Will Policy Disruption Unsettle Markets in 2025?

MIKE TOWNSEND: It has been just over a month since Election Day, and now we're in that strange in-between period. President Biden and the current Congress are finishing out their terms, rushing to get judicial appointments finalized, and aiming to pass a continuing resolution that will temporarily fund the government until probably March. It's a patch to ensure there's no government shutdown while handing off the government funding job to the 119th Congress, which will begin in three weeks. Meanwhile, President-elect Donald Trump is making headlines every day with social media posts about his policy priorities, and his cabinet, and senior staff position announcements, but he won't be sworn in for another six weeks. This interim period is an interesting one for the markets, which have reacted positively to the election outcome. The S&P 500^® is up 4.7% since election day, and that has just added to a strong year overall, with the S&P 500 up more than 27% year-to-date. Yet among investors, there's also this undercurrent of anxiety and concern. Is the market rally sustainable? How should investors think about 2025, when there are so many unknowns about what policies may emerge and how they might impact companies, consumers, and the economy as a whole? How is the market thinking about tariffs and taxes, about deportations and deregulation, about debt and deficits? Where are the opportunities and the risks? 

Welcome to WashingtonWise, a podcast for investors from Charles Schwab. I'm your host, Mike Townsend, and on this show, our goal is to cut through the noise and confusion of the nation's capital and help investors figure out what's really worth paying attention to. 

This is the final episode of WashingtonWise for 2024, and I think the best way to close out the year is to address all those questions that I've been getting through emails and during my client events over the past few weeks. While the investors I've been speaking to are happy about the market performance, they're also anxious about the future, particularly how some of the policies of the incoming administration may be good for the markets, but some may be more concerning for the markets. How does an investor sort through that? 

Over the past few weeks, I've had the opportunity to sit down with my colleague Kevin Gordon a couple of times. Kevin is a senior investment strategist at Schwab and a keen observer of the markets and the economy. Kevin and I spoke together on stage last month at Schwab's IMPACT Conference, the largest annual industry event for investment advisors, which was held in San Francisco. And we had another opportunity to talk last week at an event in New York City. We've had great conversations about the state of the equity markets and the economy, and given the uncertainties of potential policy changes coming out of Washington, where the markets might be headed in 2025. I always enjoy the opportunities I have to talk with Kevin, who is great at dissecting the many factors that play into market performance. Because everything seems to be happening right now at the intersection of our two worlds, it struck me that listeners might enjoy this kind of conversation as much as Kevin and I do. So rather than me asking Kevin a series of questions interview-style, we're inviting you to listen in on one of our conversations. Kevin, thanks so much for joining me today. Ready to give this a whirl? 

KEVIN GORDON: Sounds great to me, Mike. Let's do it.

MIKE: Well, Kevin, I have to say that as an investor, I'm certainly feeling good about what the market has been doing and continues to do right now. I mean, it's hard to feel bad when the S&P 500, as of the time we're recording, has hit an all-time high 57 times this year. But I've also been at Schwab long enough to have learned that sometimes investor enthusiasm feeds on itself, and, frankly, starting to wonder how long this can go on. I mean, none of us want to miss out if the market is going to keep moving up, but I sure don't want to hang in there too long and watch it turn down quickly. Judging from what I'm hearing at my in-person events, I'm certainly not alone in wondering how much longer the market can ride this wave. 

KEVIN: Yeah, it really has been remarkable to see the run that we've had this year. And as you mentioned, with 57 record highs, that puts 2024 on par with years like 2021, 2017, and 1995, just to name a few instances. And the one thing I'll mention regarding new highs is that they don't always precede incredibly strong years. And we have this data in our outlook that we published, and it's on schwab.com, and it's easier to look at it in-depth rather than hearing me rattle off every single statistic. But one thing that I think is worth noting is that if you go back to the 1920s, in years when we've had more than 35 record highs for the S&P 500, the median gain for the following year is just 5.8%. It's not a catastrophic return, but it's also far from the near 30% gain that we've seen so far in 2024. 

And from an investor sentiment perspective, I do find the level of froth out there quite stunning. So you mentioned investors are feeling happy but anxious, but if you look at the happy side of things, not only are people really bowled up on equities, but we're seeing some wild stuff in other markets. I mean, somebody paid $6.2 million for a piece of art that consisted of a banana duct taped to a wall. So if that doesn't scream exuberance, I'm really not sure what does. 

But even if you focus back on the stock market, I do think that frothy sentiment is growing and probably the largest risk to the market right now. Liz Ann and I went into further detail in our outlook for this, but broadly, we're seeing a sentiment environment that rivals what we saw in 2021 and the late 1990s. So everything from stock market valuations like a price-to-earnings ratio to equity exchange-traded fund inflows are looking pretty stretched. And we're always quick to remind investors that any kind of euphoria or excessive optimism in and of itself is not a reason for the market to turn lower. There needs to be some kind of negative catalyst to tip the market in the other direction. In our mind that catalyst has the potential to be something coming from Washington in 2025, especially given some of the more aggressive policies that are being proposed by the incoming Trump administration. 

MIKE: Yeah, that's a good point. And it brings me to one of the things that we've sort of marveled at as we have talked over the last few weeks, which is that it feels like we're seeing an unusually high correlation between the markets and the policy and political environment right now. You recently published a chart that pointed out how immediately after the election all 11 sectors were up by the end of that first week, but over the rest of November, there started to be a wide disparity in performance. 

For one thing, in the two weeks following election week, the healthcare sector was down 4%. Interestingly, that's when Trump nominated the controversial Robert F. Kennedy Jr. as his Secretary of Health and Human Services. I don't remember a lot of examples over the last several elections where the simple act of choosing a nominee for a Cabinet secretary position, someone who has not yet been confirmed and won't be on the job for two months, moved a sector so dramatically. But investors are worried about the impact Kennedy and significant policy changes might have on pharmaceutical companies, for example, and health insurance companies. Just one small example, but generally it just feels to me like the markets are really keeping a close eye on the political environment right now. 

Trump has made it clear that he likes the role of disruptor, but he cares a lot about market performance. He really does not want to be a president who sees the market take a big dive. The problem is that, in some ways, being a disruptor is at odds with keeping the market strong. After all, you can't disrupt big business without potentially impacting those businesses' earnings. You must be hearing similar concerns as I do, what to make of Trump's policies and how the market might react to them in 2025.

KEVIN: Well, I do find a high degree of irony in the notion that given Trump doesn't like to see the market do poorly, then that somehow means the market won't see any downside. And I do see that analysis out there, and really all you have to do is go back to his first administration to see that we did have a lot of volatility. And in just 2018 alone, the S&P 500 had a rapid 10% correction in February, which really just happened in one week, by the way, and then a 19.7% decline from September through the end of that year. Now, in fairness, if you look at the February correction, that was more driven by the implosion of what was called the short volatility trade at the time. But if you look at that near bear market at the end of the year, there were definitely more ties to the trade war, especially because that's when we started to see more deterioration in manufacturing data as Trump really started to ratchet up tensions with China. And even in 2019, that year ended up being a great year for the market from point A to point B being the beginning of the year to the end of the year, but the S&P 500 was essentially unchanged from May through mid-October. So it chopped around a lot as we continued to see some of this rolling weakness in the economy from the trade war, but also from the lagged effects from the Fed's tightening campaign that preceded it. So I think this is really key to keep in mind. Just because a president might be obsessed with looking at the stock market, that does not mean that there is limited downside. We always say that there are other important macro forces that are always at play. 

MIKE: Yeah, I think this is going to be fascinating to watch over the next few years how the markets react to various decisions the new administration and the new Congress make, and then how the president-elect reacts to the market reaction. To that end, there are five issues that stand out to me and that I think investors should have in sharp focus in the coming months. I feel pretty sure you have the same list. Now, believe me, I realize that none of these can or will act independently. They're all interrelated. But maybe for the sake of this discussion, let's just run through them one at a time, and I want to get your reaction. 

First up, immigration. Cornerstone of President-elect Trump's campaign, and one of his highest priorities. He's talked about deporting 10 to 11 million undocumented immigrants currently in the U.S. Now, certainly there are some pretty significant numbers that can be deported relatively quickly. People facing criminal charges, for example. People who have exhausted their legal appeals to stay. But deporting millions of people, many of whom are working in industries like hospitality, construction, agriculture, will be both logistically challenging and potentially destructive to the economy. When things started to open up after COVID, we saw businesses close because they couldn't find workers. And I don't think it's a stretch to say that something similar could happen if there's mass deportation. It seems like this is an issue where going slowly would be important so as not to cause an adverse reaction in the economy. 

KEVIN: Oh, yeah, I couldn't agree more. And in fact, I think that immigration policy is the most important economic needle mover, but not just for 2025. And if Trump is serious and successful about taking that many individuals out of the U.S. labor force, we are almost guaranteed to see significant negative economic consequences over several years. And growth in real gross domestic product, which we just call GDP, and the labor force, they track each other pretty closely over time. So if you cut the labor force by around 8%, which is getting more towards the extreme end of what he's proposing, the trajectory of GDP growth would fall considerably. 

And not only that, but just as a country, whether folks like it or not, we've become more dependent on immigrants over the past several years. And if you use the pandemic sort of as a starting point, the growth in our labor force since then has essentially been all due to foreign-born individuals. There has virtually been no growth in the domestic-born labor force. And that reinforces the data that we've all become quite familiar with in the western world, not just in the case of the United States, but Western birth rates are down, populations are aging, and we just simply do not have that robust rate of reproduction needed to sort of self-supply ourselves when it comes to labor. 

So given that point and your point about how quickly, or maybe not quickly, this can all happen, I think that's what makes immigration policy a multi-year issue. I don't think it's just a 2025 issue. And even if we start to see deportations kick in relatively quickly, I'm not sure how that would show up in the data right away. The economy still has some nice momentum going into the new year, but again, this all depends on the severity and the rapidity with which the labor force is reduced. So if President-elect Trump's most aggressive proposals are implemented, I could see a hit to growth occurring by the middle of the year. But as you always say, Mike, when it comes to logistics in Washington, nothing moves quickly. And I'm guessing that more than applies here, in spite of Republicans controlling Congress and the White House. 

MIKE: Yeah, absolutely. The sheer logistics of mass deportations are absolutely overwhelming, and, frankly, probably impossible. For context, during his first administration, about one and a half million people were deported over the entire four years. Vice President-elect JD Vance has talked about deporting a million people a year, which would be a huge number, but of course doesn't get you anywhere close to 10 million. To me, in all these discussions about the potential impact of policy decisions on the markets, there are two powerful forces that are being underestimated. One is time, and the other is, well, Congress, and particularly, the narrow margins in both the House and the Senate. So let me say just a little bit about both these topics. 

First, time. Congress tends to move at a glacial pace. We all know this. At the beginning of every new Congress, there's always this ambitious timeline laid out. "We're going to pass this in the first 30 days," and "This is our agenda for the first hundred days," etc. But the very nature of Congress tends to mean that those deadlines are not met. The process on Capitol Hill is slow. There are negotiations, and changes, and redrafts, and committee hearings, and multiple votes. And then the House and Senate inevitably pass different things, and they have to meet to reconcile those differences. And then that compromised product has to be voted on by each chamber again. I always think of the classic schoolhouse rock cartoon and song "I'm just a bill, sitting here on Capitol Hill." I mean, the whole premise of that song is a reminder of how hard it is to actually pass something through Congress.

And then second, the narrow margins are going to exacerbate that and make it even more difficult this year. Republicans are going to have a workable 53 to 47 margin in the Senate. It's not a huge margin. There are enough Republicans with an independent streak that every vote is far from a sure thing. But it's really the House that is going to be problematic. So after the election, Republicans have a 220 to 215 margin, but there's already been a resignation. Former Representative Matt Gaetz of Florida resigned after being briefly nominated as attorney general, and his seat won't be filled until a special election on April 1. So right away, the margin is down to 219 to 215. And Trump has nominated two other House Republicans to Cabinet-level posts. Representative Mike Waltz of Florida has been nominated to be national security advisor. He intends to resign from Congress on January 20. And representative Elise Stefanik of New York is Trump's choice to be ambassador to the United Nations. She will resign once she's confirmed, likely late January, maybe early February. So that means that the margin will be 217 to 215 for the first 10 or so weeks of the new Congress. That is a one-vote margin, because if one Republican doesn't vote along party lines, you've got a 216 to 216 tie. Ties lose in the House of Representatives. So every Republican essentially has a veto over any piece of legislation, and a lot of leverage to have something they care about maybe added to a bill in order to win their vote. 

This is going to be really complicated, and it will add to the time it takes to get things done. My point of all that is that it's just not going to be easy for things to sail through Congress. We're talking about border policy changes, for example, they're going to take time. Tax code changes take time, just about everything will take time.

But there is one thing that may not take as much time, and that's our second big issue, tariffs, another cornerstone of the Trump campaign. He has said for months that he wants to impose across-the-board tariffs of 10 to 20%, plus 60% tariffs on imports from China. Just a couple of weeks ago, he said he would impose 25% tariffs on imports from Canada and Mexico, who just happened to be our two largest trading partners. I think the expectation in Washington has long been that, ultimately, Trump won't put tariffs on absolutely everything. 

That would be inflationary. It would likely spark a global trade war, which in turn could impact economic growth. So maybe this is rhetoric that is a negotiating tactic. And look what happened with Canada. Within 48 hours, Prime Minister Trudeau was at Mar-a-Lago meeting with Trump. While no agreement was announced, it's clear that Trump got something of what he wanted because he said jump, and Canada jumped. But it's clear that we're going to get at least some tariffs. Some companies already reacting here in the U.S. We've seen some companies start to move their supply chain so as to avoid China. And we've even seen companies say the quiet part out loud, that if tariffs are imposed, they'll raise prices and pass that on to the consumer. 

Yet the market has seemed unfazed about all of this so far. So how is the market thinking about tariffs? Are we going to see the market drop on January 21 if Trump imposes significant tariffs on day one? 

KEVIN: Well, to answer your second question, first and quickly, I have no idea. I wish I knew, but I don't have that predictive skill. And by the way, nobody does. What I do know is that the last time we were in a trade war, which started in 2018, we saw a ton of stock market volatility. And I already shared some stats earlier about the declines we experienced that year. But I think it's worth pointing out that from an economic perspective, there are risks when it comes to tariffs on goods imported from other countries. 

And that brings me to a bit of a rant that I want to go on, if you'll indulge me. I often bristle when I see how tariffs are phrased and framed, be it in the media or with most people I discuss this with. You know, I often see these headlines or statements that say, quote, tariffs on China, or, quote, the U.S. is charging Mexico and Canada with X amount. OK, tariffs are not paid by other countries. They're paid by the importing company, and in this case, they're paid by U.S. companies. And I think it's really crucial to understand this, because to your point, most companies end up passing the higher cost on to the consumer. Rarely does a company want to have that entire tariff increase eat into profit margins. 

So in terms of the inflationary impact, I think it's tough to tell how much overall inflation will rise because even if you go back to 2018 and 2019, there was a clear shift up in prices for the goods that were targeted by Trump's tariffs, but headline inflation, so overall inflation, didn't rise significantly. Now, those tariffs were more targeted in nature and focused on capital goods, as opposed to end consumer goods, but if we get across-the-board tariffs for goods coming from our trading partners, as well as that 60% increase on goods coming from China, I think that could result in a pretty meaningful price level shift. 

And the way that this becomes inflationary is really if other countries retaliate, which again, is just something we don't have information on at this point. And if anything, I'm actually more concerned about tariffs dealing a hit to growth here in the U.S. And you can go back to 2018, and you could see the slowdown in areas like business capital, spending, confidence, both at the business end, but also at the consumer end, and also manufacturing, all after the tariffs started to get implemented. So there is a bit of an irony here in thinking that tariffs are somehow beneficial for bringing manufacturing back home, when in reality they dealt a hit to manufacturing the first time. 

MIKE: What about China? I mean, China is a different story. China doesn't really care about its stock market. It doesn't care about trade imbalances. It doesn't care about a trade war. 

KEVIN: Yeah, it's a great point, and you're right, China just does not have the same degree or care or sensitivity like we do here in the U.S. Plus, as is the case in the United States, China's economy is in a different place this time compared to when we experienced the trade war in 2018 and '19. And the country is still dealing with an ailing property sector, a slower recovery in certain consumer confidence metrics, and weak business sentiment. And I am far from a China expert, so I'll keep my thoughts on this relatively brief, but we'll see how Xi Jinping reacts to any opening salvos from Trump, and when it comes to tariff policy and the policies that come out of China in response to it. But my best guess is that any kind of trade spat at this point is probably met more with a ceasefire agreement, as opposed to some kind of mega-trade deal. And there's this well-respected China strategist I have followed closely for years, and he said, quote, you know, the road to a deal is paved with boulders. And I think that's a perfectly apt way to describe this. 

I think the other thing to consider here, and I'd be curious to get your thoughts on this, Mike, is really just what power the president actually has when it comes to tariffs. 

MIKE: Yeah, this is an area where the president does have pretty broad authority, which has been delegated by Congress to the president over the course of the last couple of decades. There are a couple of different paths for the president to declare that other countries' trade policies are national security threat, for example, or that he's imposing tariffs in response to an unfair trade practice from another country. But where I think this will get really interesting is, again, if members of Congress start to hear from businesses in their districts that the tariffs are hurting their company. That's going to be the key thing to watch. 

While the president has a lot of authority on tariffs, he has virtually no authority on the third big policy issue that, if it isn't already, should be on everyone's mind, and that's taxes. One thing the president can definitely not do is change the Tax Code. That is entirely in the purview of Congress. We all know that there will be a big tax bill in 2025, because all of the 2017 tax cuts, one of the signature legislative accomplishments during Trump's first term as president, are set to expire at the end of 2025. So Congress is very likely to pass a bill next year that extends those expiring provisions. We're talking about lower individual income tax rates, the higher standard deduction, the higher estate tax exclusion amount, and much more. 

The question is what happens with all the ideas that Trump talked about on the campaign trail—a corporate tax cut, ending the taxation of tip income and Social Security benefits and overtime hours, among other ideas. My sense right now is that most of those campaign promises will not be included. The cost of just extending the expiring provisions is already in the trillions of dollars. The more you add to that bill, the more that cost climbs. So maybe they pick one or two of those things to add. No one knows for sure, but it feels right now like a reduction in corporate taxes might be lower on the priority list. Obviously, companies would love to see their taxes lowered. So how do you think companies are thinking about taxes under the new administration? Is that something they're factoring into their future planning at all, or is this kind of more of a wait and see to find out whether there is movement in this direction? 

KEVIN: I think it's more wait and see, especially because it seems that in terms of sequencing, when you look at policies for the incoming administration, anything tax-related is likely to come last if we're going to take into account what needs to be done with congressional approval. Plus, I'm not sure how much of a needle-mover it will be for growth. For one thing, the effective corporate tax rate is already down to 11%, which is near the lower end of the historical range. And not only that, but when you look at the ripple effects of various factors, whether it's tax cuts, credits, or business investment, it's actually business spending that has the largest multiplier effect for the broader economy. Tax cuts can certainly be stimulative, but the magnitude of that effect might not be as large as conventional wisdom might suggest. 

Another thing worth noting is this relationship between more fiscal stimulus and the trade war. And there is this strange disconnect that occurred during the first Trump administration, and I kind of expect or suspect that it will rear its ugly head again in the second one, based on some of the rhetoric coming from the campaign trail. So if you kind of turn back time to 2018 into 2019 for that trade war, there was this villainization of trade deficits, the fact that the U.S. imports more than it exports with other countries, and at the time, in particular, China. So at the same time that the administration was trying to combat that deficit issue by starting a trade war and raising tariffs, it also enacted massive fiscal stimulus via that 2017 Tax Cuts and Jobs Act. So here's the disconnect. On the one hand, you're lowering taxes for businesses and individuals, presumably giving them more money to spend. That automatically and mathematically is going to widen out the trade deficit because we are a net importer in the United States. Yet the administration then got angry at the fact that the trade deficit was widening, thus leading to the use of this trade war as some kind of yardstick. So it sort of became this vicious circle where you didn't have both hands talking to each other, so to speak. And I think that's an important historical context because there's a prospect at least to face some sort of similar dynamic this time. And of course, no two eras are the same, but a lot of this can get confusing, especially when there are so many crosscurrents. 

And speaking of no two eras being the same, I do think it's worth pointing out that the extension of the Tax Cuts and Jobs Act would really just be keeping the status quo. It's not some sort of massive change in policy. So the real change would be if it lapsed or if we got more tax cuts built onto the extension of it. 

MIKE: Yeah, and I think that leads to this question of what the actual effect of extending the tax cuts will be, because it's not clear that it will in this time around change behavior, particularly by consumers in terms of spending, because essentially for them it's status quo in terms of how their taxes will be affected. So I think that's going to be really interesting to watch. 

All of this leads to a theme that you and I have talked about on many occasions, and that is the federal debt and the deficit. And now we're talking about it even more because many of the Trump proposals would add to the federal deficit and continue to increase the national debt. So that's kind of the fourth issue I want to discuss. It's really hard to get out of debt when the interest on the debt is the third largest line item in federal spending. Congress is going to have to raise the debt ceiling sometime by mid-2025. That's a battle that's always difficult, and it does tend to rattle the markets if and when the U.S. starts to get in danger of defaulting on its debts. But it also feels like the market kind of shrugs at the debt these days. I know you've thought a lot about the impact of rising debt and deficits on the economy over the medium- to longer-term, and the knock-on effects that could have on the markets, but it just seems like the market doesn't much care about the deficit and the national debt anymore. Is there a level at which this really becomes problematic? 

KEVIN: So the short answer right now is no. Even though we've continued to see debt grow at an unsustainable pace, the market has really shrugged it off, and whatever the sole reason is for that, we're not sure. I'm not sure there even is one reason. But we do know that the U.S. still enjoys a relatively good standing in the world, with the dollar being the global reserve currency, and other countries still having a relatively strong appetite for our debt. And it's not that I think we should just be resting on our laurels and say that there's not going to be any consequence of high and rising debt, but I think these are the major factors as to why we haven't seen some kind of epic implosion in our markets despite having this debt growth problem and having it grown exponentially so much. And we've been on the record saying that there is not a strong correlation between debt and/or deficits and inflation or markets. And you and I have worked on this, alongside Liz Ann and Kathy Jones, our chief fixed income strategist, and we all haven't been able to commit to any conclusion that you can make a strong tie between deficit spending in markets or the overall debt level in markets. 

But moving forward, I do think that one thing that might be different this time in this next round of deficit expansion, assuming that's the path that we continue to go down, is potentially more inflation stemming from the labor market. But that does assume that the incoming Trump administration is serious and successful about deportations, and then also reducing the flow of immigrants into the country. And as we've already discussed at length, we'll just have to see how that plays out. But overall, I think that if we do get this aggressive reduction in the labor force, that would ultimately deliver a stagflationary impulse to the economy, so we would get hotter inflation and weaker growth. 

MIKE: Well, we'll definitely be watching the impact of deportations on the job markets, no question. 

There's one other big X factor at play here, particularly when it comes to debt and the deficit, and that is deregulation and reducing waste in government. And that's where Washington's newest hot topic comes into the discussion, the Department of Government Efficiency, already better known as the DOGE. This is the entity that will be headed by Elon Musk and Vivek Ramaswamy, with a broad mandate to shrink the size of the federal government, cutting personnel, regulations, programs, perhaps entire departments. For companies, I think this is really interesting. I don't think there is a single business out there that wouldn't welcome at least some reduction in the burden of regulations. It would potentially reduce the cost of doing business. And reducing waste in the federal government, making the government a bit leaner, maybe get some deficit reduction out of it, there's potentially some upside for the economy there, right? 

KEVIN: So admittedly, I'm not too sure as to how much this agency can accomplish just purely based on the federal numbers alone. And if you look at personnel, the federal government has roughly 2.3 million employees. So I'm going to use some round numbers here, but around half-a-million are in Veterans Affairs. They're providing healthcare in VA hospitals. About 600,000 are civilians working for the military. Slightly more than 200,000 are working for Homeland Security. And then there are about 160,000 working at the Defense Department. I can go on, but you probably get my point. I'm not sure how gutting these departments, all of which are considered crucial and necessary, will be feasible or effective. So I sort of struggle with understanding what the end game is here. And if you look at just the mandatory components of federal spending, Medicare, Medicaid, Social Security, income security, that makes up, well, more than half the total. I'm not the political expert here, so this is where I toss it back to you, but it does not strike me that senators up for re-election in this next cycle would want to suddenly cut those programs. 

MIKE: Yeah, I go back to what I said earlier about time and Congress both being a challenge. The DOGE has a big mandate, but it does not actually have any power. It can only make recommendations to the president and to Congress. Some of those recommendations could be implemented through executive orders, but I think the bulk of what Musk and Ramaswamy are likely to come up with will require congressional action. And that's where you run into an age-old problem on Capitol Hill. Members of Congress are always for reducing the size of government and cutting programs until it's a program that actually affects their constituents. So if you propose eliminating a program, but that program is providing money to one of the largest employers in my district, as a member of Congress, I'm going to fight to keep that program in place because losing it might anger my constituents, and then suddenly my re-election chances are in trouble. It's moving from an exercise on paper to actual cuts that affect people in their districts. That's where things will get difficult. So we'll have to wait and see how it all plays out, but I think there's a real chance that this whole exercise ends up being very frustrating to someone like Elon Musk, who is used to a very different dynamic in his businesses where he can cut 80% of the workforce at somewhere like X. 

KEVIN: Yeah, couldn't have said it better myself. 

MIKE: So Kevin, I read the Market and Economic Outlook for 2025 that you and Liz Ann Sonders, who of course is Schwab's chief investment strategist, published this week. Lots of great thoughts for investors in there, and we're going to put a link in the show notes for listeners to access that. But given everything we've talked about today, all the uncertainty, all the unknowns, what kind of practical advice are you giving to investors right now? I mean, are there moves to be made? 

KEVIN: So I think the way to approach 2025 is to actually ask the question of what not to do, as opposed to what to do. And the most practical advice would be to not make any outsized moves in portfolios, and we just don't think investors should be getting out over their skis in terms of taking on a lot of risk. I'll start with the good news being that breadth metrics for the U.S. market are supportive of the market continuing to do well. So staying invested in the equity market makes a lot of sense to us here. But as I mentioned, with the potential for a much bumpier ride in 2025, there is elevated risk of much more volatility at the index level next year. And that's a pretty big contrast to this year because for all of 2024, so far up until, you know, this point that we're having this conversation, the downside at the index level has been relatively muted. So just as an example, the maximum drawdown for the S&P 500 this year has been just 8.5%. That's not even technical correction territory of 10%. Yet the average maximum drawdown for each individual member is 20%, which is bear market territory. So those statistics might sound like they're at odds with each other, but we've been able to see this minimal scarring at the index level because weakness has been rolling and rotational in nature. So just as an example, when we had that 8.5% drop from July through August, the market's weakness was disproportionately driven by the tech sector. Really, most of the other sectors fared quite well and outperformed the broader index. And we're not so sure that that dynamic continues in 2025, especially if volatility is going to be driven by tariff-related news. And again, it's hard to say that this will be a repeat of 2018—no two eras are ever the same. But I do think that we can glean insight from that year in terms of the swings that the stock market experienced. 

The one thing I would caution against doing for next year, or even the next four years, is making any kind of assumption that certain sectors will do well because of who the president is, as well as any policies being pushed by the administration. And you and I have covered this before, Mike, but the reality is that there is not a strong connection between performance and sectors that seem to be, quote, favored by a political party in power. And I always use the energy sector as an example. It was the worst-performing sector under the first Trump administration. In fact, it fell by 40% from his inauguration to his last day in office. Conversely, energy has been the best performer since Biden took office. That does not mean that Trump was secretly anti-traditional energy, and Biden has been the opposite. It just means that there are other important macro forces that have been at play. 

And one more example I want to give, since I've been seeing a lot of analysis these days that says we should just dust off the 2016 election playbook as a current playbook for the market today. When you look at the parts of the market, at least in the U.S. stock market, that outperformed sharply from election day 2016 to inauguration day 2017, and this is things like small-caps, banks, deeper cyclicals, those were sort of dubbed as the Trump winners. Those were actually the parts of the market that went on to underperform throughout 2017. It was the so-called Trump losers which did poorly right after his election that went on to outperform. 

So it's not to say that we'll get an identical setup this time. I think it's just more to point out the fact that we shouldn't extrapolate any post-election move in the stock market. I really think that the market's rally, and how sharp it was after the election, was more so due to how quick and decisive the result was. And in my opinion, there's no way that the market priced in four years of policy or four years of an administration in just one week, no matter how swift, no matter how strong the move was. 

So I wouldn't get caught up in what message has or hasn't been sent in the past month. I think investors will be served well in continuing to rebalance based on volatility, not as much on the calendar. So in other words, just let your portfolio tell you when it's time to make a move. Don't let politics or narratives do that for you. 

MIKE: Yeah, absolutely agree with that, and I think that's going to be really important to watch how the details of all these policy initiatives actually come out. We don't have many details. We don't know how tariffs are going to unfold. We don't know how the Tax Code is going to be changed. We can speculate about it, but the actual details have to go through Congress, particularly when it comes to taxes, and that takes a while. So we all know how hard it can be to focus on rebalancing when you've watched the market go up more than 27% as it has so far this year, and you think, why change what's working? So really good time to talk to your Schwab financial consultant or your investment advisor about your particular situation, and whether it makes sense for you to make any changes in anticipation of a less certain environment in the year ahead. 

On that note, Kevin, I think we'll leave it there. This has been a terrific conversation. Really appreciate you making the time to join me today. 

KEVIN: Yeah, I loved the conversation. Thanks for having me, Mike.

MIKE: Well, that's Kevin Gordon, senior investment strategist here at Charles Schwab. He is a prolific presence on X, formerly known as Twitter. You can find him there @KevRGordon. 

And that's all for this week's episode of WashingtonWise. We're going to take a break for the holidays, so our next episode will be out on January 16. The new Congress will be up and running at the time. We'll be just days away from the inauguration of President-elect Trump, so there will be lots to talk about. 

Take a moment now to follow the show in your listening app so you get an alert when that episode drops, and you don't miss any future episodes. And I'd be so grateful if you would leave us a rating or a review. Those really help new listeners discover the show. For important disclosures, see the show notes or schwab.com/WashingtonWise, where you can also find a transcript. 

And as we wrap up WashingtonWise for 2024, I want to take a moment to thank the people behind the scenes who make this podcast possible: Adam Bromberg; Deborah Hinton-Brown; my sound engineer and producer, Patrick Ricci; and Gay Matthes, my editor, producer, and all-around podcast wrangler. I could not do any of this without all of you, so thank you very much. 

I'm Mike Townsend, and this has been WashingtonWise, a podcast for investors. Wherever you are, stay safe, stay healthy, happy holidays, and keep investing wisely.