Thornburg Investment Insights: Corporate Earnings and Tariff Impacts

Thornburg Investment Insights: Corporate Earnings and Tariff Impacts

Josh Rubin: This is the CPM roundtable, where Thornburg Client Portfolio Managers will discuss topics that are top of mind for investors. My name is Josh Rubin, and I’m joined today by Phil Gronniger and Adam Sparkman. As client portfolio managers, we’re engaged daily with both the investment team and clients, which gives us a unique insight to what’s top of mind.

Last time, we talked about US/China relations and how data affects economic decision making. Today, we’re going to dive into corporate earnings and how tariffs have begun to creep in.

Adam Sparkman:  I think the reliability of data is obviously important, but also recognizing that in the current environment, the overhang of just an elevated level of uncertainty. So, you know, we talked about tariffs and US-China with that overhang and how that is ultimately going to play out. I think businesses or maybe sitting on the sidelines a little bit more waiting for clarity when it comes to, investment CapEx, those sorts of decisions. And also with the fed, you know, what inflation is going to look like on a go-forward basis when we’re going to get rate cuts, that level of forward, uncertainty about where we’re going, I think is causing at least, equal amount of uncertainty.

Josh Rubin: That was my feeling to think about the second quarter earnings season, where we certainly saw strong earnings from big tech, maybe better than expected, particularly on the margin side. But we definitely didn’t see most global companies planting a flag either to say we’re out of the woods or to say things are getting a lot worse. And that’s probably both because US tariffs haven’t really kicked in.

We won’t really see that impact until September or October, but they’re sort of on the equity side at least, always an unspoken form of revisions, which is usually consensus. Estimates start out very high and are lowered throughout the year for what earnings are going to come through. But also, companies sort of have this balance of official guidance, the whisper guidance and so on.

And, you know, we know the company earnings releases are reliable, but companies don’t necessarily trust the direction of the economy and how that’s going to flow through to their earnings power in the back half of the year either.

Adam Sparkman: Yeah, I think especially in the US second quarter earnings certainly came in stronger than many expected but important for us not to be lulled into underestimating the longer-term potential impact of tariffs just because of what we’ve seen. To your point, I think there are, some pull forward, companies trying to get out in front of the tariffs. And also, you know, burning through kind of their current inventory. So I think we’re really going to need to wait more till, fourth quarter, first quarter, next year to have a full kind of idea of the potential impact of tariffs. I also think at the sector level, when you pull back the hood. Josh, you mentioned big tech driving really an outsized, contribution of the earnings here in the US. Also, if you look at financials in the US or Europe had really solid earnings during the second quarter, but we did see a little bit of strain and some of those more consumer cyclical aspects or the segments of the economy, whether that’s autos or retail. I do think you’re seeing at least some signs of potential softening, there.

Phil Gronniger: Yeah. When you think about the potential inflationary impact, two companies can either, if you will take it in the margins or pass that through to the consumers. There are things they can do to mitigate some of that impact. You know, whether it’s shifting some supply chains, but those that tend to have a more global supply chain could be impacted a bit more.

Naturally, as Adam said on the consumer side, they may try to pass it through. And we have actually seen from an inflation standpoint, if you look at the underlying data on CPI, goods prices, were negative throughout all of 2024 and through March of this year. And they’ve turned back positive in terms of having an inflationary impact.

They’re adding to inflation. It’s on the margin. It’s a small amount. But being deflationary for 15 months. Now back to an inflationary standpoint, it could start to lead to some higher numbers in the overall CPI. So when you start to look at the impact there, as Adam said, probably going to start to feel it a bit more or see what’s really, truly happening into early next year.

Josh Rubin: You know, Phil, relative to your comments about tech and financials being a little more immune, maybe to the tariff concerns or just delivering the earnings? Well, one thing that’s interesting is neither of those really has tariffs running through their expense structure. And both of them have ways in which they are beneficiaries of inflation. So, tech you know, tending to be able to either have inflation pass through or charge a take rate on a nominally increasing goods gets a revenue benefit.

And tech also is lapping what I’ll call the big hiring, spike that led to wage inflation for tech. And right now, tech’s employing AI to do a lot more programing. So, in some ways tech has this benefit of revenue growth with some cost structure management thanks to AI. And financials also do benefit a little bit from nominal, growth, whether it’s real or, you know, has a real component or not, because the cost of building a new house or new factory still requires a loan that that it’s that much bigger.

But if the interest rate cuts are ahead, their cogs, so to speak, kind of the cost of funding their loans can go down, possibly create a little more NIM expansion or at least keep, you know, net interest margin stable. So those are two sectors where there’s really nothing flowing through other than general economic slowdown that’s protecting earnings. But then as Adam talked about, you know, consumer areas possibly some industrial areas that really do have global trade flowing through those business operations, that’s where there’s more uncertainty right now or earnings aren’t coming through.

But the last thing I’ll mention that that’s also interesting, just on a global basis, we know the U.S. has really been driven by tech over the last ten years, kind of at the market level. International markets had a headwind from that because international markets have such a bigger component of financials rather than tech. So now in some ways, you actually have international markets, U.S. markets on more even footing, just because in both cases, the two largest sectors are doing all right, rather than, you know, one having headwinds while the other one had tailwinds.

We talked a little bit about big tech or financials maybe being better insulated from the current tariff situation. Are there any other sectors or countries that the investment team is feeling could either be more defensive or more at risk in the current environment?

Adam Sparkman: Yeah, I think from a sector perspective, if you look at a couple of our portfolios in particular, you’ve seen more emphasis on sectors like communication services, especially within telecommunications as well as utilities. These are obviously sectors that are, you know, not reliant on exporting things outside of the country, or businesses that are providing mission critical services, especially in environment…

Josh Rubin: …For some of the innovative areas like you can…

Adam Sparkman: …Yeah, Yeah, I think that’s…

Josh Rubin: …You know, right, like you need the data to be transmitted, the electricity to power it.

Adam Sparkman: Yeah, when you look at, you know, some of these quote unquote boring but beautiful sectors where we’re finding opportunities that may not be, you know, on the leading edge of AI. But it’s communication services companies that utilities, companies that are providing power and the rails that a lot of these things, you know, I and the developments that we’re seeing run on and those companies are, you know, doing that, within their own country and, and less reliant on exporting a particular good, you know, across the ocean.

Josh Rubin: Phil, from a country side, there’s a couple of things maybe to tease out. One, Mexico in the US certainly have a notable, exposure, in their GDP growth to exporting to the US. But most of those exports are still protected by the US MCA, so haven’t been subject to tariffs just yet. But then if we think about other parts of the world, there’s no doubt that in one way or another, all countries and basically all companies will be impacted by these tariffs. But the headlines tend to distort the actual materiality that a lot of international companies are going to face. So just to give an example, in Germany, they are exporting over $100 billion a year to the United States, but they’re exporting more than a trillion dollars to the rest of the world, to France and Italy and to China. And you know, similar story in Japan, which exports over 100 billion to the US, but about 500 billion to the rest of the world. So, what we tend to miss in the US headlines is that the United States is only importing 15 to 20% of total global exports.

What that means is, from an international company earnings standpoint, maybe 15 to 20% of revenues get impacted, but the rest of it is fine. Globalization continues unchanged across the rest of the world, but on the United States side, there’s sort of an asymmetric effect where US companies, everything they’re importing is being impacted, and in some ways, some of the things that US companies are exporting also may have an impact, either because of foreign buyer sentiment or because of some of the tariffs other countries have.

So, there’s kind of a materiality question, but are there sectors in you know, some of these other countries that maybe are more at risk, not just the country itself?

Phil Gronniger: Yeah, you know, we think about the whole of Europe, if you will, if you think about capital goods and health care companies, they generate about 30 to 40% of the revenues from the US. So it’s important to really break down not just at the sector level, but really importantly from an active management standpoint, the individual company level and what’s their percentage of revenues to the US, and then factor in what the tariff impact might be on their cost of goods sold. And how that’s going to then influence consumer behavior, whether it’s going to hurt the margins of the company or it’s going to get pass through, become potentially inflationary.

We think about the other big trade partners. You mentioned Mexico and about 25% of the revenues from staples and capital goods, come from the US for those sectors out of Mexico. And then Canada, on the discretionary capital goods side, is about a third of the revenues from the US.

Josh Rubin: What’s complicated is if you think about, you know, pharma or even staples, sort of by definition, those are normally pretty stable demand types of products and so and not necessarily substitutable. So, you know, European pharma companies, European healthcare companies, if, US hospitals only alternatives are buying healthcare equipment from China, they probably are going to keep buying it from Europe right now. And for pharmaceutical goods, a lot of times the way the FDA, sets expectations is once a facility is approved by the FDA, drugs need to keep being made by that same facility.

You can’t just shift your drug manufacturer to a place in the US that hasn’t been fully vetted. So, it may be a case where international companies still have the bargaining power with the US purchasers, because if people are sick, they need the drugs. If hospitals have sick patients, they need the medical equipment. And if there’s not an alternative supplier, particularly a lower cost alternative supplier, those European companies pass through the tariff and, you know, US consumers or health care companies or health insurance companies just need to pay the higher price.

Phil Gronniger: Yeah, it’s a good point. The more inelastic the demand by the end user, the more bargaining power and negotiating power by the company making said product or delivering whatever service that may be.

Josh Rubin: Adam, Phil, thanks for your time today. Look forward to continuing the conversation soon.

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