Leaping over a lowered bar

Second quarter market volatility was enough to make anyone seasick. Competing waves of sentiment —tariff concerns versus AI enthusiasm—tossed the S&P 500 from a 19% sell-off to new all-time highs by the end of the quarter. Catalyzed by trade talks, a 40% rally in the tech and communication services sectors propelled history’s fastest ever recovery from a 15%+ drawdown. As the market storm dies down, the 2Q earnings season should provide investors with a valuable opportunity to get their bearings. 

Currently, consensus is projecting earnings per share (EPS) of $65.21. If realized, this implies year-over-year (y/y) growth of 7.7%, above the 10-year median of 5.3%. Looking at the three main sources of EPS growth, revenues, margins, and buybacks are expected to contribute 5.5, 3.1 and -0.8 percentage points, respectively. Tech is once again doing the heavy lifting, with the Mag 7 expected to drive 56% of this quarter’s earnings growth. Financials is the only sector outside of tech outpacing S&P 500 earnings growth this quarter.

Only a small fraction of tariff costs hit companies’ 2Q results. Over the course of the quarter, consumer and producer inflation remained tame, with headline PCE and PPI ticking up by 2.6% y/y and 2.3%, respectively, in June. Nevertheless, analysts revised down estimates for 2Q25 EPS growth by 4.0% between April 8^th and June 30^th (from 7.8% to 3.8%). So, while the percentages of companies beating earnings and revenue estimates are elevated (81% vs. 75% 10-year average for earnings, 79% vs. 64% for revenues), it’s relative to a lowered bar. Surprisingly, analysts haven’t pushed this unmaterialized tariff hit into subsequent quarters. Since July 1^st, estimates for 3Q and 4Q y/y EPS growth have been revised up by around 0.5% each and downward revisions for full year 2025 are in line with long-term averages. 

AI enthusiasm trumps tariff concerns for now

In fact, companies have been increasing guidance for both earnings and revenues, reversing the trend from April. This is partly due to lower-than-expected tariff rates, but it’s also an acknowledgement of the powerful secular transformations driving revenue growth, first and foremost, AI. The Mag 7 are on track to grow earnings by another 19% this year, and several achieved truly magnificent 2Q AI results. Cloud revenues grew an average of 30% y/y and AI is already driving double-digit increases in advertising monetization. This should give investors conviction in AI as an investment theme, but there’s dispersion within the Mag 7, and there are also highly competitive companies outside the moniker. While estimates for S&P 493 2025 EPS growth have been revised down by 1.7% since April 8^th, estimates for the Mag 7 have been revised up by 2.3%. Investments in AI also seem immune to macro and political uncertainty, which should support the broader tech sector. A lower dollar will be a tailwind for tech companies with a large proportion of sales outside the U.S. and the semiconductor industry stands to benefit from the relaxation of export controls to China. 

Tax cuts and deregulation should help too

Most policy changes besides tariffs represent earnings upside for other industries as well. Large cap banks, for example, could benefit significantly from deregulation. Moreover, the OBBBA restores 100% bonus depreciation, allowing companies to immediately deduct the full cost of assets like machinery and equipment. This, along with any future rate cuts, should be supportive of industrial and manufacturing activity. However, the benefits may not translate to companies’ bottom lines until next year. Tariff costs will start hitting hard in second half of this year, while revenues aren’t likely to increase until next year large scale projects remain on pause until policy crystallizes. 

Companies are tackling tariffs costs

• Tariff rates, particularly on China, will likely land significantly below those announced on April 8^th, which some companies used to provide guidance. Still, retaliatory and sectoral tariffs are a risk.
  
  Intuitive Surgical: “We are currently estimating the impact of tariffs for the year to be approximately 100 basis points, plus or minus 20 basis points, lower than the estimate we provided on last quarter's earnings call, primarily reflecting the reduction of bilateral tariff rates relating to U.S.-China trade.”

• Supply chains were already more domestic and resilient post-COVID, and companies are implementing additional mitigation efforts. However, these do come with both dollar and opportunity costs.
  
  RTX reduced their estimate of tariffs costs from $850mm last quarter to $500mm, stating “[a]bout half of that reduction comes from the reduced rates and the pausing…the other half comes from the improved mitigation actions… including expanding USMCA coverage, qualifying additional parts for military duty-free exemptions and maximizing the use of free trade zones.”
  
  Williams-Sonoma outlined its six-point plan to manage tariff costs: (1) cost concessions from vendors, (2) re-sourcing goods to lower tariff countries, (3) identifying further supply chain efficiencies, (4) reducing SG&A expense through tight cost control and financial discipline, (5) expanding Made in the USA production, and partnerships and (6) select price increases.

• Companies are inching up prices, but they’re wary of demand destruction. Consumer confidence is low and tolerance for additional price hikes may be limited after the inflation in 2022.
  
  Deere: “I think one of the unique components that we face today is just coming through a period of significant inflation. I think we're very mindful of how much price has been pushed through the system as an industry…”

Consumers remain relatively resilient…

Companies appear to be adapting to higher tariffs, but the critical outstanding question is the resilience of consumer demand. Consumption grew 1.4% q/q saar in Q2, accelerating from just 0.5% in Q1. Although economic data indicates consumers remain stable, delinquencies and disparities between income levels are worth monitoring. While consumption may slow in the second half of the year, spending patterns are evolving with environment. This has been reflected in 2Q earnings, with company commentary corroborating these shifts.

First, it’s worth assessing how strong the consumer is and identifying potential soft spots:

• The consumer balance sheet is solid, and wealth effects have supported consumption. Consumers have $9 in assets for every $1 in liabilities. Household net worth has grown by $50 trillion since before the pandemic as home prices, cash balances, and financial assets have all increased. Although debt levels have grown, two-thirds of aggregate liabilities are mortgages and the average effective interest rate on mortgages outstanding is 4.1%. 
• Delinquencies are rising but in categories that only account for one-quarter of consumer liabilities. Flows into early delinquencies are rising and already elevated at over 8% for auto loans, credit cards, and student loans. However, these three categories only make up about 25% of consumer liabilities.  A recent report highlighted that delinquencies for households earning $150,000+ has doubled since 2023, but that overall delinquency rate is just 0.34%.¹ “Our delinquency rates are also in line with expectations. You saw that we kept our net charge-off guidance unchanged.” - JPMorgan Chase. Wells Fargo and Bank of America noted declining net charge-offs.
• Nominally, household debt has never been higher, but debt service is sustainable. The household debt service ratio peaked at 15.8% prior to the Financial Crisis. After dropping to 9.1% in 2021, it has risen to 11.2% today, still below the 11.8% average rate it achieved from 2012-2020. 
• Spending more, saving less. The savings rate has fallen to 4.5% vs. 5.6% on average over the last 25 years. If consumers are spending more but saving less, that supports current consumption but leaves less future firepower.
• High income households were driving spending growth, although the divergence between income cohorts looks increasingly less pronounced. Lower income spending boomed in 2021 with stimulus checks and accelerating wage growth. However, excess savings dried up, inflation surged and high-income households took the driver’s seat. Yet, spending growth is now converging across income cohorts. “We haven't seen anything that's really showing us a differentiation in patterns between the lower end consumer and those that are looking for the premium or even the luxury” – Carnival

• “No fire, no hire” jobs market, with high-income employment on watch. Although JOLTS data can be volatile, the general trend is that hiring and openings are down and layoffs are up relative to the first six months of last year. Although lower income consumers may have weaker balance sheets, hiring and payrolls are still growing and layoffs are slowing. For high income employees, payrolls are stagnating and layoffs are accelerating, diminishing a key source of consumer strength. This may force upper-income households to re-evaluate how they spend.
  
  “When you look at casual dining in general, we're seeing growth across most income cohorts. The only group that is still soft is the below $50,000 household. And in fact, if you actually look at the $150,000 plus, that's actually where we're seeing a little bit more growth on casual dining.” – Darden

…but spending patterns are evolving.

So, where are consumers still spending? Chase data, retail sales, personal consumption expenditures data, and company results all echo some common themes:

• Discretionary spending growth has remained robust. Chase spending data reveals that discretionary spending growth has been outpacing non-discretionary since 2024. So far in July, discretionary spend has been growing 6% y/y vs. 1.8% for non-discretionary. Ulta Beauty notes its consumers are “…more willing to make trade-offs in other discretionary areas to maintain their beauty regimens. At the same time, they are cautious, and value is an increasingly important priority as they navigate ongoing wallet pressures.”

• Gas stations are a notable laggard, freeing up budget. Data from Chase, retail sales and personal consumption expenditures all point to less spending at the pump as energy prices have declined, which may be creating room to spend in other categories.
  
• Staying local, but dining out. Airline and hotel spend has declined every month this year, while restaurant spending is broadly accelerating. However, airlines are assuming the worst is behind us: “Demand feels to us like it is inflected upward and is returning toward the normal trend line we expected at the start of the year.” - United Airlines
• Hotels are sharing the optimism: “You can go look at what all the airlines said and you can sort of get that same thing. Things have sort of stabilized... you're going from ‘the great wait-and-see’ to ‘the great thaw’ happening, but it's early.” – Hilton Worldwide
  
  Value does seem to be a focus for travelers, which has benefited cruises: “We are an incredibly stupid value when it comes to the alternatives.” – Carnival
  
  And restaurants continue to benefit from consumers wanting to indulge more locally: “Consumers are figuring out that casual dining is a great value.” – Darden. 
  

• Indulging in simple luxuries. Health and personal care items top retail sales growth y/y, perhaps indicating that while consumers are not necessarily splurging on the big-ticket items they are still enjoying simple luxuries. Ulta Beauty notes customers “are leaning into beauty as a comfort and escape from the stress of macro uncertainty.” Apparel continues to see solid retail sales and real consumer spending.
  
  Miscellaneous retailers and other retail (think specialty retail) have had considerable momentum based on Chase spending and retail sales. Hasbro explains, “[The toy category] tends to be a category of small luxuries…which is heavily gift oriented. And so we think it's going to fare better than other discretionary categories or other experience categories.”

• Front-loaded goods are subdued. Categories such as electronics, appliances and recreational goods have been more subdued, but the monthly trend of real consumer spending shows some potential front-loading in the spring ahead of tariffs. Autos and auto parts experienced similar dynamics, although demand appears to have stabilized for now: “Consumers in our industry have proven their resilience in responding to short-term shocks, whether caused by tariff-driven inflation, spikes in gas prices, or other factors.” – O’Reilly Automotive

“Cracks in the consumer” has been a popular refrain over the last several years, but that has yet to materialize. While the consumer could shift from growing to slowing, companies remain cautiously optimistic about demand and are adapting their strategies to cater to pockets of resilience by offering value, innovation and simple indulgences.

Investment implications

• Tech continues to boast impressive profits by monetizing AI, driving revenues, maintaining margins and benefiting from a lower dollar.
• Financials is the only sector outside of the tech outpacing S&P 500 earnings growth, supported by a steepening yield curve, a stabilizing macro backdrop and prospects for deregulation.
• Consumer sectors tend to have slimmer margins and may be caught in the tariff crosshairs. However, pockets of resilience include simple luxuries, like dining, toys and beauty products, rather than big-ticket items. Companies that can offer value, discounts or packages are likely to drive revenue growth.
• For the first time in a long time, consumers have compelling choices across value and growth, as sector performance is not restricted to just the Mag 7. However, given potential headwinds from tariffs, this warrants an active and selective approach to companies that have resilient demand, healthy margins and are adapting to the post-tariff environment.

1.      VantageScore, “VantageScore Data Points to Potential Trouble for High-Income Consumers.” July 30, 2025.

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The firms highlighted above have been selected based on their significance and are shown for illustrative purposes only. They are not recommendations.