The market is pricing in 11.76% EPS growth for 2025, following 11.02% in 2024 and just 1.7% in 2023. That’s an aggressive expectation, especially given the headwinds piling up. While US equities are grinding higher off this bounce, the risks are still disproportionately skewed to the downside - and Q1 earnings season in April could be the wake-up call.
# Why Another Selloff is Coming:
1. Tariffs Haven’t Hit Yet – But They Will
* The recent tariff measures haven’t shown up in earnings reports or macro data yet. But second-order effects will hit margins hard. Investors seem to be dismissing the impact, but history suggests otherwise - trade tensions have always led to earnings revisions lower.
* Higher input costs can’t always be passed to consumers in a softening demand environment, meaning companies will either eat the costs (hitting margins) or lose volume (hitting revenue).
* Supply chain disruptions will create inefficiencies, further eroding bottom-line growth.
2. The Market Is Fully Priced for Perfection
* At an avg. 20.3x NTM PE (S&P 500), US equities aren’t leaving room for downside surprises.
* For context, the market bottomed at 15.2x NTM PE in 2022 and 13.5x NTM PE in 2020.
* If multiples revert to 2022 lows, that implies a 26% downside from here. Meanwhile, if we stretch to December’s all-time high multiple of 22.5x, the upside is only 10.8%.
* The risk/reward is simply not attractive at current levels.
# Breaking Down the Magnitude of Impact on U.S. Corporate Earnings
1. Direct Cost Impact: Tariff Rates vs. Corporate Margins
* U.S. tariffs on Chinese imports are increasing on semiconductors (25%), electric vehicles (100%), medical equipment (25%), and critical industrial inputs (25%).
* Many of these products are core cost inputs for U.S. manufacturers, meaning input costs will rise immediately.
* S&P 500 net margins sit around 10.84% today—meaning for every 1% increase in costs that can't be passed on, margins compress by nearly 10bps.
2. Supply Chain Inflation and Productivity Loss
* Tariffs force companies to adjust supply chains, often moving production to less efficient or more expensive locations.
* This doesn't just increase direct costs but also creates inefficiencies, from longer lead times to increased transportation costs.
* Example: If a company sources 50% of its raw materials from China and tariff costs increase by 25% on those imports, that translates to an immediate 12.5% increase in total input costs.
3. Who Absorbs the Cost?
* Can companies pass costs to consumers? Unlikely, given that core inflation is already elevated and discretionary spending is softening.
* If firms try to absorb the costs, that’s a direct EPS hit. Assume a 5% increase in tariffs on 20% of the total cost structure:
* If gross margins are 40%, and costs rise by 1% of revenue, operating income would drop by 2.5%, assuming no price pass-through.
* At an S&P 500 average 20.3x NTM PE today, that translates to a potential \~4.5% decline in stock prices, before any sentiment-driven multiple contraction.
4. Historical Context: What Happened in 2018-2019?
* The last round of Trump-era tariffs led to earnings revisions downwards of \~3-5% for industrials, tech, and consumer discretionary stocks.
* Companies adjusted by shifting production, but that took 12-18 months, leading to an earnings slowdown before supply chains stabilized.
* Markets didn’t price in the full impact until earnings confirmed the pressure, which could happen again in Q1 earnings in April this year.
# How Bad Could It Get?
* A 2-5% hit to S&P 500 EPS is not unrealistic, especially in tariff-sensitive industries like manufacturing, semiconductors, and consumer goods.
* At the current market multiple (20.3x NTM PE), every 1% EPS decline implies a \~1.5%-2% downside in index pricing (assuming multiple stability).
* If tariffs contribute to a 5% aggregate hit to S&P 500 earnings, the market could drop by 7-10% just from EPS pressure alone.
* If we add multiple contraction from overvaluation (i.e., a reversion closer to historical lows of 15.2x), that implies a 25%+ market downside potential.
# Bottom Line: The Risk/Reward Isn’t Worth It
Markets are fully priced for perfection, but earnings growth assumptions are fragile. Tariff impacts on supply chains, margins, and corporate profits are not yet priced in. The risk-to-reward at 20.3x NTM PE is simply not worth it.
# What Should You Do?
Well, here’s what I’m doing:
I transitioned 100% to cash at the beginning of February, and I’m still sitting on the sidelines. I’ve parked it in a HISA earning \~4% interest while I take a wait-and-see approach.
I don’t short the market, and I don’t do options - not because I don’t believe in them, but because markets can be irrational longer than you think and I can be wrong. Valuations can stretch further, and momentum can defy logic. But this setup feels asymmetric to the downside, and right now, I’d rather collect a risk-free 4% and wait for a better entry.
Anyway, these are just my thoughts - open to discussion. Curious what others think about the current setup.