By Jacob Sonenshine

Companies don't appear to be raising prices despite tariffs, and that's weighing on profit margins.

In April, President Donald Trump announced a 10% tax on goods from most countries, plus additional country-specific levies that are now on pause. Wall Street was concerned that tariffs would fan inflation as a result. But the consumer price index only rose 2.3% year over year, a tick below March's result and lower than the projection of 2.4%.

The assumption before Trump's initial tariff announcements was that most companies would offset higher costs with price increases. Instead, many companies have elected not to lift prices enough to fully offset higher costs, which has weighed on gross margins.

"Companies are absorbing most of it [tariff costs], so where are you seeing the inflation?" says Mahoney Asset Management's Ken Mahoney. "You're not."

The positive is that consumers shouldn't be turned away by higher prices, which could keep gross profits and earnings growing, even with lower gross margins. But in the worst-case scenario, which would dent many stocks, subdued pricing would reduce gross margins, and customers pull back on buying more stuff. Companies would have to confront lower gross margins, no boost to gross profits, and lower earnings.

TJX Cos. is an example. Total revenue in the first quarter grew by 5.1% year over year to $13.11 billion, driven by 3% same-store sales growth and some added store locations. The cost of goods grew a bit more, pushing the gross margin down by a few tenths of a percentage point.

Management's guidance for fiscal 2026 calls for 2.5% same-store-sales growth at the midpoint of the range. They forecast gross margin to drop a few tenths of a point to 30.5%, which includes the impact of higher costs from tariffs.

CEO Ernie Herman told analysts on the earnings call that TJX could offset some of the higher costs by adjusting prices, but only if the retail market allows for that. He emphasized the company's off-price model. If higher-end retailers lift prices, TJX could increase theirs by the same percentage, maintaining the same percentage discount on apparel. But if others don't raise prices, TJX would be forced to keep prices steady.

For the moment, the stock market is worried about slimmer gross margins for TJX. Other operating expenses are expected to grow, which won't help either. Unless demand for TJX's goods jumps in the coming quarters, earnings will frustrate. Management forecasts earnings per share to grow just 3% to $4.39 at the midpoint this year, below analysts' forecast of $4.49.

The stock is down 6% from its record high on May 19, a few days before earnings.

TJX isn't alone.

Carrier Global said at its May investor day that it plans to lift prices by $300 million, or about 1% of expected sales this year, to offset tariff costs. That's a partial offset, the company noted, and it proves that gross margins would likely be higher without tariffs.

All in, margin pressure is something the stock market will monitor, especially when second-quarter results come over the summer. The fairly low price increases reflect waning confidence in consumer demand, and the disappointing margins could hold back earnings growth.

This ultimately puts most stocks at risk. The equal-weight S&P 500, a better gauge of the average stock in the index, trades at almost 17 times expected earnings for the coming twelve months, close to the top of its range over the past three years, according to FactSet. That means any disappointment on earnings -- maybe emanating from margins -- would drive stocks lower, especially if it looks as if margins will remain lower beyond just this year.

Watch those margins.

Write to Jacob Sonenshine at jacob.sonenshine@barrons.com

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May 27, 2025 01:30 ET (05:30 GMT)

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