2025: THE GOOD, THE BAD, AND THE UGLY

In our last newsletter, we discussed the lofty valuations, and ‘irrational exuberance’ connected to portions of the US market. This started to manifest in mid-January, with the S&P 500 falling nearly 10% from the intra-year high through the end of the quarter. On April 2, the US announced a new wave of tariffs, pushing markets down further and potentially setting up more volatility as we go through the year. That’s the Bad news. 

The Good news is that, as we often have preached, the best protection against market volatility is a well-diversified portfolio, and diversified investors were well insulated against the US market declines in the first quarter as most other asset classes did well during the quarter. Particularly in most cases, the strong performance of international stocks in client portfolios was enough to offset losses on domestic stocks.

The market pullback also has made some portions of the market, particularly small cap and value stocks, attractively priced below historical average valuation multiples, assuming tariff headwinds are temporary, and we avoid a recession in the second half of the year. 
Now, the Ugly. While only time will show what the long-term impact of the new trade policy will be, everyone agrees that we are in for short-term pain, as long as these tariffs remain in effect. The degree of that impact will be influenced by how other countries choose to respond, including whether they apply their own retaliatory tariffs. We’ll delve into this with more detail inside this quarter’s newsletter and remind you of the things you can proactively do during a market downturn while also emphasizing that many times, if you have a properly diversified portfolio and good financial plan, the best thing to do is nothing.

WHERE DO WE GO FROM HERE?

On April 2nd, President Trump announced new wide-ranging tariffs. Markets reacted pessimistically the following day, having one of the largest sell-offs since the 2008 financial crisis. This selling accelerated on the next day, as China retaliated with their own tariffs, setting up the feared worst-case scenario of a prolonged trade war. While policy can shift quickly and the surprising news of this week could just as quickly reverse next week, if the tariffs do remain in force through the remainder of the year, the most likely results will be decreased global economic growth and increased domestic inflation. 

Over the past week, we’ve been reading through analysis and predictions from the various experts we listen to, and have coalesced around three potential scenarios, depending on how the administration moves forward from here. The best-case scenario is a quick reversal of all previously announced tariffs and essentially moving us back to trade policy as it was a month ago. Most experts agree that at this point, it would be hard to put the toothpaste back in the tube, but we think in such a scenario, we could see equity markets recover most of the decline since mid-January without larger structural damage to the economy. The middle scenario, which is our base case, is that the 10% blanket tariffs enacted on April 6th stay longer term, but the higher reciprocal tariffs going into effect on April 9th are short lived for most countries. In this scenario, we would expect stocks to continue to stay around the current level, with a 40% potential for a recession in the second half of the year pushing the Federal Reserve to put through 2-3 rate cuts.

This leaves the worst-case scenario, where the high reciprocal tariffs remain in place, and other countries retaliate with their own tariffs, as China has done, and other countries are considering. We believe if the duration of tariffs is less than three months, the economy should escape significant damage, and markets should be able to recover at least a portion of recent declines. This is built on the expectation, echoed by analysts on Wall Street, that most businesses will initially adopt a wait-and-see approach before making radical changes to their businesses, such as doing mass layoffs only to need to turn around and re-hire when tariffs go away. We believe beyond three months, chances increase significantly for inflation and unemployment to rise, with a 70% chance for a recession in the second half of the year. Using fair market valuation and 15% reduction in corporate earnings, that could equate to the market moving down an additional 20-30%.

Note: With the current tariffs being a very fluid situation and policy changing on a daily basis, right before we finalized this newsletter on April 9th, President Trump has announced a 90-day pause on the reciprocal tariffs, except for China, while keeping the baseline 10% tariffs in place. This policy, if maintained, most closely resembles the base case mentioned above.

Actionable Strategies to Explore during Bear Markets

Rebalancing

This is the easiest free lunch for being calm during market volatility. Rebalancing a portfolio means automatically buying low and selling high. Imagine a $100 portfolio with a target allocation of 50% stocks, 50% bonds. If the stocks lose 50% and bonds gain 10%, the $80 portfolio will now include $55 in bonds and $25 in stocks. Rebalancing back to the target 50/50 allocation means selling $15 of bonds and buying $15 of stocks. When the stock market subsequently recovers to its original level and bonds maintain their value, you would then have the $40 in bonds and $80 in stocks, for a portfolio value of $120, 20% better than where you started. For our advisory clients, where we manage your investments, this rebalancing is something we are already proactively keeping an eye on and doing as necessary. For most employer sponsored plans, such as a 401(k), this is also something done automatically. If you are managing investments on your own, now can be a good time to make sure the current allocation matches your long-term goals, and adjusting if not. 

Roth Conversions

If you have been exploring and completing Roth conversions of your retirement accounts in order to reduce future taxes and Required Minimum Distributions, a market dip can provide a way to get more conversion bang for your tax buck, by completing a conversion on a reduced account value, and allowing the market recovery to occur with the funds in the Roth account, where the growth will be tax-free.

Gifting Strategies

If you are routinely making gifts to reduce the size of your estate, such as to children or grandchildren, a down market can be a good time to gift investment assets, to reduce the amount of your lifetime exclusion amount used by the gift and allowing the recovery in value to occur outside your estate, such as in an irrevocable trust for your children. With 2025 being potentially the last year for existing increased allowances for lifetime gift tax exclusions, this could be the last chance for a while for families to have such a large opportunity for reducing future estate taxes for their children.

Cash Flow Strategies

If you’re still working and regularly contributing to a retirement plan at work, each new contribution into your plan is buying it at a better entry point during a market decline. It is a different and potentially more challenging scenario if you are already retired. If you are taking distributions at a sustainable rate, in most years the gain in value of the investments should more than offset the distributions coming out. In years when market returns are negative, the negative impact of both distributions and market loss can be concerning to see. First, remember that with a diversified portfolio and regular rebalancing, funds can be raised strategically from the investments whose value is holding up well, like bonds right now. Next, to the extent possible, try to delay large irregular expenses, like a kitchen renovation or once in a lifetime expensive vacation, until after the market recovers. Lastly, and most importantly, talk to your advisor! 

Talking to your Advisor

The most important thing you can do if you’re feeling worried about your investments and financial plan, is to talk to your advisor.  Remember that when we are doing financial planning and stress tests, the average return over your entire life is what matters, and it is assumed and expected that in that mix of years, there’ll be some really great years, also some really bad years. Knowing that your financial plan accounts for these fluctuations, try to resist the urge to make radical changes to your investment philosophy on plan, just because of increased market volatility or a down year in the market. If you’d like to come in for a review meeting or just a quick 10 minute phone call to review your own accounts and situation, call or email to schedule!

BASEBALL IS BACK!

Baseball is back!  We’ve reserved three nights for baseball. We will be sending out more details about how to register soon including the registration open date, but if you’re wanting to look at your calendars, we will have tickets available for 7 PM games on the following dates: Saturday, June 7th, Friday, June 27th and Tuesday, July 15^th.

 Look for details to come through a flyer in the mail and on our Facebook page! Stay informed about this and future client appreciation events by visiting our Facebook page, which you can follow by scanning the QR code at the bottom of this page. This is a great way of making sure future newsletters or client event invitations do not get lost in the mail!

(540) 639 – 2139

www.PlottAndFrench.com

All data sourced from Ycharts.com as of 3/31/2024. Stocks refers to S&P 500 Index. International Stocks refers to the Xtrackers MSCI EAFE High Dividend Intex ETF. Bonds refers to the JP Morgan Income Fund. Interest Rates are upper limit of Fed Funds Overnight Rate. Inflation is Year-over-Year Consumer Price Index. Securities and Advisory Services offered through Geneos Wealth Management. Member FINRA/SIPC.