Corporate profits

Why the Trade War Won’t Crush US Corporate Profits

Trade tensions between the United States and China will escalate with further tariff increases on both sides due to take effect June 1, a growing cause for concern on Wall Street. But a new report from Goldman Sachs suggests the damage to U.S. corporate profits will be minimal. While U.S. companies have exposure to China, Goldman says the exposure isn’t enough to warrant a serious drop in earnings. Businesses will be able to mitigate the adverse effects of tariffs by moderately raising prices to consumers and adjusting their supply chains.

Why the trade war won’t kill corporate profits

(2 scenarios)

1. 25% tariffs on $200 billion of imports from China

– 2% EPS revision, can offset with less than 1% price increase

2. 25% tariff on everything imports from China

– EPS revision of 6%, which can be offset by a price increase of 1%

Source: Goldman Sachs

What this means for investors

The very trade imbalance between the United States and China that the Trump administration hopes to rectify highlights the exposures to China that American businesses face. Since exports to China are less than imports, most of the damage will come from higher import costs than lost sales.

In terms of sales, S&P 500 companies generate a majority (70%) from the United States, while only 2% of their sales are generated explicitly from Greater China. Certainly, when it comes to imports, 18% of total US imports come from China, according to Goldman Sachs. But Goldman says companies can take steps to mitigate any impact.

While a 25% tariff on all imports from China could reduce current consensus earnings per share (EPS) estimates for the S&P 500 by as much as 6%, this harsh scenario is unlikely. The more moderate scenario described by the bank represents the current reality: 25% tariffs on $200 billion of imports from China. In this scenario, consensus EPS estimates could be lowered by 2%.

And in both scenarios above, US companies would be able to mitigate the negative effects of tariffs through price increases and substitution of Chinese suppliers with others. A less than 1% increase in prices would be enough to offset the 2% decline in the consensus EPS estimate, according to Goldman Sachs. And a 1% price increase would more than offset Goldman’s worst-case scenario.

Look forward

Similar to Goldman Sachs’ optimism about U.S. corporate earnings, veteran economic analyst and CEO of Cornerstone Macro, Nancy Lazar, is optimistic about the outlook for the U.S. economy despite escalating trade tensions. Without a doubt, ‘trade wars are bad’, she said Barrons. “But in the longer term, there are strong reasons for investment to return to the United States because of higher costs in China, coupled with our lower corporate tax rate.”