After today’s report was finalized, Moody’s downgraded the United States, which has now lost the prestigious AAA rating by the three biggest services. Fitch and Standard & Poor’s had already downgraded America. I’ll have more to say on that coming soon.
For this Sunday morning, I have attempted to estimate the impact of Trump’s tariff war on US corporate earnings, with an assumption that the most significant change is the amount of the tax. Please note that Trump’s tariffs are a sales tax collected from Americans at the border when goods enter the US. We can estimate the total goods trade deficit at $1.2 trillion annually. We can estimate the tariff rate from zero to as high as 145% on certain Chinese imports.
Note that I never expected that the 145% (reciprocal plus base) tariffs between the US and China would last. The reason? They are simply too high and therefore discouraged most trade. Tariffs are taxes, and like most taxes they are subject to a “Laffer Curve” analysis. The cliff notes version of Laffer is, zero tariffs and you get zero taxes; 100% tariffs and you get near-zero taxes. The optimal solution is the smallest equilibrium number in between zero and 100, and that number is best determined by customs line-item-by-line-item analysis. That’s why trade negotiations take time and are usually very complex. A broad-based tariff regime means some items are on one side of the Laffer Curve while others are in a different place.
We have no way to know what any final tariff levels will be. We can only guess. And I admit at the start that the second-derivative changes are likely to make the impact of tariffs on earnings worse, but I needed a starting point for the tariff-shock estimate. For a weekly Trump tariff status update, I recommend the Tax Foundation website: “Trump Tariffs: The Economic Impact of the Trump Trade War,” https://taxfoundation.org/research/all/federal/trump-tariffs-trade-war/.
I consulted many sources including S&P, the Wharton model, the Yale model, and numerous tax-related estimators. These estimates below are mine alone. The only thing we know about them is they are wrong. But I think they are within a reasonable guessing range for a starting point.
The center point of the estimates is that the tariff shock, as we presently understand it, will reduce the EPS for the S&P 500 by 30 cents in a full 12-month period that follows the complete implementation of the known tariffs. That would lower the current estimates of $2.60 per share down to $2.30 per share. Of course, this figure assumes that there are no other protectionist policy changes. I derive that number from models that attempt to convert a tariff level to an equivalent corporate tax-rate change.
What if the Trump tax plan lowers the corporate tax rate? That’s a fair question, and we have no way to know now what a final tax policy will be. Currently, since the Congress is responsible for the final tax policy, we have only an array of assumptions. If the corporate rate is lowered from the existing 21% rate, there would be an estimated increase in EPS for the S&P 500 of 2 cents for each 1% reduction in the tax rate. That calculation assumes no other changes in the corporate tax code. The tariff war cost estimate equates to about a 15-point hike in the corporate tax rate (from 21% to 36%), which is how we get the reduction in earnings of 30 cents.
This calculation assumes no severe recession, some business slowdown, no damage from foreign exchange-rate adjustments, and no significant changes in interest rates. Of course, in the real world we expect that any and/or all of those things can and do happen. As Bloomberg Business Week noted on May 13, the effects of tariffs are, at this point, mostly yet to be felt across the economy, as businesses are still selling the inventory they stocked up on ahead of the tariffs. Though retailers are not yet in a position to have to raise prices, prices on imported products will edge upward over time given tariffs now in place. There is no getting around the numbers: “Estimates by the Yale Budget Lab show consumers now face an overall average effective tariff rate of 17.8%, the highest since 1934.”
(“Inflation Watchers Aren’t Ready to Relax Yet,”
https://www.bloomberg.com/news/newsletters/2025-05-13/april-cpi-report-doesn-t-show-trump-tariffs-full-effect)
I wanted a starting point so that I could get to an estimation of the earnings-per-share shock that is commencing in Q2, 2025. It is likely to intensify as the year progresses. I do not expect Trump to admit any error in judgment about his tariff plan.
I am holding to my downside estimate that the Trump shock in total will reduce the S&P 500 earnings level to $200–$220 for the first full year of tariff implementation. The starting point for that estimate is the assumption that tariffs as we currently expect them will take about 30 cents away from the pre-tariff-war earnings estimates. We expect the business slowdown or a mild recession to cause the additional drop in earnings.
At 20 times earnings, the estimated price of the S&P 500 Index would be in the 4000 to 4400 range. But rising Treasury yields could lower the 20 times multiple since the equity risk premium is sensitive to the so-called riskless rate. I discussed this in detail with Jack Farley on his Monetary Matters podcast in April. (See https://podcashttps://www.youtube.com/watch?v=Err3XwmgtA8.) Note that falling interest rates have the reverse effect. A recession with rising unemployment and only a mild increase in tariff-caused inflation could end with a 10-yr US Treasury note yield of 3% or so.
So, the worst case for the S&P 500 Index looks to be under 4000 for a bottom. That outcome would be consistent with a full-blown bear market decline of 40% or so from peak to trough. A moderate case is for an S&P closer to 5000 and is based on a final tariff policy much more in line with the originally expected 10% tariff level applied to a great portion of the $1.2 trillion goods trade deficit. Note that this scenario assumes mild retaliatory tariffs on America’s services trade surplus. We’re not sure about that either. We have written about how the services surplus is now at risk because of the goods tariff war.
Of course, a Trump pivot could change this trajectory. And a financial crisis that triggers Fed intervention could also change things. We have written about the level of US credit default swap pricing as a warning about growing credit risk.
Please note that the Fed did not create any of this tariff war mess. And while Trump continues to “hammer” Powell, we think the Fed is doing the most prudent thing by waiting to see how much stagflation will come from the Trump tariff war. All we know today is that some is on the way.
What can change this? Does anybody remember the “TARP moment” and the spineless Congress? Congress owns this tariff mess. They gave away the power to levy this tax. They handed it to the president. They can take it back at any time.
I expect that the Fed will ultimately be required to come in and clean up the mess after financial stability gets sufficiently derailed by the Trump 2.0 tariff war. That is when financial stability is threatened sufficiently such that the central bank becomes the engine of last resort to save the American economy.
Personal note: I don’t like writing this missive, and I wish circumstances were otherwise. But I believe this extraordinary Trump tariff war “supply shock” requires analysis and honesty.
This estimate (opinion) is mine and mine alone.
Resources
“Secondary Tariffs — Do They Work?”
https://kotokreport.com/secondary-tariffs-do-they-work/
“Tariffs: A Black Eye for Services,”
https://kotokreport.com/tariffs-a-black-eye-for-services/
“Tax Simulator: Revenue and Prices,”
https://budgetmodel.wharton.upenn.edu/issues/2025/2/26/tariff-revenue-simulator .
“The Fiscal and Economic Effects of the Revised April 9 Tariffs,”
https://budgetlab.yale.edu/research/fiscal-and-economic-effects-revised-april-9-tariffs
“Empty shelves, for-lease signs and job layoffs point to recession by summer,”
https://www.marketwatch.com/story/empty-shelves-for-lease-signs-and-job-layoffs-point-to-recession-by-summer-697ff68b?mod=home_lead
“The Intellectual Godfathers of Protectionism,”
https://www.thefp.com/p/the-intellectual-godfathers-of-protectionism?utm_medium=email
“The 2025 Trade War: Dynamic Impacts Across U.S. States and the Global Economy,”
https://www.frbsf.org/research-and-insights/publications/working-papers/2025/05/the-2025-trade-war-dynamic-impacts-across-u-s-states-and-the-global-economy
