Two Fundamental Factors More Critical Than a Trade War Threat

By Mike Burnick

The on-again, off-again trade war news coming out of Washington these days isn’t the only concern causing big swings in the stock market. In fact, it’s not even the most important one.

The stock market is getting more volatile by the day, while the S&P 500 is still trading at a rich valuation of nearly 25X earnings. 

So, investors should be more focused on two fundamental factors – factors the market may watch closely this week:

  • Earnings estimates, which help support high market values…
  • And a potential inflation uptick, meaning higher interest rates.

Today, we’ll take a closer look at these two fundamental market factors and why this week’s data could prove to be market moving.

But first, let’s start with the good news about earnings.

Checking in on Earnings & Inflation

We’re now just past the halfway point for this earnings season, with just over 60% of S&P 500 component companies having reported their quarterly results so far. The good news? Actual results have come in well ahead of expectations.

  • 76% of S&P 500 companies have delivered upside profit surprises, beating estimates by an average of 6.4%.
  • Top-line sales are also ahead of estimates – with 63% of companies beating expectations.
  • The S&P 500 is on track for 14.8% profit growth this quarter, which is well above the 9.6% estimates from the beginning of January.

All in all, these are terrific results – and they need to be, given that the S&P 500 is at 24.8X trailing earnings (including the recent positive surprises) and 22.4X its forward earnings estimates (that’s Wall Street’s best guess).

So far, financials, technology, and consumer discretionary stocks take the honors of reporting both the strongest profit growth and the biggest positive earnings surprises this season.

Meanwhile, energy and basic materials stocks are both posting negative sales year –over year and profit growth.

And now for the bad news… Wall Street analysts are becoming more aggressive than usual in cutting their earnings-per-share (EPS) estimates for future quarters – and that’s a cause for concern:

As you can see above, the consensus of analyst EPS estimates for all four quarters of 2025 are falling. Particularly troubling is the big drop in Q4 2025 estimates – from an expected 17% EPS growth to less than 13%!

Granted, if these estimates hold, it still represents double-digit profit growth for full year of 2025. However, the relative trend in earnings estimates at the margin is moving in the wrong direction.

In addition to worries about earnings growth – which must remain strong given high market valuations- inflation worries are gaining traction again.

Now, the good news here is that inflation has steadily declined, according to Consumer Price Index (CPI) data:  from nearly 10% in 2022 down to just above 3% today:

But recent consumer surveys show a sharp uptick in future inflation expectations. And as you can see on the far right of this chart, the data confirms this trend.

Both the three- and six-month CPI growth rates have turned upward again, with the three-month rate up to nearly 4%!

Even worse, market-based inflation measures have been moving higher again:

Two-year inflation swaps, a proxy for expected inflation two years ahead, recently climbed above 2.6% – near the upper level of its range since 2023 – and a breakout above this level could spell trouble.

That’s because inflation can be a big emotional factor for consumers. When folks expect higher prices, they tend to spend more now before prices move even higher, which in turn fuels even higher inflation. And that psychological fear factor can be hard to break.

That’s why this is a big week for those concerned about inflation. Tomorrow is the release date for the monthly CPI report, followed by the Producer Price Index (PPI) on Thursday. Stay tuned.

The reality is, no matter which inflation measures you look at, they’re above the Federal Reserve’s comfort zone. That likely means no more rate cuts coming from the Fed in 2025.

Worse, there is a growing possibility the Fed may be forced to reverse course – and consider hiking rates again this year. And that could spell trouble for the highly valued S&P.

Mike Burnick’s Bottom Line: Ongoing trade war uncertainty is contributing to greater market volatility. But attentive investors should keep a watchful eye on the more important fundamental factors: earnings growth and inflation. That includes this week’s CPI and PPI reports, plus the developing trend in Wall Street’s profit estimates for the rest of 2025.

Good investing,

Mike Burnick
Senior Analyst, TradeSmith

P.S. With inflation concerns rising and future earnings estimates under pressure, investors could soon face rapid changes in market environment. And as much as news out of Washington is raising volatility, the Federal Reserve’s next moves (or lack of) could have a much major impact – driven by this week’s inflation data.

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