Rising valuations, cloudy earnings view confronts US stocks after tariff rebound

Yahoo

07-05-2025

By Lewis Krauskopf
NEW YORK (Reuters) -After a round-trip for U.S. stocks following their tariff-fueled swoon, investors are wary of obstacles that will prevent the market from more significant gains in the near term.
A stronger-than-expected first-quarter earnings season and optimism that worst-case trade fears will not come to pass underpinned the stock market's recent gains, after President Donald Trump's April 2 announcement of sweeping tariffs unleashed a burst of severe volatility.
The roller-coaster nature of developments in reaching deals with the top U.S. trade partners - most notably China - was seen in stark relief on Tuesday, with sentiment largely depressed during regular Wall Street trading only to reverse course in the evening on news that top U.S. officials will meet with a top China official in Switzerland later in the week.
Even so, stocks may struggle as they trade at loftier valuations than they did after recent declines, while companies still face a murky earnings and economic outlook because of the fluctuating trade backdrop, investors said. The S&P 500 has pulled back to start the week after the benchmark index as of Friday had erased its losses since April 2.
"We've been surprised on the magnitude and just how quickly the market has rebounded," said Michael Reynolds, vice president of investment strategy at Glenmede. "We think to some extent the markets are probably a little overly optimistic relative to where we sit through negotiations and just the fact that there's still so much unknown."
Progress on trade, such as deals with key trading partners, could be one catalyst to drive stocks higher. Focus is also on Wednesday's Federal Reserve monetary policy meeting and whether the central bank will signal openness to resuming interest rate cuts.
U.S. Treasury Secretary Scott Bessent will meet with China's vice premier, He Lifeng, in Switzerland later this week. Bessent said that, at least for now, he sees the meeting as "about de-escalation."
Even with the recent rebound, which included a nine-session streak of gains that ended Friday, the S&P 500 remains down over 8% from its February record high.
Here's a look at several factors investors are watching after the S&P 500 erased its "Liberation Day" losses:
STRONG Q1 EARNINGS, OUTLOOK MURKIER
Investors have pointed to a solid first-quarter earnings season helping to soothe stocks in the wake of the tariff-driven declines. With over 70% of the S&P 500 having reported, earnings overall are on pace to have climbed 13.6% in the quarter from a year ago, according to LSEG IBES. That compares to an estimate of an 8% rise as of April 1.
However, in a reflection of the murky outlook, consensus analyst estimates for profit growth in the next three quarters of 2025 have all come down.
In a note on Friday, Goldman Sachs strategists said 56% of companies had issued guidance below consensus estimates, compared to the historical average of 51%.
Current visibility on the ultimate tariff landscape remains very low, said Allen Bond, portfolio manager at Jensen Investment Management.
"To the extent that we start to see some idea of how these policies take shape, companies are going to have to come out and reevaluate what that means for their businesses," Bond said.
VALUATIONS RISING AGAIN
The forward price-to-earnings ratio as of Monday stood at 20.6 times earnings estimates for the next 12 months, according to LSEG Datastream, which is the same P/E ratio where it stood on April 2. The level is well above the index's 10-year average P/E of 18.5 and long-term average of 15.8.
Several factors could make the valuation look more expensive. The yield on the 10-year Treasury is around 4.3%, over 10 basis points higher than on April 2. Higher Treasury yields tend to weigh on equities in several ways, including indicating higher borrowing costs for companies and consumers and greater investment competition from fixed income.
Analysts also expect earnings estimates could fall even further because of the tariff fallout, which could mean current valuations are factoring an overly rosy outlook for companies.
"The market is starting to embed a lot of good news and is vulnerable to bad news now, which is the opposite to where we were at the lows," said Keith Lerner, "If something goes wrong, you don't have much of a buffer for negative news."
NEARING A KEY TREND LINE
Investors said the stock market had been due to bounce after its steep decline in April, and its recent streak of gains could bode well.
Of 12 times since 1991 that the S&P 500 has gained for at least eight straight sessions, the index posted a positive performance in the next six months in 11 of those times, according to Mark Hackett, chief market strategist at Nationwide.
Investors are now focusing on whether the S&P 500 can surpass its 200-day moving average, which is a closely watched long-term trend line. That trend line is about 2% above the S&P 500's current level and may provide resistance against further gains.
Unless something significantly positive occurs on the trade front or another catalyst emerges, "we're going to be hard-pressed to push through" that level, said Walter Todd, chief investment officer at Greenwood Capital.
PEAK UNCERTAINTY?
A belief that "peak uncertainty" when it comes to the tariff situation is in the past also has been driving stocks higher, investors said.
The Cboe Volatility index, an options-based gauge of investor anxiety, has moderated. After spiking to 52.33 on April 8, its highest closing level in five years, the VIX index has come down to around 25. But that is still above its long-term median level of 17.6, according to LSEG Datastream.
"We do think we're through this period of max uncertainty," Reynolds said. "But to call a direction from here I think is really difficult because we could get a news release out of the White House tomorrow on new tariffs and that could completely change the game."
(Reporting by Lewis Krauskopf; editing by Megan Davies and Leslie Adler)