Tit-for-tat trade hostilities continued today, as China accused U.S. Secretary of State Mike Pompeo of slander after he said the CEO of China-based Huawei Technologies was lying about his company’s links to Beijing.

Huawei is the world’s largest maker of telecom networking equipment. The White House last week put Huawei on a trade blacklist, banning U.S. firms from doing business with the company. The Trump administration’s trade hawks are concerned that Huawei is a conduit for corporate espionage and the theft of intellectual property. Huawei denies it is controlled by the Chinese government.

Further inflaming trade tensions, the U.S. Commerce Department on Thursday said it has been considering tariffs on countries that purposely undervalue their currencies to the detriment of U.S. companies. Trump accuses China of manipulating its yuan.

Today, the trade rhetoric softened somewhat. But don’t take that to heart. The Trump team has signaled its intention to play “good cop, bad cop” all the way up to the 2020 elections. These trade theatrics are in large part designed for domestic political consumption, to show toughness with perceived villains overseas. The strategy could backfire, as farmers in red states suffer huge losses from agricultural sanctions. But for the rest of the year and beyond, periodic outbursts of trade belligerence are likely to continue.

When it comes to trade, Wall Street reacts in knee-jerk fashion to every presidential press release or tweet. Just make sure that you don’t do the same.

The flare-up in trade tensions this week has roiled stocks, especially among chipmakers that heavily rely on China for sales. During previous bouts of anxiety, strong corporate earnings have calmed investor fears. That pillar of the bull market is now missing.

After a blockbuster corporate earnings performance in 2018, expectations for earnings growth this year plummeted. Some of that pessimism was born of basic math. Year-over-year comparisons became more problematic, after the temporary boost provided to 2018’s earnings from the U.S. tax overhaul bill signed in December 2017.

In the following chart, you can see the expected sharp decline in earnings growth for 2019. Momentum isn’t expected to pick up until 2020.

Source: Refinitiv

To date, more than 90% of the companies in the S&P 500 have reported earnings for the first quarter of 2019. The blended earnings per share (EPS) decline for Q1 is -0.5%. “Blended” combines actual results for companies that have reported and estimated results for companies yet to report.

Tariffs already are hurting companies with greater overseas exposure, by increasing costs, lowering demand and squeezing profit margins. For S&P 500 firms that derive more than 50% of revenue inside the U.S., the blended EPS growth rate this quarter is 6.2%. For firms that get less than 50% of revenue inside the U.S., the blended earnings decline is -12.8%.

The good, the bad, and the ugly…

The silver lining is that expectations were so negative earlier this year, most companies are beating them, albeit not by much. Among companies that have reported, 76% have posted actual EPS above the mean estimate, exceeding the five-year average of 72%. In aggregate, earnings have exceeded expectations by 5.4%, which also surpasses the five-year average of 4.8%.

In light of this corporate outperformance on earnings relative to highly negative expectations, you’d think investors would be happy with the companies that beat the naysayers. On the contrary. Sentiment overall has been unforgiving. During this earnings season, Wall Street has rewarded positive earnings surprises less than average and punished negative earnings surprises more than average.

According to the latest data from FactSet, firms in the S&P 500 that have reported positive first-quarter earnings surprises have seen their share price increase by 0.7% on average from two days before the company reported actual results through two days after the firm reported actual results.

Over the past five years, companies in the S&P 500 that have reported positive earnings surprises have enjoyed an average 1.0% increase in share price during this four-day time frame.

Many companies have run afoul of the expectations game, whereby the good isn’t good enough, and reaction to the bad gets ugly.

For those S&P firms that have reported negative first-quarter earnings surprises, share prices have on average fallen -3.5% from two days before the company reported actual results through two days after the company reported actual results. Over the past five years, companies that have reported negative earnings surprises have gotten hit with an average share price decline of -2.5% during this four-day time frame.

As for the second quarter, 80% of S&P 500 companies have issued negative EPS guidance. Headwinds cited by managers include rising input costs due to tariffs, slowing growth in China and the euro zone, and uncertainty in the U.S. over government policy and interest rates.

In previous quarters, robust earnings growth was a major factor keeping the bull market alive. The 2017 U.S. tax cut acted like a shot of steroids, fueling stock market gains as companies used their tax windfalls to launch share buyback programs.

Well, the steroids are wearing off. The tax cut also generated a massive federal budget deficit that will come back to haunt investors. Does that mean you should avoid growth stocks altogether?

In a word, no. If you do, you’ll be leaving money on the table. But you should emphasize value, as economic recovery gets long in the tooth and signs of a downturn multiply. You can still find reasonably valued growth stocks that are poised for market-beating gains.

The key is to focus on strong financial metrics that include low debt, robust free cash flow, and projected positive earnings growth. It’s also important that these companies provide products and services that customers will need well into the future.

You should elevate cash levels and pocket at least partial gains from your biggest winners, especially in the technology sector. Tech stocks have returned to high valuations and they’re especially vulnerable to trade sanctions.

Emphasize sectors appropriate for the late stage of economic recovery, such as energy, utilities and health care. Also consider aerospace/defense, a recession-resistant sector that actually benefits from headline risk.

Questions about recent earnings results and how they affect your investing decisions? Drop me a line: mailbag@investingdaily.com

John Persinos is the managing editor of Investing Daily.