To The Moon

$Wal-Mart(WMT)$ $Netflix(NFLX)$ $T-Mobile US(TMUS)$

Many economists, including members of the Federal Open Market Committee (FOMC), are expecting a soft landing for the U.S. economy in 2025. This would involve a slowdown in gross domestic product growth without tipping into a recession. However, a single misstep in Federal Reserve policy could have significant negative consequences for the economy, making the coming months crucial for the central bank. If the Fed cuts rates too quickly, it could provoke a dangerous resurgence of inflation. Conversely, if rate cuts are too slow, they could push the economy into a recession.

While economic recessions are a normal part of the economic cycle and not a cause for panic, investors can navigate these challenging times by staying informed about key risk factors and adjusting their portfolios to maximize performance if a recession appears likely in 2025.

Tariffs

The Major economic risk for 2025 is tariffs. President-elect Donald Trump has committed to imposing aggressive tariffs on imports from China and other trade partners, making tariffs a core component of his economic agenda. Supporters argue that this will help U.S. businesses compete against lower-cost international companies and encourage hiring within the U.S. However, critics contend that tariffs will drive up the cost of imported goods and components for U.S. companies, and these businesses may pass on the increased costs to consumers through higher prices. Widespread price hikes could worsen an already high inflation scenario.

Adding to the complexity, the final phase of the inflation battle may prove the most challenging for the Federal Reserve, due to the phenomenon of sticky inflation. Sticky inflation refers to price increases in goods and services that are less responsive to monetary policy adjustments, such as children’s clothing, auto insurance, and medical products. Even as inflation declines in other sectors, sticky inflation may delay the Fed’s ability to reach its inflation target, forcing it to slow the pace of interest rate cuts longer than many investors anticipate.

Inflation

Inflation

Any investor who has been paying attention over the past two years knows that inflation is the key economic risk factor for 2025. After hitting a 40-year peak of 9.1% in June 2022, year-over-year consumer price index inflation dropped to 2.6% by October 2024.

While the Federal Reserve can take some credit for the progress made in 2024, the latest core personal consumption expenditures (PCE) price index reading from late October indicates that it's premature to declare victory over inflation. The core PCE, which excludes the volatile food and energy prices and is the Fed's preferred inflation gauge, was up 2.7% year-over-year in September, still above the Fed’s 2% target.

Fed rate cuts 2024/25

In its most recent long-term economic projections in September, the FOMC projected two additional 25-basis-point rate cuts by the end of 2024, followed by four more cuts in 2025, bringing the federal funds target range to between 3.25% and 3.5% by the start of 2026. However, investors remain doubtful that the Fed will stick to this plan. The bond market is currently pricing in less than a 60% likelihood that the FOMC will implement a rate cut in December, and only about an 11% chance of four or more rate cuts by the end of 2025.

Recession in 2025 Confirmed?

Fortunately, inflation and high interest rates have not yet significantly harmed the U.S. economy, but investors should continue to monitor the labor market and other economic indicators in the coming months, as the impact of tight monetary policy often lags.

In October, the U.S. economy added only 12,000 jobs, marking the weakest growth since December 2020. This figure was likely influenced by the effects of hurricanes and a strike at Boeing Co. The U.S. unemployment rate remained at 4.1%. Meanwhile, U.S. GDP growth slowed from 3% in the second quarter to 2.8% in the third quarter of 2024. The latest Federal Reserve projections suggest that growth will further decelerate to an annual rate of 2% in 2025.

After more than two years of inversion, the U.S. Treasury yield curve returned to positive territory in the latter half of 2024, a sign of optimism for the economy. U.S. credit card debt has reached a record high of over $1.17 trillion, but delinquency rates on that debt improved from 9.1% to 8.8% in the most recent quarter. Auto loan delinquencies recently hit a 15-year high, which investors should watch as a potential warning signal for consumer strength. While a 4.1% unemployment rate is not historically high, it is significantly above the 3.4% low seen in 2023.

"Remote work" in the U.S. are at a five-year high, an under-the-radar signal that the economy remains healthy heading into 2025.

The real indicator for the U.S. economy’s trajectory may lie in workers' return to the office. If a recession is imminent, we should see office occupancy rise significantly as employees prioritize job security over remote work."

The S&P 500 is on track for its second consecutive year of 20%-plus gains, with investors encouraged by earnings growth, Fed rate cuts, and Trump's plan to extend the 2017 corporate tax cuts that are set to expire at the end of 2025. However, the New York Fed's recession probability model indicates there is still a 42% chance of a U.S. recession within the next 12 months.

What to Invest in During a Recession

While it's never something to hope for, if a recession does occur, there are several general strategies investors can adopt to manage risk and capitalize on opportunities if the U.S. economy weakens in 2025.

First, consider reducing exposure to volatile stocks and increasing cash holdings. While cash may not be the most exciting option, it reduces market risk and provides financial flexibility if a recession creates buying opportunities. Additionally, investors can currently earn over 4% interest on a one-year certificate of deposit, potentially locking in that yield as the Fed continues cutting rates.

Certain stocks and sectors are more defensive and tend to outperform during recessions. Utility stocks, healthcare stocks, and consumer staples stocks are considered defensive because their earnings are typically less affected by economic cycles and shifts in consumer confidence.

Moreover, some individual stocks have consistently outperformed during past U.S. recessions. Companies like Walmart Inc., Netflix Inc. (NFLX), and T-Mobile US Inc. (TMUS) have outpaced the S&P 500 during the bear markets of both 2008 and 2020.

For investors with long-term financial goals, another option is to stay the course and ignore any recessionary concerns.

The S&P 500 is currently in an extended bull market, similar to the one from 1995 to 2000. That intra-year corrections are typical during long bull runs, but investors who stay the course have historically been rewarded.

"We believe the S&P 500 will reach 8,000 to 10,000 by the end of the decade," Bartels says. At the time of writing, the index is trading below 6,000.

"This optimistic outlook is driven by productivity gains from AI, a strong U.S. economy, lower corporate taxes, lower interest rates, and continued stimulus from the Biden administration’s legislative efforts (such as Infrastructure & Jobs, Inflation Reduction, and CHIPs) that help companies maintain strong earnings growth."

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