A Choppy Start

Quick Take: Stocks finished January higher in a topsy-turvy start to the year amid volatility in the technology sector.[1] Bond yields declined (prices higher) but remain elevated.[2]

Stocks rose to kick off the year, despite a tech sell-off sparked by China’s advances in artificial intelligence (from startup DeepSeek), followed by tariff announcements. [3] Just as tech names had started to recover, the White House announced 25% tariffs on Canada and Mexico and 10% tariffs on China, providing stock markets with a headwind to end January. [4]

Despite ending the month on a weak note, major stock averages still managed a strong advance to start 2025, with the S&P 500 up 2.7% and the Nasdaq up 1.6%.[5] The S&P even logged another record high, surpassing the 6,100 milestone late January as investors anticipated pro-growth measures from the new administration.[6]

Source: https://www.bloomberg.com/news/articles/2025-01-22/stock-market-today-dow-s-p-live-updates

Treasuries finished the rollercoaster month higher, with the Bloomberg index of Treasury prices up around 0.6% near the end of January.[7] Having slumped in December and the first half of January, bond prices reflected concerns that inflation could reignite from steep tariffs and trade tensions.[8] The fact that tariffs weren’t implemented on Day 1 of the new administration gave markets some relief, and cooler inflation data along with a tech sell-off attracted safe haven flows to the bond market.[9]

DeepSeek Surprises Markets

Equity markets had powered to another record in part because of hype from $500 billion in planned investments, as President Trump declared the US the global AI leader.[10] A week later, Chinese startup DeepSeek unveiled an AI platform that appeared to rival anything on the market — at a fraction of the price and energy consumption. The emergence of DeepSeek’s AI model raised questions about whether the hundreds of billions in AI investments could return enough profits to justify the rich megacap stock valuations. These megacap tech stocks now account for 30% of the S&P (more than at any time in history). [11]

Source: https://www.reuters.com/technology/tech-stock-selloff-deepens-deepseek-triggers-ai-rethink-2025-01-28/

This sudden challenge to US AI dominance shook markets, prompting a $589 billion plunge in the market value of chipmaker Nvidia, the biggest one-day wipeout in corporate history.[12] During the rout, the tech-heavy Nasdaq quickly erased its gains for the year.

As the dust settled from the initial knee-jerk reaction, battered tech names staged a comeback in the following session.[13] There seemed to be the sense that some of the sell-off could have been overdone. The claims that DeepSeek built their platform with a much lower cost still needs to be substantiated. Also, DeepSeek’s AI model is open source, which means that its source code is freely available on the web for modification and reuse.[14] The advancement in technology is arguably positive for general AI adoption.

Source: https://www.blackrock.com/corporate/literature/market-commentary/weekly-investment-commentary-en-us-20250203-ai-mega-force-could-be-accelerating.pdf

Taking a step back – large capital spending has the potential to unlock further innovation in AI. Strong earnings results and guidance from the magnificent seven stocks have established that they can support heavy AI expenditures.[15] Already, the investment surge is hundreds of billions of dollars, a staggering expenditure that rivals all of US government research and development spending.[16] The hope is that all of this investment can broaden the set of AI beneficiaries and generate further revenue streams. For now the market seems to be focused on a select few, driving up valuations.

Equities in Demand

High valuations might trigger greater sensitivity of stocks to sensational headlines. While there are a few different measures used to quantify stock valuation, one measure is the equity risk premium. This is essentially the additional reward that equity investors receive for holding stocks over government bonds that offer a fixed income stream.

Source: https://www.ft.com/content/f8b6dbb5-eb9b-4639-b72a-e7c9b2925bb3

Compared to government bonds, US equities have become more expensive than at any time since the dot com era.[17] The additional compensation investors require for the risk of holding stocks dropped into negative territory in January, something which hasn’t happened since 2002.[18] Even with bonds offering relatively high yields, investors seem still content to hold stocks. The flows substantiate this — $62.5 billion poured into US equity mutual funds and ETFs in December, which was the highest monthly inflow on record according to Morningstar.[19]

Fed On Hold

On the monetary policy front near month end, the Federal Reserve (Fed) left its benchmark interest rate unchanged after three cuts last year, noting a stabilized unemployment rate (4.1%) and “solid” job market while inflation “remains somewhat elevated.”[20] Such a prognosis is more likely to support fewer rate cuts up ahead. The market is pricing in a less than 20% chance that we’ll see a rate cut in March.[21]

Source: https://finance.yahoo.com/news/bonds-gain-january-trump-return-122828965.html

Strong economic growth has kept longer-term interest rates elevated. Recently the benchmark 10-year Treasury yield went above 4.8%, its highest level since 2023.[22] This leaves mortgage rates stretched, as the average rate on a 30-yr mortgage hovers just below 7% after increasing for five straight weeks.[23]

Expectations of generally higher interest rates have meant that longer-term Treasury yields remain above (prices lower) September levels, when the Fed began cutting rates.[24]

What’s Next

Looking ahead to February, the corporate earnings results season continues.[25] So far, S&P 500 Q4 earnings year-over-year looks to have increased 13.2%, which would be the highest growth rate since Q4 of 2021.[26] While tech volatility might still be a feature in the coming months, the first batch of large cap results seemed to provide some reassurance for investors who believe the AI growth story remains intact.[27] Meanwhile, policy changes may trigger further unpredictability  — 25% tariffs on Canadian and Mexican goods have been put on hold, while China has responded with retaliatory tariffs to take effect Feb 10.[28]

The market journey in January reinforces a timeless lesson: headlines ebb and flow with a forceful capacity to move markets. New events may sway markets, but your financial strategy is designed for the long run. A diversified, goal-oriented approach helps you stay on track, even through periods of uncertainty.

As we reflect on the market, we also recognize that many in our community are facing sobering challenges. The hardship and tragic loss of homes, livelihoods, and lives weigh on us from the Los Angeles wildfires. Recovery and rebuilding take time, and we are reminded of the importance of resilience and support. Communities are strongest in the face of adversity.

We are here for you and value the opportunity to offer our support – please don’t hesitate to connect with us.

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