2025 Economic Outlook

Matt 

Welcome everybody to our 2025 economic outlook video. I am here with Hannah, and I’m Matt, from Sherwood Financial Partners. We love to start off the year giving insight as to what we expect in the coming year.  

Right now, it’s a pretty interesting time. We’ve seen a lot of volatility in the market already. So, let’s take this chance to walk through what we’re seeing in the coming year.  

Hannah 

For the last few weeks, the market has been really choppy and we’ve had quite a few down days—some significant down days—especially relative to last year and the prior years. But we’ve had some great returns. There is this sense of volatility going on and a lot of uncertainty.  

We’ve been trying to get to this economic outlook for a while now, but every time we sit down to really dig into it, it feels like the information changes.   

A lot of what we have been talking about and the themes we’ve been looking at lately revolve around, “how do we handle uncertainty? What do we do with constantly changing information?”  

Even as the market is selling off, it’s not a significant sell off. It feels like a correction. Things were expensive. It’s not really—and you said this, and I thought it was well-put—it's not a crisis point; it’s a change in our economic reality. It's not like everything is awful, but things are different and there is a different reality. As the market digests that information, we’re seeing movement.  

Do you want to talk about what we’re seeing in terms of that different economic reality? What has changed?  

Matt 

It’s a great point. It’s especially difficult because it keeps changing, like you said, and it’s creating a high level of uncertainty. That in itself drives market performance and economics.  

As people become less certain, they’re less likely to deploy capital and invest, and are more likely to hold on to cash and wait to see how things play out. That takes money out of the economy and company earnings. Then there are lower results and the market comes down. 

We’re facing a little bit of uncertainty. And that doesn’t necessarily mean recession, but it does mean potentially lower growth. You combine that with tariffs, which I think we’ll get into later, less globalization (so less optimization of various markets and various labor workforces), which leads to higher costs that then typically hit the consumer, which means now there are less dollars to go around. You have to spend more on your core goods. All of that shifts everyone's outlook. We’re seeing that play out in the market as that sentiment has shifted over the last six weeks or so.  

Hannah 

One of the things that stood out to us, and one of the things that we want to talk about today, is the past market sell-off hit everything hard. That was tough, because we talk a lot about the benefits of diversification and why we’re in all these different segments of the portfolio.  

We’re not going to say it’s “nice,” but what is “beneficial” about this current market environment is that it’s not hitting every region in the same way or every sector. We’re seeing the benefits of diversification back in action even with all that uncertainty.  

International has been positive on the year. It's had a great start to the year. We’re seeing that bonds are up again and doing well, as are different parts of the stock market, in part because companies are experiencing this environment differently. It’s going to hit some companies differently than others. 

The question is, “Where are those pockets of value, and how is diversification really benefiting us at this moment?” That said, there are going to be downsides.  

You talked about the US being really expensive to start with going into this year. PEs have been really high. There’s this question—can companies that have done so well in the past get the earnings to justify those prices? I think the market is saying, “We’re not sure anymore, and maybe they should come down a little bit.” In some respects, it’s more of a correction.  

What we’re seeing is not that everything is awful, and we’re not headed straight into a recession, but growth is slowing. We expect lower economic growth. We had surprising GDP growth last year. A lot of the economists we’re reading are saying that’s going to come down this year. Expectations for Q1 are negative. Expectations for the rest of the year are that it might come down a percent or so.  

A lot of that is linked to expectations around tariffs, so let’s move on to that. What are the implications of these tariffs? 

Matt 

Tariffs are a hot topic right now. People might be tired of hearing about them because they’re all over. Obviously, there is partisanship to it, and people bring it up in that context, but we always say we don’t care about the politics as much. Our job is to respond to policy that is implemented and then optimize that for our clients. 

Tariffs, at their core, are taxes on goods that are coming in typically from overseas. You can pick the country, you can pick the industry, but it’s the importer who pays it.   

Let’s pretend we’re importing cars, the new Sherwood “flash car.” It comes in from being manufactured overseas, and we try to sell it in the U.S. We’ll pay a 20% tax on that and obviously you and I are not going to eat that. We’ll raise our price so when we sell it to our end consumer, we’ll still have profit on top of that.  

It inevitably happens with tariffs that prices increase for your end consumer. It’s the reverse if we’re exporters. Canada or Mexico have retaliatory tariffs—so the same thing would occur for our manufacturing that we send overseas. They have to mark up their goods to sell to their consumer because of their tariffs there, which makes us less competitive overseas. In the end you see it’s net-net. It’s more expensive on both sides. It’s why we’ve done so well in a globalized world for so long, by keeping these protective strategies low and goods really flowed well. That’s not the world we’re in now, so the threat is we’re seeing this big shift.  

Countries have optimized their industries based on what made sense. We have a lot of great agricultural goods in the US, we’re very fertile here, so we export a lot, but labor is expensive here, so we don’t have lots of factories, etc. So we went to places that had cheap labor and optimized factories there. It was an optimized global environment, and now it’s breaking apart. Every country needs to produce more of its own stuff internally again. That’s a strategy, and we’re seeing that play out, but it’s a big shift from history. We’ll see how that settles.  

To your point, the interesting thing is it will impact companies very differently. It won’t affect service-based companies much at all. People who are already manufacturing domestically? Maybe not, depending on how much they export. If they produce domestically and sell domestically, they are probably relatively insulated. But for people who export or import a lot, probably significant impacts to those companies.  

Anything to add?  

Hannah 

Bringing it back together, it all has an inflationary effect. One of the fears we’re seeing in the market is, if we end up in this environment of lower growth and inflation (and that is such a tricky place to be because costs are rising for consumers, but the environment isn’t conducive to making more money to pay for it), where does that take us?  

That naturally leads to asking, “What does the Fed do?” We’ve had this inflationary environment coming out of COVID—the Fed raised rates and they were higher than they’ve been in a really long time. The expectation was that as inflation came back down, they’d cut rates. And that’s not quite the expectation anymore. There’s less certainty about if they’re going to cut rates and how many times they’re going to cut rates. The market is trying to process that. It had built in a certain number of cuts, and now, maybe inflation isn’t coming down, and maybe it’s going up. That creates uncertainty as well. Where does that take us? On the bond side, those rates affect yields, so what are the expectations there? If you want to talk a little bit about that… 

Matt 

It’s such an interesting market dynamic, and it gets very complex. Multiple things can be true at once. We think inflation might be increasing in the short term. Typically, that makes the Fed pause. We’ve seen that in past environments, they raise rates during this time to try to squish inflation. Right now bond markets are reacting with the attitude that inflation is a short-term problem balanced by lower growth expectations. So, there’s this pause in short-term yields, but some of the longer-term yields have actually come down, even though we think inflation is going to come up in the short term.  

The market is trying its best. It’s never perfect, but it’s the combined knowledge of everybody out there, trying to predict the most likely outcome. Right now, it’s probably suggesting sustained inflation.   

We also need to focus on eggs for whatever reason. Egg prices continue to stay high. That’s frustrating. From what I hear, that’s expected to continue.  

We’ve seen bonds rally this year, especially in the longer-term space. We’re buoying the idea that, yes, we can see some short-term inflation. But overall, right now, the best guess about all of these variables coming together is lower economic growth in the long term.  

For our portfolios and for diversification, it’s been nice. As the market has sold off, we’ve seen that diversification work. Like you said, we’ve seen bonds rally. We’ve got positive returns for bonds, several percent this year to date, which is a great start to the year. Especially for our retirees, who are more in bonds, that helped tamper volatility. It’s been better than when inflation popped up a few years ago, and we had markets sell-off, and bonds sell off at the same side, which was a very different environment.  

Hannah 

This takes us to yield expectations. If we really think that’s true, it points to the possibility of an inverted yield curve. That’s why we’re hearing talk about the probability of a recession increasing. But we’ve talked about this in the past: not all recessions are the same. A deep recession and a shallow recession are not the same. The length of a recession matters. You can have a three-month recession, and it does not feel like a recession. Things feel normal.  

So, then, how do we feel about the economy? Economic growth comes down to two factors: productivity, which is how many people are working, and efficiency, how efficient are they? We expect economic growth when either more people are working, or they get more efficient. On the one side, demographics are slowing, so there is concern that we’re going to have fewer people working in the future and that’s a drag on economic growth. But then the conversation becomes, can workers become more efficient and, really, the big buzzword there right now is AI.  

What’s tough about that is, we don’t know yet. There hasn’t been a clear understanding of what AI is going to do and where the money will flow. 

There is an argument to be made for the sectors that are generating energy because we don’t know where AI is going, but we know it’s going to take a lot of energy. There are bumps in the companies that are building out the infrastructure and finding ways to generate energy.  

Outside of that, it still is a big question mark. How do we harness it?  

Matt 

No one has shown, so far, a significant competitive advantage using AI. I agree that it’s a fun buzzword. It’s going to have a future impact, there’s no doubt. The technology is amazing, but it’s not there yet. 

People are still trying to figure out how to make money off the investment. There is the easy Nvidia, the chipmaker itself. That skyrocketed. Microsoft, when they showed their advances in it, that took off.  

Now we’re moving to the ancillary winners. Who is going to produce the energy for AI? And then the next big question is, who is going to utilize it to make their workers that much more efficient to increase their profits that much more?  

It’s still relatively expensive to deploy, so as those costs come down (as they naturally will), who can then make money from it? That will be the very interesting piece in the coming years. We’re not quite there yet and so I don’t think we’re really seeing it as an overall economy. The average person at this point is not really benefiting from AI. 

Hannah 

So what does this mean for our clients? What are we saying when we meet with people? How does this come down to the financial plan and what are the impacts for our people who are watching this video?  

Matt 

It’s a great question. You and I love this. We love to talk about this, go to conferences, read reports. But then what do you do with all this information? 

One, we go back to our core tenet of diversification. It’s wildly important in this environment because there are so many unknowns. While we say recession is not a huge, glaring alarm right now, that could change rapidly. Information changes constantly. Maybe we see consumer credit really start to turn negative, just the average person struggling to pay their bills…that would dramatically increase the likelihood of a recession. Those things happen fast and when that information comes out, it turns quickly.  

We want to make sure we’re diversified across all the various sectors. It’s a great way to insulate from uncertainty. That is what we continue to do. We feel great about that. 

International markets doing well this year wasn’t necessarily projected to happen. It was an unexpected impact of these tariffs. Even some of the withdrawn support from Ukraine. We’re seeing Germany willing to take out more debt, which means more governmental spending and more money into their economy. That is an unexpected side effect. But that is, again, why you stay diversified and offset our U.S. exposure. 

A great question is why not cash in an environment like this? You’re uncertain? Just sell to cash. That can work, but it takes two great trades. You have to sell out ahead of the sell off and then buy back in after the sell off, before it rallies back. The window is actually smaller than most people appreciate and hard to nail down. Usually the turnaround happens right when the news is at its worst. There’s an exhaustion point. It’s hard to make that call. 

Money markets are yielding well right now. If we do think yields will continue to drop, things like money market are only good for seven days. Over the last year, those yields have really been coming down. Why we like bonds is that we’re getting the same yield, but as that comes down, bond prices go up, so we get yield plus capital appreciation.  

So we look more at a total return. That is how we approach investing. That’s important; it can be significant additional returns for our clients versus holding something that is giving you less and less.  

We’ve seen that this year. As bonds have rallied, we’re getting extra capital appreciation, which has been good for our portfolio. This again helps insulate us from the market downturn, which is something that cash will not do. Because we still are worried about inflation. We need our portfolios to return in these environments. 

Bonds are still easily the 3-4% for your typical bond, maybe a little bit higher on some more aggressive bond funds. We’re really happy about that.  

We tend to still lean value, especially as long-term growth is coming down. These companies that were expected to earn more and more and more and more and we were paying a premium for this future growth, we tend to shy away from that. We want to make sure whatever we’re buying represents a good value, so our equity leans that way. That has helped insulate us so far this year and I think that is a good idea going forward.  

We’re very sensitive to if it’s going to be lower growth. Getting things like higher dividends, higher yields are incredibly invaluable. Suddenly my 2% yield on the dividend-paying stock might be half my return going forward in a low-return environment. Those things play a more important role than the hope for future profit. I would rather get that cash in hand. The market’s going to value that more. We tend to stay there.  

It’s time to maybe use a little more active investing. We tend to be more passive. We tend to index. We don’t want to miss. We don’t want to take risk. But admittedly, if there are tariffs, changing environments, and changing  government funding about who is getting what… there are going to be some winners and losers. Maybe being a little bit more active out there—whether the bond or the stock side—could be more valuable to this environment. 

We’re making sure that if you’re going to pay those higher fees for active management, it’s worth it. That’s something that we’re going to constantly monitor in an environment like this.  

Hannah 

That’s where you and I are headed next. When there is a lot of information, the people we want to be with are the people that understand that information the best.  

We are continuing to go through our fund managers and the individuals that we use to support the portfolios. Who has the best grasp of all this constantly moving information? Who is well resourced to find those pockets of value? Then ultimately, we come back to our core tenet of planning matters…what can we understand the best and where can we find certainty? 

The market is very choppy right now, but we feel well-positioned in the portfolios. How do we then couch that in understanding changes to the tax code and understanding the environment that is changing your own policy that affects our plans? How do we factor that in for our clients, to make sure that we’re still maximizing for them what we can maximize? And what is a little more certain? We’ll continue to lean into that and track all of that. 

It's great to see diversification working again. We feel good about the portfolios. We had a great conversation last week about looking through the funds, having that process of questioning again, and getting to the same place that we really like…how we’re positioned and how that fits within the broader Sherwood context.  

It’s nice to have these conversations and sit and talk through them for clients. It’s fun that we’re in our new office, which is great. We’re excited to be here together and having more clients in here, which is wonderful. If you’ve not had a chance to stop by, we would love to have you out, have a beverage, talk through any questions that you have.  

We should be releasing information soon around this summer's client appreciation event. We’re really excited to head back up to Santa Barbara to the Museum of Natural History. That should be a great event, but as always, we invite you to reach out if there is anything we can be doing for you. We hope that your year is going well so far. Thanks.