Should You Worry About a Recession? What Investors Need to Know in 2025 (EP.197)

0:26We all need to make smart decisions with our money. sentiment about markets and the economy has changed markedly as investors are digesting the diverging fortunes of national economies, the shifts in policy, and rapid technological change. Now, at one point, the S &P 500 was down 10 % from its peak, allowing everyone to start using the term, quote, correction when describing the market environment. Historically, I've sent out an email to clients every single time the S &P 500 crosses into correction territory, but sending that email has always been something that gives me mixed feelings. On one hand, I imagine we do have clients who feel anxious in response to the headlines and these, quote, experts who are offering gloomy outlooks.

1:12But on the other hand, I imagine that most of our clients have learned that such market movements are perfectly normal and should be ignored. So when a client receives an email from their chief investment officer pointing out the market correction, I sort of worry that they think this is anything other than normal. So for me, it's pretty tough to strike a balance because I really don't think these downturns are a big deal. But I also do feel that it's okay if you're feeling nervous. In fact, it's perfectly human. And if you're feeling uneasy, I promise you that you are not alone. So why am I talking about all this?

1:51Well, this year, I did not send that email. And this time around, our outreach was a bit more manual and more targeted because I figured we had clients that, at a minimum, are curious about what's going on and, at worst, are worried about what's going on. So now that the quarter is coming to a close, it seems as good a time as any to share some of my thoughts here on this podcast about the markets. I'd like to start with an idea that I think is always very helpful when reading headlines or listening to financial market commentary, and that is that stock prices very closely track earnings over the long term.

2:31Now, the short-term price movements, they can be thought of as just the market repricing earnings expectations. And to me, the recent market sell-off reflects adjusting expectations on how policy will be set, particularly as it pertains to tariffs. At the beginning of the year, it was widely expected that the threat of tariffs was merely a negotiation tactic. Similarly, it was widely believed that the White House would adapt policy in response to negative market outcomes. However, the White House has broadcasted a very different message recently, going so far as to say that there could be some pain as we adjust to new policies.

3:09The result? Markets are pricing in lower earnings. Staying on the theme of earnings, stock returns are composed of three things. Changes in earnings, the cash return to shareholders in the form of dividends or share buybacks, and changes in valuation. Now, I've already spent some time on earnings. market participants, they're repricing expectations for U.S. earnings. But for several years now, we've been saying that U.S. valuations are relatively high and make that part of a diversified portfolio a bit more fragile to unexpected shocks. And I think it's as simple as saying that we're seeing that play out right now.

3:49Economic data is slowing, and let's be clear, a slowdown means growth is still happening, but at a slower pace. So GDP is probably still positive, we can see that jobs are still being added, and consumers are still spending just a little less aggressively. A recession, on the other hand, is typically defined as a broad-based decline in economic activity. The National Bureau of Economic Research, who are the folks who often make the official call of whether or not something is or isn't a recession, will look at a wide range of things like GDP, employment, industrial production, income, etc. Right now, what we're seeing looks like a slowdown.

4:30No collapse, no contraction, just deceleration. And let me repeat the point I just made. Stock prices closely track earnings over the long run. So when we get short term price movements, it's often just the market adjusting its outlook for future earnings. And the economy and the stock market are different things, but I think you can connect the two in some very basic ways. So think about this. Are Coca-Cola and McDonald's going to stop trying to sell soda and cheeseburgers? No. But if tariffs raise costs or slow consumer spending, their earnings might be impacted. And that's what the market is responding to.

5:10And perhaps because there's greater uncertainty about those future earnings, the valuation in which investors are willing to pay is probably shrinking a bit too. The next thing I want you to keep in mind as you're looking at what has happened here in markets thus far in 2025 is that diversification is working. The worst of the pain in this downturn has been in portions of the markets that experienced the largest run-ups in prices, specifically U.S. large cap growth. But let's also be real here. The S &P 500 is about flat year-to-date, despite being down 10 % from its peak. And it also just had two consecutive years with total returns of about 25 % a year.

5:54So things have been pretty good for U.S. investors, and we know that nothing goes straight up. But if you're a diversified investor, international markets are softening the blow. There is a really good slide from last quarter's market webinar, and I publish a client webinar every single quarter. I'll put a link in the show notes if you want to go see it because there's one slide that's at about minute 19 that shows that international stocks outperform US stocks 94 % of the time when US stocks have a return less than 6%. And historically, international stocks have outperformed every time US stock returns were less than 4%.

6:36So if you're in a globally diversified portfolio, there is a pretty good chance that your stock portion of the portfolio is actually up for the year. And then add in the fact that fixed income markets are also providing diversification and return benefits, and it creates a situation where things aren't nearly as bad as what the headlines are suggesting. One final big thought or series of thoughts that I want to share before signing off. After the election, I experienced a spike in client and listener outreach from people concerned about, quote, the state of the world. And one thing I want everyone to know is that I get this type of response after every election.

7:18And I'm not a political guy, so I think this makes it easier to do my job in these situations. But every time, this contingent of people sounds the same. It really is just driven by whether or not their person won the election. Now, because markets experienced a correction this year, I suppose some of those people might argue that they were right. If that's the case, I want to remind you again that the S &P 500 is basically flat for the year. And it was also up, again, I think roughly 25 % per year the two years coming into 2025. I would hardly say that a 10 % correction is something I would deem to be a crisis.

7:56In fact, the S &P 500 experiences a double-digit decline every year or two. It experiences a 20 % decline about once every four years and a 30 % or greater decline about once a decade. So I'm not making a political statement here when I say that market losses are normal. They are simply the cost of earning a return that is sufficient to meet your financial goals. I'll also note that since I started my career nearly two decades ago, people who get out of the market rarely get back in. And when they do, it's after they've missed out on substantial returns. I've seen so many different types of bad investment behavior throughout my career within this profession, and I'm really not sure that there is anything worse than getting out of the market for any reason.

8:47So if you are having that feeling that you want to get out of the market, I would tell you the better course of action is to review your financial plan. A good financial plan should be considering that market downturns will happen with a similar magnitude and frequency as they have in the past. And that way, you don't have to predict the when or the why they'll occur, but instead, you can just plan on them occurring and build a portfolio that can withstand those downturns whenever they happen. Now, if you aren't using a financial advisor, getting out of the market is a sign that an advisor could add a tremendous amount of value simply by helping you stay the course.

9:25If you want to learn more about how we help people, I'd encourage you to schedule a call with me and see how we can perhaps help you out and help you get into a good financial plan that will help you through any sort of market outcome in any sort of market environment in the future. If you'd like to learn more about working with PlanCorp, you can always go to callwithpeter.com. There'll also be a link in this episode's description inside your podcast app. As always, thanks for listening. And until next time to long-term investing. Thanks for listening to the Long-Term Investor podcast. To access free financial resources and submit questions to be answered on the show, visit thelongterminvestor.com.

10:09Peter Lazaroff is an employee of PlanCorp and BrightPlan. All opinions expressed by Peter and any podcast guests are solely their own opinions and do not reflect the opinions of PlanCorp or BrightPlan. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of PlanCorp and BrightPlan may maintain positions in the securities discussed in this podcast.