We see risk assets in a tug-of-war between solid U.S. corporate earnings, powered by the artificial intelligence (AI) theme, and tariffs hurting growth while lifting inflation. Q2 earnings results suggest the AI theme is winning, but questions remain about who will pay for tariffs.
Early signs indicate a mix of consumers and companies. We think U.S. corporate strength could cushion the blow and stay overweight the AI theme and U.S. stocks. We get granular when eying the tariff hit.
The U.S. “reciprocal” tariffs announced on April 2, which stoked historic market volatility, are now taking shape as the U.S. reaches agreements or imposes higher levies. U.S. tariffs on imports are now ending up at an effective rate around 15- 20%, higher than we expected earlier this year, and generated revenues of $27 billion in June, Treasury data show. That means someone is paying the tariffs – and how much they hurt growth and stoke inflation will depend on who pays. Ultimately it is some mix of foreign suppliers, U.S. companies via profit margins and consumers via inflation.
Yet U.S. corporate earnings are robust: Q2 U.S. earnings are up about 8% year-over-year even with tariffs, LSEG data show. U.S. profit margins are at record highs relative to flat margins in Europe. See the chart. U.S. mega cap tech is lifting AI investment as seen with Microsoft and Meta last week.
The slew of trade agreements announced in recent weeks removes some of the uncertainty of the ultimate effective landing zone for tariffs – even if they’re several times higher than where they were at the end of 2024.
The tariff impact on U.S. consumers has been slow to show up in part because companies rushed to import goods before expected tariffs in April. Tariffs do not apply to ships that left the port, shipping can take several weeks and companies can delay payments even when goods arrive. Many have not yet raised prices until they have greater clarity. Yet that offset is fading: second quarter U.S. inflation data showed durable goods prices rising at the fastest pace since 1991 outside the pandemic.
So consumers are starting to pay some of the tariff costs, especially in household appliances and electronics. And companies have also started paying: global automakers, some of the most exposed to tariffs, are reporting large earnings writedowns.
Automakers highlight how complicated the tariff story is. U.S. automakers like General Motors and Ford are among those taking the large profit hits as tariffs are implemented – and chose to eat the tariffs. Japanese and South Korean automakers are absorbing tariff costs by cutting the prices of the vehicles they sell to the U.S. This pressure on pricing is especially acute in Europe where automakers battle with China’s cheaper electric vehicles and are constrained in raising prices.
By contrast, quality producers like Ferrari are lifting prices – highlighting the importance of pricing power. This is why corporate earnings resilience matters, in our view. Automakers are manufacturers. The industrials sector – where supply chains are among the most integrated globally – is dominated by manufacturers and is likely feeling the biggest impact of tariffs.
And yet the industrials sector is the best-performing S&P 500 sector this year, up some 15% compared with 6% for the index, according to LSEG data. Why?
Industrials benefit from the AI buildout and other key themes driven by mega forces, such as geopolitical fragmentation and the boost to defense spending this year. That’s why this environment favors getting granular with views below the sector level and favors an active approach to achieving returns. Bottom line: We see a tug-of-war between the economic drag of tariffs and U.S. corporate earnings strength driven by AI.
The latter is winning so far, in our view, but getting granular views is key as companies and consumers each eat tariff costs.
