With the new Presidential administration, AI developments from China, Federal Reserve policy, and recent tariff announcements, there is no shortage of discussion points in the market. Despite the tumultuous environment, the markets had a solid January. The S&P 500 advanced 2.7%, bonds inched higher, and even international stocks advanced. The majority of our client questions center around AI developments and impact of tariffs on the market.
The threat of tariffs has been well known by the market for several months. It is built into our outlook for a choppy year with modest returns. Recent announcements do not call for a change of strategy. Still, it is logical for the market to decline somewhat on tariff announcements. They raise uncertainty, which leads to lower prices, all else equal. We note that the recent tariffs are explicitly aimed at reducing fentanyl trafficking. This is in direct contrast to the 2018/2019 tariffs which were done in pursuit of “fair trade” and narrowing the trade deficit. This raises the odds that a compromise will reached to reduce the economic impact of tariffs. Also, in the context of a nearly $30 trillion US economy in which 70% of GDP is spent on services, the effect of trade is contained. Simply put, we do not think that tariffs will lead to a recession or a bear market.
News of the Chinese AI model DeepSeek roiled the market last week. The model was reportedly trained on less expensive and less energy-intensive chips than what leading US AI models use. The implication is negative for companies that provide AI infrastructure – chips, power, electric grid infrastructure, etc. However, most of the companies in the market are AI users. For them, and thus for the overall market and economy, cheaper and less energy intensive AI is unequivocally positive. Longer term, we think cheaper AI, and thus quicker widespread adaptation, is ultimately a good thing for the AI infrastructure companies as well. We plan to discuss this topic in more depth on our Mid-Month Market call on February 12th.
In other developments, corporate earnings season is off to a good start. 77% of companies have beaten estimates so far, and the blended growth rate is currently expected to be 13.2%, according to data from Factset. Remember that the stock market is 98% correlated to the direction of earnings over time, based on analysis from Dwyer Strategy. Bond yields have declined slightly from their highs, and we still think bonds are attractive. On the technical front, the market rally in the 2nd half of January was based on broad demand and a contraction in supply. The weight of the technical evidence remains positive. We expect continued choppiness and occasional declines during the year, but the evidence still suggests the market is in a secular bull market with years left to run.
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