MIKE TOWNSEND: For investors, 2025 has been quite the roller coaster. It's almost like we've experienced three entire market cycles—and it's only May.
From the beginning of the year to the market high on February 19, the S&P 500® was up 4.7%, and the Nasdaq Composite rose 4%. A solid start to the year, no question.
But rising concerns about the economic impact of tariffs and other policy initiatives coming out of the White House sparked a big market sell-off. From the peak on February 19 to the bottom on April 8, the S&P 500 fell nearly 19%, while the Nasdaq Composite dropped almost 24%. During the freefall, there were articles counseling investors not to look at their 401(k) balances.
On April 9, President Trump eased the tariff policy. Since then, the S&P 500 has bounced back 19.5%, while the Nasdaq has rebounded more than 25%.
Put it all together, and as of market close on May 19, the S&P 500 is up about 1.5% year to date, and the Nasdaq is about a half a percentage point down from where it started the year. Essentially, the market is flat since 2025 began—but few investors have experienced the level of calm that implies.
So the question is, what does the rest of the year have in store for us as investors? Of course, no one can predict what the markets will do. But it feels harder than ever to make sense of what's going on with policy in Washington, with the economy, and with the markets. Earlier this month, Jerome Powell, the chairman of the Federal Reserve, said the quiet part out loud, noting in a press conference after the most recent Fed meeting that "it really is not at all clear what it is we should do."
I mean, if the chairman of the Federal Reserve doesn't know what to do, what are we as investors supposed to do?
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.
Coming up in just a few minutes, I am going to chat with Liz Ann Sonders, chief investment strategist here at Charles Schwab, about tariffs, the economy, recession risk, this roller-coaster ride stock market investors have experienced so far in 2025, and where she thinks things are headed. And while Liz Ann doesn't have all the answers, I think you'll find our conversation helpful as we talk about how investors can sort through the barrage of information we're all getting and keep at least a bit calmer in the face of a lot of uncertainty.
But first, here's what I'm watching in Washington right now.
Usually, I highlight three things—but this week, all of the oxygen in the nation's capital is devoted to just one thing: the so-called "one big, beautiful bill." The House of Representatives is struggling toward the finish line in its effort to pass by the end of this week the massive bill that will cut taxes, cut spending, and increase funding for defense and border security.
So what's in the bill? On the tax side, the heart of the legislation is that it makes permanent all of the 2017 tax cuts, which are set to expire at the end of 2025. The biggest takeaway there is that the current individual income tax rates will remain the same. The bill will increase the standard deduction to $16,000 for individuals and $32,000 for couples. The child tax credit will increase from $2,000 to $2,500 for the next few years.
The amount of assets that can be inherited without triggering the estate tax will rise to $15 million per person in 2026, and it will be indexed to inflation in future years.
Some of the president's priorities from last year's campaign are also included in the bill. The bill will end the taxation of tip income for the next four years, subject to a number of exceptions. And it will end the taxation of overtime hours, again with some complicated rules and restrictions on who it applies to.
The president's promise to end the taxation of Social Security benefits has instead been turned into a special $4,000 tax credit for seniors, subject to income limitations.
The bill would also increase taxes on college and university endowments, with rates as high as 21% on the largest endowments. And it will increase taxes on private foundations.
On the spending-cut side, there are countless cuts to current programs, some big, some small. But the most controversial are reductions in Medicaid, cuts to the Supplemental Nutrition Assistance Program, or SNAP, which is the term for food stamps, and cuts to a number of green energy programs that were the result of the Inflation Reduction Act that Congress passed in 2022.
At the same time, defense spending gets a $150 billion increase, and the budget for border security and immigration policy is increased by more than $46 billion.
And there's one other really important thing in this bill—a $4 trillion increase in the debt ceiling. It's important because it is the one element of the bill that has a fast-approaching deadline. Treasury Secretary Scott Bessent recently told Congress that the so-called "X date"—the date by which Congress must raise the debt ceiling or the country will default on its debts for the first time in its history—will arrive sometime in August. Since Congress is usually on recess for the month of August, the real deadline for passing the one big, beautiful bill is the end of July.
So here's where things stand. Eleven different House committees have crafted sections of the bill that are in their jurisdiction. The House Budget Committee then stitched it all together into one big bill that runs, at least in its current iteration, to 1,116 pages. But a group of conservatives balked last Friday, and they postponed that committee's vote. Late Sunday night, the Budget Committee approved the bill, but only because four conservatives voted "present" to allow the bill to move forward amid further negotiations.
Republican leaders really want to pass this bill before the Memorial Day recess begins. But they have just a three-vote majority in the House, meaning they cannot lose more than three Republicans and still pass the bill, since no Democrats will support it. And there are a lot of Republicans unhappy with the bill—and in ways that are often in contradiction with each other. Conservatives want to see tougher Medicaid cuts. Moderates want to see fewer Medicaid cuts. Republicans in high-tax blue states like California, New Jersey, and New York want to see the state-and-local-tax deduction, known as SALT, increased, but Republicans from red states don't care about that at all, except they know that the higher the cap, the more impact it has to the overall cost of the bill. Some Republicans want to end clean-energy tax credits from the Biden administration as soon as possible, but others want to preserve some of those credits that benefit people and businesses in their states. Threading the needle on these and dozens of other internal mini-battles is proving to be very difficult for Republican leaders.
So one of two things is going to happen here by the end of the week. Either the House will pass the one big, beautiful bill, or it will collapse, temporarily; everyone will go home mad for the Memorial Day break; and they'll try again in early June. Either way, the House is likely to find a way to pass the bill sooner or later. And then it will go to the Senate, which will undoubtedly change it, almost assuredly in ways that will frustrate a lot of House members. But eventually, both the House and Senate have to pass the exact same bill. And they need to do that by August because of the ticking clock on the debt ceiling.
The bottom line on all of this: Congress still has a long way to go. And we can expect a lot more drama between now and the finish line. Stay tuned.
On my deeper dive today, I want to take a closer look at the current state of the markets and the economy. It's only May, but it feels like 2025 has already been one of the wildest years for the stock market in recent memory. As I noted at the top of the show, the S&P 500 is up just 1.5% for the year, but that included a 20% recovery from its low point in April. The NASDAQ has seen a 26% recovery from its low point. It's been a rocky ride that has tested the fortitude of even veteran investors.
To help me sort through what's been going on with the economy and how that's fueled this up and down and up again market, I'm really pleased to welcome Liz Ann Sonders, chief investment strategist here at Schwab, and co-host of our sister podcast On Investing. Liz Ann, great to have you back on WashingtonWise.
LIZ ANN SONDERS: Oh, I'm thrilled to be here, Mike. I always enjoy our conversation, so thanks for having me.
MIKE: Well, Liz Ann, we're experiencing really uncertain times. You and I have both been in this business for a long time. We've seen plenty of stock and bond market booms and busts. We've seen global tensions with our adversaries, serious threats to our economy, times of extreme partisanship. But what makes this time feel so different is that all of those worries and more seem to be hitting at the same time. And I think that's what is creating so much fear and confusion for individual investors, to the point that it's easy to become frozen, or worse, get so spun up that we take some rash action that totally goes against our carefully laid-out financial plans. I really think there's an information overload for investors right now, where there's just so much happening every day that it can be impossible to know what to react to.
So today, I want to talk through some of the questions that you and I are both getting as we talk to investors all over the country, and I want to start with tariffs because they seem to be the biggest driver of uncertainty. President Trump's so-called Liberation Day when he announced sweeping tariffs was just over six weeks ago, which actually seems a much shorter time than it really has been. Since then, we've had a number of pauses and delays and changes, so that it's hard to keep track of what's on and what's off. So can you just walk us through where things currently stand with tariffs?
LIZ ANN: Yeah, and Mike, the timeline is such an interesting one because there was a lot that was already in play before the so-called Liberation Day announcements. And I won't go through every detail of the timeline, but basically it was the beginning of March where you had the tariffs on imports from the three major trading partners with the United States, so Canada, Mexico, and China. And then just before that Liberation Day, we got additional details on auto and auto part tariffs. Then of course came Liberation Day, and that's where so-called reciprocal tariffs were announced on 60 trading partners that each one had a different specific rate, plus an across the board 10% tariffs. But we've of course had de-escalation since then, but we've also had retaliations announced since then by many of our trading partners. But it was on April 9 … you and I remember this well because we were both on a panel at one of our conferences on that April 9 day when there was a 90-day pause in terms of escalating the so-called reciprocal tariffs. And we've had additional slight de-escalations along the way. The fact that we tape this before it actually airs means that this could change just in the next couple of days. But right now it's somewhere in the mid-teens in terms of the average effective tariff rate. Just to put that in context of where we were pre-Inauguration Day, the average effective weighted tariff rate in the United States was about 2.5%. So even if things settle where they are now and we don't re-escalate, this is a pretty lofty percentage in terms of tariffs.
The last thing I would say, and where I'm going with this, Mike, I think there's too much shorthand by the media sometimes, even by members of the administration when talking about tariffs. The shorthand typically being statements like or headlines like, "tariffs on China," "tariffs on Canada," or "China will be paying tariffs." Let's remember that tariffs are paid by the U.S. company—companies importing the goods from the targeted countries. They're not paid by the countries that are being targeted. Now, it's a relevant debate to talk about who ultimately bears the cost. Do companies, U.S. companies, pass on those higher costs to consumers? Do they eat it in their profit margins? Do they maybe exert some price concessions from foreign trading partners? But the tariff is paid by the U.S. company importing the goods.
MIKE: You know, Liz Ann, I think as you and I have discussed, I talk about this at all of my client events also, because I just think there's a lot of misunderstanding about that. But when you're talking about tariffs, I think you hit on one of the points that's really important, which is that among all the high-profile reciprocal tariffs, whether they're on, whether they're off, China tariffs going to 145% and then coming back down to 30%, it's that 10% baseline tariff across the board on all imports—I think a lot of people forget that that's even there because that hasn't really been in the headlines, and that's where the impact on the American consumer can really start to be felt, and I think it's going to continue to be felt as we go forward. As we start to look at the data, Liz Ann, the Consumer Price Index did come in lower than expected. There are still tariffs in place that are obviously impacting the economy, and I don't know that those have shown up in the data quite yet. So even if some of the worst of the tariffs are behind us or on pause, it feels like the economy isn't exactly out of the woods.
But with all the tariff adjustments that have happened, I think that there's been a change in recession expectations. There was a lot of firms that had expectations of a recession as high as 60% just a few weeks ago. I think with the change in the China tariffs and other changes, some of those estimates are now below 50, in the 30% range. But I wonder what your take is on where we are on the recession spectrum, and along with CPI, what should investors be watching?
LIZ ANN: So as you know, Mike, we don't tend to go out there with anything precise in terms of probability percentage-wise on recessions. I had been saying and writing in advance of the de-escalation that really kicked in on April 9 that I thought if we're going to come close to doing percentages, probably better than even odds that a recession was within our sites in the somewhat near term. And with the de-escalation, maybe that goes down to something less than even odds. But I think for those economists that do publish odds, I think it will continue to be a moving target.
But I agree with you, Mike. I do not think that we are out of the woods. I think the growth impact is still ahead of us. We know that we have seen a pretty significant compression in what's called the soft economic data. So survey-based data, everything from consumer confidence and consumer sentiment to inflation expectations to CEO confidence, a lot of the surveys around capital-spending plans and big investment plans, and those have all sunk like a stone. We haven't yet seen a commensurate amount of weakness in the hard data. Hard data would be the actual tracked data, industrial production or GDP or retail sales. We have started to see some weakness show up, but I'm not sure that we have yet fully felt the brunt of it, and I'm pretty sure we have definitely not felt the brunt of it in terms of inflation. So the reference point for the recent batch of inflation data, including Consumer Price Index, Producer Price Index, covers a period where the average effective tariff rate was only about 4 or 5%, not that far above the 2.5% that existed pre-Inauguration Day. So I don't think we have fully felt it yet in inflation.
And in addition, I've heard a lot of outcry of, "It's not going to happen because, see, we didn't see it in import prices." Well, import prices are published exclusive of tariffs. People say, "Well, we didn't see it in the PPI, the Producer Price Index, that went down." Producer prices are excluding tariffs.
So everybody needs to understand the math associated with this. I still think that we have the effects to come, and that will be dependent on whether the de-escalation continues or whether we ramp back up. But I don't think we're out of the woods yet. I think some of the weakness is still to come.
MIKE: Well, one of the places where I know you're watching really carefully is on the jobs side. And we've already seen big layoffs of government employees of course, which definitely has an impact in areas with high numbers of federal workers. Also, there is starting to be a trickle-down effect to state and county levels. But now we're starting to see companies announce layoffs possibly in anticipation of lower sales as a result of cooling customer demand and those tariffs. Yet so far, the unemployment rate has barely moved, and jobs numbers have remained above expectations. So at what point does unemployment become a real problem for the economy, or is that not a good metric in this situation?
LIZ ANN: One reminder, and I would have said this in any backdrop, any timeframe, not just tied into a trade policy, that the unemployment rate—it's a widely watched metric of the labor market; it's certainly cited by the Fed quite often—but we have to remember that it is not only the most lagging of all labor market indicators, it's one of the most lagging of all economic indicators. So it's one of the last things to inflect, which is why it's important to focus on leading indicators, specifically the leading indicators that lead a change in the unemployment rate. Everything from layoff announcements, as you mentioned to job openings to initial unemployment claims. So far, we have seen an increase in layoff announcements. We have seen a decrease in job postings that comes from the Job Opening and Labor Turnover Survey. Somewhat benign picture right now with unemployment claims, but we've had more than a few weeks where we've seen a bit of an uptick in claims. That's what I would keep most close an eye on, are the claims data, and not just at the aggregate level, but there's a separate claims metric for federal workers. That saw a huge spike, as you probably remember, in that early phase of the DOGE-related cuts. That has since settled down, but that could see a re-acceleration. You would have to combine that with the traditional initial unemployment claims.
We've had a resilient labor market. There was a lot of concerns about the labor market really weakening in 2022, the last time we really saw elevated recession expectations. And it turned out that the whole notion of labor hoarding was real, and companies, they paired back hours worked, they held off on a lot of new hiring, but they didn't get to the point of significant layoffs. That's what's key to watch at this point. We could see the same thing, where companies are still hesitant to let go of a lot of workers, but you might pick up some of the demand weakness in things like cutting of hours, eliminating new postings, not hiring on a net basis to a significant degree. So that would be an indirect measure of weakness. That is something to keep an eye on.
MIKE: Another big one to watch obviously, GDP slowed in the first quarter, was negative in the first quarter. Now, with the change in tariffs, expectations have shifted to a moderate growth picture, possibly 1%. That's not much, but it's not negative. Is that ringing true with what you are seeing, and what real concerns are out there that could change that outlook?
LIZ ANN: Mike, it rings true somewhat just based on math. The fact that you had a contraction in GDP in the first quarter that was driven by two particular components. You've got the net exports component that goes into GDP, which was a big drag on GDP. Now, we as a country import more than we export. So unless we really accelerate exports and contract imports, we're going to import more than we export. So it ends up being a net negative, and that was the case for first quarter because we saw a huge surge in imports because of a lot of front-running of the tariffs. We also saw a big hit came from the government side of things, government spending, no big surprise there. So you're naturally going to have a bit of a snapback given that so much of that activity was condensed in the first quarter, and that front-running happened.
We also provided probably a bit of an economic cushion by virtue of front-running of tariffs. So you do a major amount of ordering, you get a fairly low-cost basis in that ordering. That builds inventories and takes some of the pressure off in terms of having inventories for the sales cycle. We haven't seen a significant deterioration in the labor market. We already touched on that. That has kept consumer spending relatively healthy. I think consumer spending, which is 68, 69% of GDP, that always holds the key to the success of GDP in any given quarter. I think ultimately, what will tie to whether consumption continues to hang in there is the labor market.
So, much as we touched on in the last question, the labor market holds the key. It holds the key for the economy, it holds the key for consumption, and it even holds the key for Fed policy. So it all really comes back to the labor market.
MIKE: Yeah, as you mentioned, this is what the Fed is keeping its eye on. The Fed obviously left rates unchanged at its meeting in early May, as it has done at all of its meetings in 2025. But it's clear that the Fed is really feeling the pressure of all the uncertainty as well. Fed Chair Jerome Powell said in a speech last week, "A critical question is how to foster a broader understanding of the uncertainty that the economy generally faces." And he went on to talk about the likelihood that we are headed into a time of more frequent and potentially more persistent supply shocks, which will be, in his words, "A difficult challenge for the economy and for central banks." So we talked about unemployment, one side of the Fed's dual mandate. Now Powell is voicing concern for the other side, stable prices, which really just means inflation. So what are the shocks he is referencing, and what impact will they have on how the Fed manages that dual mandate of maximum employment and price stability?
LIZ ANN: Well, supply shocks are a real thing and a real concern, given the nature of the trade war and the fact that it having significantly escalated specific to China more so than other countries, although de-escalated in the past month or so, as we already touched on. To just put it in really practical terms, massive amount of goods are sold in the United States, particularly through retailers like Walmart, that come from China. On average, it takes about 30 days for a container ship of goods to make its way from China to one of the U.S. ports. We've all read stories and seen headlines of significant diminution in the containers that are coming over, those coming over that go back empty. That is literally an ocean liner, not a speedboat. So even if we get further de-escalation, or if tariffs are canceled, to use a very generic word, restarting that process is not going to happen on a dime.
That said, as we already touched on, we did see a lot of tariff front-running. So you have seen many companies stock up and try to build themselves a bit of a cushion. And that might delay the impact on inflation. I also think it gives companies a little bit of flexibility to kind of test the waters in terms of price increases. They have that low cost basis on the inventories that they've accumulated, and now that they can kind of see what might stick, where the tolerance for price increases.
So it could bounce around a little bit, but interestingly, the Fed is the only major central bank that operates on a dual mandate, the labor market and inflation. So they have to keep an eye on both sides of the mandate. And the big question is if we see that stagflationary impulse, meaning weaker on the employment side and higher on the inflation side—it's a chicken-and-egg thing, which is going to come first? And that does put the fed in a little bit of a policy pickle. Most other global central banks only operate with an inflation mandate, and for the most part, countries are facing disinflation, not the concerns about rising inflation, and certainly not the kind of rising inflation expectations that we're seeing in the United States. So they have that flexibility from a central bank perspective to continue in fairly aggressive easing mode, and that sort of further sets the United States apart.
But I think the Fed put themselves in a timeout, so to speak, and at least for the next meeting or two, unless we have a real significant crack in the economy and in particular the labor market, I think for the time being call it the next, I don't know, couple of Fed meetings that I think the Fed stays in timeout mode as they try to gauge the impact on this dual mandate.
MIKE: One of the challenges that the Fed has, and you've talked a lot about this, is trying to sort through what are the real goals here of tariffs. And the president talks a lot about trade deficits, and a couple of things there. The president's been putting tariffs on countries that he feels don't purchase enough from the U.S., but tariffs really can't rectify the fact that another country doesn't need or can't afford often what the U.S. has to sell. And on the flip side of that, as a nation of consumers, a lot of money flows out of the U.S. and into other countries that are making things that we want. So how do you think about that conundrum and the implications that has on the market?
LIZ ANN: It's such an important point, Mike, because when the now infamous big, giant cardboard sign was held up on Liberation Day, there were a wide variety of percentages applied to each country, and it was pretty quickly figured out that it wasn't really reciprocity from a tariff perspective—those were set based on trade deficits with those countries. And to your point, let's just use an example. If you're a small poor country, if you are Bangladesh, or you are Madagascar, and there's a trade deficit with the United States, Madagascar produces a lot of vanilla. We buy a lot of vanilla. Madagascar can't afford to buy what we export to the rest of the world, which is high-value-added, up the innovation chain, more services-oriented. Bangladesh is one of the world's largest producers of jute. We take advantage of that. We buy jute from Bangladesh. They again can't afford to buy anything from us. Not to mention the fact that those two examples—vanilla, jute—it gives those countries an industry. That means that their people, their population, has an industry in which to work. But we shouldn't really expect, let alone try to even trade, because they are poor countries. So that's, I think, one of the reasons why there was so much confusion and at times criticism of tying so-called reciprocal tariffs to trade deficits, because we're not going to even that out.
And then the bigger picture, as you touched on in the beginning of the question, is that when you run a trade deficit as the United States does in the aggregate, the reciprocal of that, or the mirror image of that, is that we have a capital account surplus. So very simply, we import more than we export, which means we send dollars out into the rest of the world when we are buying their goods. Those dollars in the hands of foreigners then have to be put to work. They have to be invested at least short-term. Number one, global trade is still mostly done in U.S. dollars, still about 60%. And those dollars tend to and have been invested back in our securities, our Treasury securities, even our corporate bond securities, our equity securities, such that as of now, about a third of Treasury securities are owned by foreigners, 20% of the U.S. equity market owned by foreigners. So part of the reason that dollars have been re-invested in U.S. Treasuries, not just by domestic investors, but by foreign investors, is that it's the most liquid bond market in the world and perceived to be the safest.
What we're now experiencing in the last month or two are justified concerns about the potential for some capital flight. Even if it's not flight out of our securities, have we lost that important regular buyer, that non-price-sensitive buyer of, say, Treasuries? And that's part of the reason why we saw a lot of volatility in the Treasury market, even more so than the equity market, is just some concerns about, if we're changing the world order, what about this change to the capital account issue?
And then the final thing I'd say is you're absolutely right to point out an uncertainty with regard to what are the ultimate goals, because trade deficits were clearly behind what was announced on reciprocal tariffs. Now, more and more, you're hearing about the benefits of raising revenue via tariffs to offset some of the tax cuts, keeping in mind that, again, tariffs are paid by U.S. companies, which means you're taxing U.S. companies, in essence, to help pay for extending the tax cuts, which were in part for U.S. companies. So it's a little bit circular there. Is it about exacting some sort of trade concessions or deals? If so, then that would mean if you get deals, you would back off of some of these tariffs, which means then you can't extrapolate the current amount of revenues being raised into the future.
So we could go on and on on this part of the conundrum, but I think that there's still uncertainty with regard to goal. And as you know, we hear from companies all the time, "Just tell us what the playing field is, tell us what the rules of the game are, and we can figure out how to navigate around that." And I think everybody's still trying to figure out what are the end goals here?
MIKE: Liz Ann, I think that's such a critically important point, and just the way the tariffs have unfolded have left companies with so many more questions than they have answers. But I want to switch to talk about the stock market because obviously the markets have been on a rapid upswing over the last few weeks. That certainly accelerated when the China tariffs were significantly eased. Things have bounced around a bit, but most of our listeners have undoubtedly noticed the improvement in their portfolios. But I wonder if this rally is sustainable. You are a keen observer of investors sentiment indicators, which seem to show that worries are still there. So are investors confident again, or are they just waiting for the next shoe to drop?
LIZ ANN: To some degree, Mike, I think it's a function of what type of investor are you? One of the interesting things about the sentiment environment is, and you know this is my 40th year doing this, and I've been a four-decade student of investor sentiment, and I literally and figuratively grew up in this business working for the late great Marty Zweig, who was just a pioneer in investor sentiment. He invented the put-call ratio, which is a measure of sentiment, and I'm always quick to talk to people about different buckets that sentiment can fall in. There's attitudinal measures of sentiment, so survey data, kind of like the soft economic data that we touched on. Just asking investors how they feel about the market. That's an attitudinal measure. And then there's behavioral measures. What are investors actually doing. Whether it's picked up in the options market or mutual-fund or exchange-traded-fund flows, allocation, invested exposure moves up and down, those are behavioral measures of sentiment. And at times they can differ, and that has characterized this year. When we were in that sort of crescendo down period in the aftermath of the Liberation Day announcements, but even prior to that, the market had its most recent peak in mid-February and was descending and then really accelerated to the downside when we got those Liberation Day announcements. And sentiment got very, very washed out, at least on the attitudinal side, and that really represented the setup for why then the de-escalation announced on April 9 allowed for that V bottom. And we know the market has become at the mercy of these policy-related announcements. And we also know because we've learned they can come anytime, intraday, via social media post. I think what's important for investors to consider is the setup going into those either positive catalysts or negative catalysts. And I think the setup at the early April lows was, one, that sentiment was sufficiently washed out that you got that de-escalation, and it was enough to cause a V bottom.
The other interesting thing is another way to think about differences in sentiment is these days there's a big difference between older investors and younger investors, and even institutions and individual investors. And one of the interesting dichotomies that's happened is older investors tend to be a little bit more cautious. They're closer to retirement. They get a bit more worried and almost panicky when you have these downturns. The new-ish retail trader, boy, have they become dominant in this market, and they have so stuck with the buy-the-dip mentality. And the most fascinating thing about this V bottom move up off the early April lows is it's got the retail trader fingerprints all over it. So meme stocks doing well again, if you remember that back in 2001. And Goldman Sachs has a basket called retail favorites, done extraordinarily well, beaten the S&P since the early April lows. Non-profitable tech, so some of those high-flyers that are lower in quality, but retail favorites, those of what have done well. So I think from a sentiment perspective, it really depends on who you ask and whether you're measuring attitudes or behaviors.
Where we are now, I think the setup is one where there's maybe not a lot of froth, but a bit of complacency. So the setup is such that were we to get a negative catalyst, it could trigger a bit of downside that wouldn't necessarily happen if the setup was that there was more pessimism, because sentiment acts as a contrarian indicator all else equal. So it's an interesting time.
MIKE: Yeah, your point about the generational gap is so interesting. I often wondered whether the connection for young investors is an environment of legalized gambling on sports, and they've just grown up in a time in which they're just not fazed by ups and downs quite as much as some of us older investors are.
LIZ ANN: Well, not to mention they've got devices in their hands. The ability to trade is at your fingertips at a very, very low cost. Schwab might have had something to do with commissions going to zero. And so yeah, I think it's really fed on itself and grew out of COVID.
MIKE: Well, I want to ask you about one other big piece of news recently. That was the downgrade late last week by Moody's to the U.S. credit rating for the first time for Moody's since 1917. I think a lot of people forget that the other two rating agencies had already downgraded U.S. debt, Standard and Poor's back in 2011 and Fitch in 2023. In announcing its decision, Moody, of course pointed to years of poor fiscal choices—a nice way to put that—made in Washington that have, of course, piled up annual budget deficits, run the national debt to more than $36 trillion. And of course, this was done in the context of the debate on Capitol Hill right now on the "one big, beautiful bill," which will continue to run budget deficits and add trillions to the debt. But investors seemed mostly to shrug off the downgrade announcement, maybe bond investors less so. Is this something ordinary investors should be worried about?
LIZ ANN: Well, frankly, I think ordinary investors have been worried about this a lot longer than it's been sort of day-to-day news. You and I talk about this all the time. At every single client event I've done for years, the first, if not second, question that I get is concern about the deficit and debt, and is there some tipping point. Now I think that the downgrade, but even prior to that, just the wranglings around the budget, and more publication in the public sphere of where the deficit is likely to go inclusive of the tax package that's trying to be passed or the budget package trying to be passed. There's more attention on the debt and deficit, even though I think the investor class has cared very deeply about this for some time.
I think the reason maybe why Fitch's downgrade from 2023 and this most recent Moody's downgrade didn't rattle markets to the same degree as what happened in 2011 when S&P did the downgrade is, number one, S&P was first out of the blocks. That was many, many years ago now, and that was the first time it had happened. So there was that initial knee jerk, "Oh gosh, what does this mean?" But very importantly, at that time, there was grave concern about whether a lot of institutions, pension funds and endowments and foundations that had had a mandate to only own AAA securities were going to be forced into selling. What they ended up doing was really just making amendments to the bylaws, if that's what they're called, and just switching the terminology to investment-grade, as opposed to having an AAA letter mandate. So that's why the Fitch downgrade and the Moody's downgrade didn't lead to many of those concerns, because that problem was sort of nipped in the bud back in 2011.
But it does put a spotlight on something that I think … and it's important to put a spotlight on it because I think constituents—the investor classes cared a lot about this for a long time—constituents haven't cared that much about it, maybe in the abstract, but they don't tend to vote based on it. And if a spotlight becomes brighter and brighter, then it may force some reckoning within both parties of, "OK, how are we going to address that?" And if not, then at some point maybe constituents decide, "You know what? This is something I'm actually going to vote based on." It hasn't happened to-date, and I don't know whether you think that that's going to be the turn, but …
MIKE: Yeah, we'll see. It's been interesting because one thing I have thought for a long time is that the average voter, when you talk about a $36 trillion debt, it's just a made-up number. It doesn't mean anything. And most people, I don't think, really have any idea how or why that connects to their life, their ordinary, everyday life. And so it's just not something you see people on the steps of the Capitol protesting about. I mean, there are people protesting about everything on the steps of the Capitol. And I think there's a big gap there in understanding about whether this matters to me as an ordinary person. At some point, I think it will. And I think you're right that you'll see more constituents, more voters, push their members of Congress to do something about this. But I've thought that for a long time.
LIZ ANN: Not to mention action in the markets. I mean, we did see a significant scare in terms of big pop-up in yields, and I think there's going to be a lot of attention on the messages from the bond market about sustainability of our fiscal situation.
MIKE: I want to get your take, obviously, on where investors should go from here. But before we do that, I also want to ask you about corporate earnings because there's been an interesting thing going on in earnings calls recently, which is companies are clearly becoming more and more reluctant to offer forward guidance. And I think that is another symbol of the overall uncertainty here. So what do you expect going forward from companies in earnings and valuations and how companies are going to be thinking about that?
LIZ ANN: You're right to point out the withdrawal of guidance. The last time we saw it, to a more significant degree then, was during the early part of COVID for somewhat obvious reasons. Companies that might've otherwise or typically provide guidance a quarter out, two quarters out, three quarters out to the analysts covering their companies, they might guide up, which just means that they might tell analysts, "Hey, the estimates you've published seem a little low. We think we're going to do better than that," or vice versa. Trying to provide guidance in the early part of the pandemic was just a fool's game. So you saw a record number of companies withdraw guidance. We don't have a record number of companies withdrawing guidance, but we have a rising number of companies, and some pretty high-profile companies have opted to do that, or done scenario analysis, which is under certain circumstances, you know, continued de-escalation in tariffs if they're impacted by tariffs, "We were on track to meet the consensus estimates. But under a more deleterious backdrop, recession-type backdrop, your estimates are 50% too high." I'm just throwing numbers out there. So it is an uncertain time, and that's being reflected in the analysis of companies.
Interestingly, we basically completed first-quarter earnings season, which was better than expected. We ended up with about 14% earnings growth. That was well better than what was expected at the beginning of the year. But maybe most interesting is that there's been no extrapolation of that into the latter part of the year, meaning the remaining three quarters. So at the beginning of this year, estimates were that 2025 calendar year earnings for the S&P 500 would be up close to 15% year-over-year. Now that's down to 8%. So even with the first quarter in the bag at a much healthier than expected reading, you are not seeing analysts say, "Oh, that bodes well for the rest of the year," because of course that was first-quarter earnings only through March, so in advance of Liberation Day and the aftermath of all of that.
So it does tell you that companies' guidance, as well as analysts, are still on the cautious side. That may mean, ultimately, the bar has gotten set sufficiently low. But we're now looking based on consensus at a year that will have lower earnings growth than last year. My line I always like to say, sometimes better or worse can matter more than good or bad. So if 8% earnings growth, that's not a bad backdrop, if it's accurate, but down from 12% in 2024. So it's that trajectory.
And then valuations, prices having come down during the corrective phase, put downward pressure on multiples, P/E ratios. That was a good thing. The problem is that the earnings estimate, the E, was also coming down. So we didn't make a lot of headway. And now with the reversal back up in the stock market, without the earnings having improved, the market has become expensive again because you're not seeing earnings do that heavy lifting. It's just been multiple contraction and then multiple expansion. So we yet again have a bit of a valuation problem.
MIKE: Well, Liz Ann, you and I have covered a ton of ground in this conversation. I think we have to get to the question on every investor's mind, which is, "What do I do now?" What do you see as the important takeaways for investors in this environment?
LIZ ANN: So in terms of anything percentage-wise, what kind of exposure should I have? Should I be adding to areas or trimming from areas? That's always a function of who the investor is, and where they sit on the risk spectrum, and their tolerance for risk, and need for income, all of those individual facets. But I'd say that one of the things that happens when you go through a volatile period, it hopefully reminds investors of the power of the disciplines we espouse all the time. Diversification across and within asset classes. That would have meant having a bit more international exposure. If you had done rebalancing and heeded the message of wanting to be diversified, international has handily outperformed the U.S. this year. It would have helped you maybe avoid the concentration in areas like the Magnificent Seven group of stocks. For those that didn't do that, what to do at this point? Well, it's never a bad time to assess your portfolio, how that compares to your risk tolerance. Sometimes we learn the hard way during tough market environments that maybe our emotional risk tolerance and our financial risk tolerance are not quite the same.
Now, to think about what to do within the equity portion of portfolios, which is my bailiwick, we think you still want to stay up in quality. That's been Kathy Jones' message on the fixed income side. It's our message on the equity side. Don't try to make big sector bets. Try to invest in high-quality companies that have stable profit margins and a positive earnings outlook, strong balance sheets. Really kind of hug that quality. It gives you a bit of an anchor to windward in an environment where we could still see a lot of swings. Don't let FOMO get in your way. Don't let panic get in your way. Neither are investing strategies.
MIKE: Great advice, as always, Liz Ann. Well, I've really enjoyed this conversation, really appreciate you taking the time to talk today.
LIZ ANN: Thanks, Mike. It's always a pleasure to be here.
MIKE: That's Liz Ann Sonders, chief investment strategist at Charles Schwab. You can follow Liz Ann on X, formerly Twitter, @LizAnnSonders. And be sure to sign up for her great podcast with our colleague Kathy Jones, On Investing. It comes out every Friday, and you can find it on Apple Podcasts, Spotify, or wherever you get your podcasts.
Well, that's all for this week's episode of WashingtonWise. We'll be back with a new episode in two weeks, when I'm going to focus on the ever-changing landscape of financial fraud and what we can all do to protect ourselves.
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For important disclosures, see the show notes or schwab.com/WashingtonWise, where you can also find a transcript.
I'm Mike Townsend, and this has been WashingtonWise, a podcast for investors. Wherever you are, stay safe, stay healthy, and keep investing wisely.
