Corporate earnings reports have always served as a window into business health, but this earnings season carries particular significance given ongoing trade policy developments. Despite major indices achieving record highs amid stabilizing trade relationships, questions remain about how tariffs may impact both consumers and corporations. Encouragingly, new trade partnerships are emerging while companies continue to exceed earnings forecasts.

Recent data indicates that consumer expenditure remains robust and corporate profit growth surpasses projections. The Yale Budget Lab reports that consumers now encounter an average effective tariff rate of 20.2% as of July 23, marking the highest level since 1911.

The absence of this impact in consumer spending patterns suggests many companies are absorbing tariff costs rather than immediately transferring them to customers. This appears feasible due to strong earnings performance and healthy profit margins.

Notably, among the one-third of S&P 500 companies that have disclosed second quarter results, 80% delivered earnings-per-share beats, with blended earnings growth of 6.4% surpassing the anticipated 4.9%, per FactSet data.

Though this growth trails recent quarters, it indicates an “earnings recession” – characterized by steep profit declines like those seen in 2020 or 2022 – appears less probable than initially anticipated.

Corporate earnings are beating expectations so far

Understanding tariff mechanics and their financial impact requires examining who bears these costs. While governments collect tariff revenue, the actual burden falls on either exporters to the U.S. or domestic consumers and businesses through elevated prices. The distribution between these groups hinges on their respective “pricing power.”

Consider rare earth metals essential for electronics, where the U.S. imports nearly all supplies. Given limited alternative sources, tariff costs would likely transfer directly to consumers. This explains the administration’s pursuit of expanded rare earth imports agreements with China and increased focus on domestic production capabilities.

Conversely, the automotive sector features intense competition among domestic manufacturers and numerous exporting nations. When one country faces automotive tariffs, manufacturers may absorb costs to maintain competitiveness against vehicles from other countries and domestic producers.

Short-term tariff effects thus depend on industry competitiveness and available alternatives for consumers and businesses. Over longer periods, supply chains can adapt and currency values may adjust accordingly.

Consequently, tariff impacts on earnings and corporate responses differ significantly across industries. General Motors reported $1.1 billion in tariff-related profit losses during the second quarter, with margins declining from 9% to 6.1%.

Conversely, Cleveland-Cliffs, a domestic flat-rolled steel producer, announced second quarter earnings exceeding expectations, benefiting from tariffs that reduced steel imports.

The chart above demonstrates how earnings expectations vary considerably across sectors, partially reflecting trade impacts. Several quarters may be needed to fully comprehend tariff effects on companies, particularly as new trade agreements emerge.

Multiple countries have established new arrangements, some featuring substantially lower tariffs than those initially declared April 2. Recent announcements indicate the European Union and Japan will face 15% tariffs on U.S. exports, while Indonesia and the Philippines will encounter 19% tariffs. Meanwhile, China discussions continue following earlier trade truce developments.

Markets continue to reach new all-time highs

Markets have sustained their climb to record levels as earnings beats emerge alongside new trade agreements. The chart above shows the S&P 500 achieving over a dozen new records this year, with most occurring within the past month. The Nasdaq has similarly reached historic levels, surpassing its previous December peak, while the Dow approaches new record territory. Though these elevated levels may concern some investors, major indices typically establish numerous all-time highs annually during expansion periods.

While markets perform well, concerns about tariff economic impacts remain. Various economic projections, including Federal Reserve forecasts, suggest inflation may run slightly higher with somewhat slower growth. Industry impacts will vary based on input costs, with import-dependent sectors facing compressed margins. However, these projections must be balanced against domestic investment benefits and companies’ potential for adaptive innovation and efficiency gains.

Though tariffs stand at historically elevated levels, predictability matters more since stable business conditions enable more effective operational and supply chain adaptations. Looking ahead, Wall Street consensus projects S&P 500 earnings growth at a 9.5% annual rate. These forecasts anticipate accelerating growth over the next two years as global trade stabilizes, though significant changes could occur.

Earnings are an important long-term driver of returns

Stock markets generally track corporate earnings over extended periods. The accompanying chart reveals that while S&P 500 prices and earnings don’t align perfectly, they follow similar broad trajectories. This occurs because economic expansion drives earnings higher, which subsequently elevates stock prices. Though the economy and stock market aren’t identical, they connect closely through corporate performance.

This relationship explains how tariff profit impacts can affect investors. Market valuation as “cheap” or “expensive” depends not solely on stock prices but also corporate performance. The price-to-earnings ratio simply divides stock or index prices by earnings measures, such as projected twelve-month earnings.

This means that even with unchanged prices, rising earnings make markets more attractive, and the reverse holds true. The current S&P 500 price-to-earnings ratio stands at 22.2x, significantly above the 15.8x historical average and approaching the dot-com bubble peak of 24.5x. While current earnings trends appear positive, continued market attractiveness will depend on economic growth and earnings performance.

The bottom line? This earnings season may offer valuable insights into how tariffs affect consumers and businesses. For investors, understanding these developments while maintaining long-term planning focus remains the optimal approach for achieving financial objectives.