall Street seems to be viewing the latest tweets as the former -- a tool of negotiation. China’s trade delegation is still coming to Washington for high-level talks this week. Strategists from Goldman Sachs Group Inc. to Citigroup Inc. shrugged off the concerns and remained positive a trade deal will be reached. There’s a similar take at J.P. Morgan Asset Management

“On the whole, we still expect a narrow trade deal, but there is a risk -- the risk is that markets priced that in to a large degree already,” Mike Albrecht, global macro strategist at JPMorgan Asset Management, said in an interview at Bloomberg’s New York headquarters. “So there is this large chance that you get a trade deal and a little bit of a bump to markets, but a small chance that you get a complete blowup and quite the sell-off.”

To contact the reporter on this story: Sarah Ponczek in New York at sponczek2@bloomberg.net

To contact the editors responsible for this story: Jeremy Herron at jherron8@bloomberg.net, Chris Nagi

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