Weekly Investment Perspective

After closing out another strong week of gains last week that pushed the S&P 500 to a new all-time high with a 1.8% advance, major U.S. equity indices are pulling back in this week’s early trading driven by a plunge in tech stocks levered to AI enthusiasm. Late last week, a Chinese AI startup called DeepSeek released a powerful and highly cost-efficient new AI model that has cast uncertainty on the payoff of billions of dollars being plowed into AI chips and data centers by U.S. firms. The S&P 500 and the tech-heavy Nasdaq are under the most pressure due to their higher weight to tech giants like Nvidia that have soared over the last year, while the Dow Jones and small cap stocks are holding up better.

Regarding the recent AI development, DeepSeek’s new AI model matched the performance of leading models from U.S. firms like OpenAI’s ChatGPT but with much greater cost efficiency. The Chinese firm has had to work around constrained access to leading AI chips like Nvidia GPUs due to tightening trade restrictions, and this model shows impressive ability to do more with less computing power. In response, tech stocks serving as the picks and shovels to the AI investment boom are selling off as the development injects uncertainty into expectations for ever-increasing capital investment into ever-growing AI data centers. While the sell-off takes some air out of the AI frenzy that had reached frothy levels, there are also many positives to the implications of much more cost-efficient AI models that drive greater innovation and adoption of AI applications. With that backdrop, this week’s quarterly earnings calls will take on even more investor scrutiny as several tech giants are on the docket including Microsoft, Meta, and Apple.

The tech sell-off comes on the back of a busy first week in office for the Trump Administration. On his first day in office, President Trump signed a record 26 executive orders, more than any other administration in history. From a macroeconomic perspective, these new orders focused on four key areas – energy, immigration reform, tariffs and technology. While the new policy proposals were in many cases more measured than anticipated – which was welcome by stock markets –expect bouts of market volatility ahead as new policy updates are released.

Stepping back from the headlines on policy developments and AI uncertainty, the fundamental picture looks to be on firm footing with a strong start to fourth quarter earnings season. Earnings expectations rose slightly as the second week’s batch of quarterly results came in. As of Friday, fourth-quarter net income was expected to rise by 12.7% compared with the year-ago quarter, based on S&P 500 companies that have already reported plus projections for those that haven’t yet released results. Such an outcome would mark the highest quarterly earnings growth rate in three years, according to FactSet.

In economic news, U.S. consumer sentiment weakened in January for the first time in six months, based on Friday’s reading from a University of Michigan survey. Relative to the previous month’s survey, growing numbers of participants said that they expect inflation and unemployment will rise this year.

High interest rates continued to weigh on the U.S. residential real estate market in 2024, as the National Association of Realtors on Friday reported that existing home sales fell to the lowest full-year level since 1995. Last year’s total of 4.06 million home sales was down less than 1% from 2023’s total.

It’s widely expected that the U.S. Federal Reserve will keep interest rates unchanged when it concludes a two-day meeting on Wednesday, although post-meeting comments from Fed Chair Jerome Powell could move markets. The Fed cut rates a full percentage point in its final three policy meetings of 2024, but the outlook for further cuts has been clouded by mixed readings on inflation.

Thursday’s scheduled release of the U.S. government’s initial estimate of fourth-quarter GDP is expected to show that the economy remained on a solid growth track. The pending result will follow the 3.1% annual growth rate that the economy posted in last year’s third quarter and a 2.0% figure in the second quarter.