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WEEK AHEAD
Feb 3-7, 2025
At the end of January, our tactical models remained balanced and fully invested in positive technicals and momentum. With the recent tariff developments, uncertainties and volatility are expected to be on the rise.
The S&P 500 stumbled through a volatile week, shedding 0.99%, its footing shaken by an unexpected contender from across the Pacific. On Monday, markets recoiled at news from DeepSeek, a Chinese upstart that lobbed a proverbial grenade into the artificial intelligence arena. Its open-source large language model, crafted at a budget-friendly $6 million in just two months, rattled nerves from Silicon Valley to Wall Street. Nvidia, the poster child of the AI boom, bore the brunt, plummeting 16.9% in its worst single-day performance since March 2020. The sell-off rippled through tech corridors globally, raising existential questions about America's dominance in AI.
Meanwhile, domestic policy offered its own brand of turbulence. The Trump administration unveiled a "deferred resignation" program, enticing federal employees to exit stage left by February 6, amid a broader push for five-day office returns and leaner bureaucracies. Over in the marble halls of the Federal Reserve, the FOMC chose to hold rates steady, an unsurprising yet sobering reminder that inflation remains a stubborn guest at the economic table. The PCE Price Index rose 0.3% month-over-month, translating to a 2.6% annual increase—still a few ticks north of the Fed's 2% sweet spot. Jobless claims painted a picture of resilience, with initial claims falling to 207,000 and continuing claims dipping to 1.858 million.
The broader economy flexed its muscles as GDP clocked a 2.3% annualized growth rate in Q4, wrapping up 2024 with a 2.8% gain, just a whisker shy of the previous year's 2.9%. Consumer spending surged 4.2%, proving that American wallets remain delightfully loose. Even Treasury yields played along, with the 10-year yield easing by five basis points to 4.58%, despite the Fed's rate freeze. Ever the speculative creature, the market still whispers of one to two modest rate cuts in 2025. In a week of global tech jitters and domestic fiscal posturing, the only constant was uncertainty—a familiar bedfellow for markets and policymakers alike.
In a testament to the market's resilience, the S&P 500 shrugged off a volatile backdrop to close January with a robust 2.78% gain. The charge was led by strong corporate earnings and buoyant consumer spending, which painted a picture of economic vitality despite macroeconomic headwinds. Significantly, the S&P 500 Equal-Weighted Index outpaced its market-cap-weighted counterpart, climbing 3.5% and outperforming by 77 basis points—a signal that market breadth may be widening in 2025, in stark contrast to the narrow leadership of 2024.
Mid- and small-cap stocks flexed their muscles, with the Russell Mid-Cap Index surging 4.4%, suggesting that investors are diversifying beyond the familiar safe havens of large-cap giants. Sector performance told a story of rotation: Communication Services, Health Care, and Financials led the pack, while Information Technology stumbled, down 1.1%, burdened by AI-related concerns that weighed heavily on stalwarts like NVIDIA, Microsoft, and Apple.
Meta Platforms stole the spotlight among the market's titans, soaring 17% in January. The social media behemoth reported a staggering 50% earnings growth, with EPS hitting $8.02 and revenue climbing 21% to $48.38 billion. However, investors blinked at Meta's 2025 operating expense forecast, which landed well above expectations.
JP Morgan also had a banner month, gaining 12% as it unveiled fourth-quarter net income of over $14 billion, a 50% year-over-year surge that handily beat Wall Street forecasts. The bank's robust profit and revenue figures underscored the strength of the financial sector amidst shifting economic tides.
Amazon rounded out the roster of standout performers with an 8.3% gain, fueled by robust consumer spending and optimistic sentiment ahead of its eagerly anticipated fourth-quarter earnings report on February 6. In a market environment where resilience meets recalibration, January's performance suggests that investors are both confident and cautiously opportunistic as they navigate the road ahead.
As we approach a week laden with earnings reports from industrial and bellwether companies, investors are poised to navigate the choppy waters of market volatility. In a move that has left markets bracing for impact, President Donald Trump officially declared a tariff war on Saturday, imposing tariffs of 10% on all imports from China and 25% on those from Mexico and Canada. Notably, energy imports from Canada, including oil, natural gas, and electricity, will face a 10% tariff. The task at hand will be to decipher the short- and long-term implications of these tariffs, balancing immediate market reactions against the broader economic landscape.
"At all times forecasts are conditional at a minimum on just a set of expectations, and they're highly uncertain in both directions. We know that economic forecasting is really difficult, beyond just a month or two out. So, in the current situation, there's probably some elevated uncertainty because of significant policy shifts in those four areas that I mentioned: tariffs, immigration, fiscal policy, and regulatory policy. So there's probably some additional uncertainty, but that should be passing, we should go through that. And then we'll be back to the regular amount of uncertain so, what forecasters are doing, not just us, but everybody's doing is they've got sort of just a set of assumptions about what might happen, but they're really kind of in the nature of a placeholder."
—Chair Powell's FOMC Press Conference, January 29, 2025
DeepSeek & AI: Evolution, Not Disruption
Key Takeaways
Your OCIO office has naturally been following this story with great interest; it touches not only US stocks in this space, but also China and the rest of emerging markets, which are full of stocks exposed to the AI theme—and not just chipmakers, but many others in the broader supply chain including those making components for data centers. We want to share our initial thoughts with you here. As an advisor that runs strategies in both developed and emerging markets, we offer what I hope you'll consider a balanced perspective on this hot topic.
First, based on the process by which DeepSeek built and trained its model—while they undoubtedly did a number of clever and very cool things to achieve the efficiencies they're reporting—their approach has been hyped a little too much, in our view. For one thing, there are legitimate questions as to how low training costs truly were and how much they leaned on incumbents like OpenAI to develop their own model. It seems very unlikely to us that their model will supplant those developed by OpenAI and others in the space. Still, expecting models like DeepSeek's to proliferate over time seems very reasonable. That's actually how technological revolutions like this usually play out, with first-movers overcoming the big, expensive obstacles and smaller, scrappier players eventually riding their coattails to their own breakthroughs.
Along those lines, however, there's an important corollary. Suppose you've been reading about DeepSeek in the media. In that case, you've probably seen references to the 'Jevons paradox': the notion that as a resource becomes more efficient to use, demand for that resource may actually increase. This is the right way to think about how AI usage will play out in the face of DeepSeek and similar advances that inevitably hit the market. In short, it's early innings in terms of how AI will be utilized, and the demand for chips will not majorly weaken. Fundamentally, we don't believe DeepSeek is a threat to the AI theme.
But another angle to this story is also worth considering: Is DeepSeek a threat to AI theme stocks? Our Chief Research Officer, Dr. Phil Wool, spoke with Reuters recently about that, and they kindly published some of his comments here. As mentioned, DeepSeek will not fundamentally hurt the AI supply chain in the long run. Still, we believe this saga that unfolded over the last week has further exposed how expensive US tech has become—i.e., how much of that fundamental growth is already priced in. But this has also been obvious to anyone watching Mag 7 earnings over the last few quarters, where companies often 'beat' and the market is still disappointed because expectations have gotten so high. Investors are becoming increasingly skeptical about the crazy AI capex these companies are doing, which is continuing indefinitely.
So, it's clear there was a massive amount of growth being baked into the price of companies like Nvidia and ASML, which means there's little margin for error when any potential threat to those assumptions emerges (and DeepSeek isn't the only threat—US containment of China's chip demand is another big one). I think the upshot for investors is that it pays to be active, do research, and be more selective in this theme. As a firm that runs both US and EM strategies, we truly believe there are much better opportunities within the emerging markets to buy stocks at much better valuations that will continue growing as the data center buildout continues unabated. We expect EM to outperform DM over the next decade, and this is one of the channels through which that happens: relatively cheap EM tech catches up with its relatively expensive DM counterpart.
Advisory services offered through Sowell Management, a Registered Investment Advisor. The views expressed represent the opinion of Sowell Management. The views are subject to change and are not intended as a forecast or guarantee of future results. This material is for informational purposes only. It does not constitute investment advice and is not intended as an endorsement of any specific investment. Stated information is derived from proprietary and non-proprietary sources that have not been independently verified for accuracy or completeness. While Sowell Management believes the information to be accurate and reliable, we do not claim or have responsibility for its completeness, accuracy, or reliability. Statements of future expectations, estimates, projections, and other forward-looking statements are based on available information and Sowell Management’s view as of the time of these statements. Accordingly, such statements are inherently speculative as they are based on assumptions that may involve known and unknown risks and uncertainties. Actual results, performance or events may differ materially from those expressed or implied in such statements. Investing in securities involves risks, including the potential loss of principal. While equities may offer the potential for greater long-term growth than most debt securities, they generally have higher volatility. International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles, or from economic or political instability in other nations. Past performance is not indicative of future results.