Markets See Nothing but Blue Skies Ahead
But possibly severe sanctions against Russia give pause
For now, businesses are absorbing tariff related cost increases. However, the longer tariffs persist, the more likely businesses will pass on the cost of tariffs to final product prices. According to July 25’s Wall Street Journal, economists estimate the effective average tariff rate on all imported goods jumped up from the 2.3% of a year ago to nearly 17% today.
Upwardly revised earnings forecast for Q2 2025’s S&P 500 is short of breadth …
Factset reports the consensus estimate for the yearly growth rate for Q2 2025’s S&P 500 corporate earnings was revised higher from the 4.9% atf the end of June 2025 to a recent 6.4%. However, only three of the S&P 500’s 11 corporate groups are expected to realize a yearly increase by earnings that tops 6.4%. They are the 34.0% of communications services (up from June 30, 2025’s 29.4% forecast), the 16.7% of information technology (up from June 30’s 16.4%), and the 10.1% of the financials (way up from June 30’s 2.3%).
The highest yearly earnings growth projection for the remaining eight corporate groups was the puny 0.8% of real estate (down from June 30’s 1.0%) followed by the imperceptible 0.1% of health care (down from June 30’s 4.0%). The Q2 2025 earnings for each of the other six groups is now expected to drop year-on-year.
Do not trust Artificial Intelligence (AI) regarding the meaning of economic data …
I asked my browser whether tariffs are included in the BLS’ import price index. The AI function of my browser incorrectly answered tariffs are included in the import price index.
By contrast, a BLS publication clearly states that the import price index is before the imposition of tariffs. In other words, tariffs do not directly enter into the calculation of the import price index. If anything, tariffs may put downward pressure on the import price index if the foreign exporter lowers the US’ import price limit the rise by the after-tariff dollar price paid by the US purchaser of the import.
The following is a list of possible tariff-driven price hikes …
Let’s begin with recent year-on-year increases for industrial commodity prices such as the 20% of aluminum, 40% of copper, and the 34% of steel. Elsewhere, lumber futures were up by 35% year-over-year despite a decidedly subpar homebuilding activity. My goodness, what might happen to lumber prices if home sales recvover?
Lately, the containment of inflation has received considerable help from the recent yearly price declines of -16% for WTI crude oil and the -9.5% of retail gasoline. Partly because of the reopening and expansion of export markets for LNG, the price of natural gas was recently up by 52% from a year earlier.
June’s CPI showed monthly increases of 1.9% for appliances, 1.2% for tools & hardware, 1.0% for electricity, 1.4% for beverages, and 1.1% for soups that might be tariff related. Now elevated tariffs on steel and aluminum may have been responsible for the outsized price monthly price increases of canned beverages and canned soups.
P:E multiples top 10-year averages despite above-average bond yields …
As of July 25, FactSet’s analysis of earnings forecasts produces a forward-looking price-to-earnings ratio of 22.4:1 for the S&P 500’s member companies. The latter is well above its lagging 10-year average of 18.4:1. In other words, each dollar of today’s projected earnings is priced 21.7% above its average price of the previous 10 years.
Today’s expected corporate earnings command a higher price vis a vis the average of the past 10-years despite how the latest 4.40% 10-year Treasury yield exceeds its 2.60% average of the past 10 years. In addition, the S&P 500 is richly priced notwithstanding how the latest 6.11% long-term Baa corporate bond yield also tops its lagging 10-year average of 4.77%.
A forward-looking price-to-earnings ratio uses the consensus estimate of corporate earnings over the next four quarters, whereas a trailing price-to-earnings ratio uses the actual earnings of the latest available four-quarter span. There is no guarantee that the consensus forecast of corporate earnings will be realized.
Intuitively, the more uncertain is the outlook for corporate earnings, the less the market will pay for a dollar of future earnings, which means the price-to-earnings ratio will be lower than otherwise.
Baa yield spread shows a relatively high correlation with S&P 500’s P:E ratio …
Among broad financial market indicators, the S&P 500’s forward-looking, price-to-earnings ratio shows one of its highest correlations of -0.47 with Moody's long-term Baa corporate bond yield spread over the 30-year Treasury bond.
And the relationship makes sense. When investors worry more about either diminished profitability or heightened leverage, the Baa corporate bond yield spread widens. It follows that the very same worry over weakened corporate finances will also reduce what equity investors are willing to pay for a dollar of future corporate earnings. As the Baa corporate bond yield spread narrows, investors will be willing to pay more for each future dollar of corporate earnings, and vice versa.
The Baa long-term corporate bond yield spread was recently at 117 basis points (bp), which was well under its lagging 10-year average of 174 bp, which complements the S&P 500’s now well above average price-to-earnings ratio.
Among the S&P 500 price-to-earnings ratio's other correlations were the -0.28 with the high-yield bond spread and the +0.10 with the VIX. Some may find it odd that the S&P 500 P:E ratio shows a relatively high correlation of the correct sign with the Baa corporate bond yield spread but shows a meaningless correlation of the incorrect sign with the VIX.
Below-trend VIX finally joins below-trend high-yield bond spread …
Speaking of the VIX, for the longest period of time, an above-trend VIX remained well above what otherwise might be inferred from a persistently below-trend high-yield bond spread. Thus far in July, the VIX’s average has been less than its long-term median.
July 25’s 14.9 points was the lowest close for the VIX since the 14.8 of February 14, 2025, as well as falling short of its long-term median of 16.8 points.
The high-yield bond spread’s range of the past 12 months has been the lowest since the span-ended June 2007. Thereafter, high-yield bonds entered into deep slide. The high-yield bond spread’s month-long average widened from June 2007’s extremely upbeat 278 bp to June 2008’s dour 655 bp before peaking at the overly pessimistic 1,951 bp of December 2008. Meanwhile, the VIX’s month-long average climbed up from June 2007’s 14.9 points to June 2008’s 22.1 points before cresting at November 2008’s unsustainably high 62.7 points.
