Market Pricing Of August 1 Tariff Implementation
Looking to keep track of global markets and cross-asset price action? Every morning in The Morning Lineup we provide commentary on developments since the prior US close, covering major macro catalysts, geopolitics, economic data, local market price action, earnings, and more. This morning we talked about the implicit market pricing of odds that the latest round of tariff announcements will be implemented on August 1. An excerpt from this morning's note is below. The Morning Lineup is included in our Premium subscription tier. Sign up for a complimentary trial now!
US equity index futures legged lower in the wake of the 35% Canada tariff and 15-20% universal tariff but only by about 75 bps. They then gained back more than half of that selloff before falling again as Europe started trading to hit session lows down 84 bps versus the pre-headline level. Regardless of that small selloff, markets are clearly not pricing much in the way of risk premium that these tariffs actually go into effect. To estimate how much exactly is being priced, we can use S&P 500 EPS estimates, multiples, and prices to create a couple of scenarios and see how those relate to current prices.
We assume two scenarios: one where recent announcements are enacted into law as paid tariffs, and one where they are not. Since the recent wave of announcements is generally in-line with Liberation Day levels (and in some cases like Brazil is significantly worse), we assume that the post-Liberation Day valuation low is the correct multiple for that scenario. We also assume that the forward EPS multiple that number is based on would fall roughly 1% (which is what happened to forward EPS estimates in the wake of the Liberation Day announcement). Taken together, the 19.76x forward multiple and 1% decline in EPS estimates versus current gets to a 5516 level for the S&P 500.
In our second scenario, we assume current forward EPS are valued at the same multiple as the post-COVID valuation peak (23.41x versus 22.17x current). That implies a 6594 S&P 500 price. Given the market currently trades around 6240, we can back out how each scenario is priced in probability terms. As shown below, current market prices imply a 94% chance of no enactment for the current wave of tariffs. Of course, we are making a number of assumptions in this analysis, but we think they’re defensible. The key takeaway here is that the market is pricing very low odds of full enactment for the current wave of tariffs. At the very least, that creates asymmetry to the downside as far as payoff goes. That is one reason we advocated a relatively cheap hedging strategy in The Closer last night (link).
