Not just the taco trade — why stocks should be resilient to tariff news, says Morgan Stanley

Morgan Stanley's Mike Wilson posits that despite tariff-related investor unease, the S&P 500 should remain resilient, citing historical data on market pullbacks from highs and potential USMCA exemptions for Mexican/Canadian goods. Key risks identified are a material increase in China tariffs, due to broad industry and market cap exposure, and potential sectoral tariffs on semiconductors. This resilience is further supported by a dramatic positive shift in analyst earnings revisions and the new tax bill's upfront R&D expensing, which significantly lowers the effective corporate tax rate for major tech companies, boosting their cash flows and explaining recent outperformance.

Analysis

Despite investor apprehension surrounding new tariff announcements, Morgan Stanley's analysis suggests market resilience, supported by multiple factors. Historically, when the S&P 500 is trading near record highs, significant pullbacks are not immediate; UBS data indicates an average of 105 days before a 5% correction, during which stocks typically outperform T-bills. The direct impact of North American tariffs may be mitigated by exemptions for goods compliant with the USMCA agreement. The most material risk to equity indices stems from a potential escalation of tariffs on China, given the significant import exposure and market capitalization weighting of affected U.S. industries. A secondary, but critical, risk involves any new sectoral tariffs targeting the semiconductor industry due to its integral role in U.S. supply chains. Beyond trade policy, the market's fundamental footing appears to be strengthening, evidenced by a dramatic reversal in analyst earnings revisions, which have shifted from -25% in April to +3% currently, with financials showing the most significant rebound. Furthermore, a new tax bill allowing for upfront R&D expensing is set to lower the effective corporate tax rate to 13% from 20% for R&D-heavy firms, directly boosting cash flow for companies like Alphabet, Amazon, Meta, Microsoft, Apple, Intel, and General Motors, which helps explain the recent outperformance of large-cap tech.

Key Decisions for Investors

• Given the historical market resilience near all-time highs and positive earnings momentum, investors should consider maintaining equity exposure instead of reacting to tariff headlines by moving to cash.
• The new tax law's R&D expensing provision creates a direct cash flow benefit for specific large-cap tech and industrial firms, warranting a review of positions in identified beneficiaries such as Alphabet, Amazon, Microsoft, and Intel.
• Investors should closely monitor U.S.-China trade negotiations, as an increase in tariffs on Chinese goods or new levies on the semiconductor sector represent the most significant near-term risks to equity markets.
• The pronounced positive shift in earnings per share revisions for the financial sector suggests strengthening fundamentals, making it a sector to consider for tactical overweighting.