DeepSeek Raises Questions
While the markets remain positive for the year, this week some cracks appeared as technology companies fell on news out of China. Aside from this surprise, the week was filled with earnings announcements and economic data, including the fourth quarter GDP. Earnings remain strong, with guidance being positive for the most part. Additionally, economic growth and labor strength continue to indicate a robust economy that doesn’t appear to be slowing much, if at all. While volatility and uncertainty remain a fixture, for now, the underlying picture shows resilience.
The big surprise this week was delivered by a Chinese AI startup named DeepSeek, which has allegedly been able to develop a highly competitive large-language model for what has been quoted as less than $6 million. For reference, Microsoft and Meta are each planning to spend over $60 billion on AI this year alone. I say allegedly because the claimed cost may not completely reflect the resources that went into building this new model, and there are allegations that it was trained using OpenAI’s data. However, the model does exist and has apparently been verified. This is a game changer and calls into question whether U.S. companies are overspending. Regardless, this innovation could spark the next leap forward for AI as U.S. companies incorporate some of these new methods into their own models. While the markets were clearly concerned by this development, you could look at it as having the potential to supercharge this space in the coming years.
While the technology sector has clearly been an important driver of market performance for the past few years, broadening earnings growth has contributed to a rotation in market leadership. Over the past six months, the consumer discretionary, communication, financial, and industrial sectors have outperformed the technology sector. We expect market performance to continue to widen beyond technology stocks as investors look toward investments with more domestic exposure and potential for earnings growth and valuation expansion.
Perhaps the second biggest news event this week was that the Federal Open Market Committee (FOMC) concluded its January meeting, maintaining its target range for the federal funds rate at 4.25%-4.5%. The Federal Reserve also made no change to its balance-sheet-reduction program, known as quantitative tightening (QT). To be clear, no one expected the Fed to cut rates at this meeting. The Fed has suggested it may cut rates twice this year, while the market is hoping for one rate cut. In truth, if inflation does begin to show signs of heating up, any rate cut this year may be off the table. If you are a saver, in retirement, or depend on interest income, you’re in luck. However, if you are younger and perhaps need to borrow to buy a home or a car or are a startup business that needs a loan, you aren’t going to be as happy about things.
As I mentioned in the intro, the third piece of news that moved markets this week is the first reading for fourth-quarter GDP, which showed that the U.S. economy exited 2024 on strong footing. Real GDP grew 2.3% annualized in the fourth quarter and 2.8% for the year. Looking into what drove this growth, we find that personal consumption was responsible for the lion’s share, expanding at a 4.2% annualized rate. Healthy labor-market conditions and moderating inflation (eggs aside) should help extend the economic expansion into 2025.
Having painted an optimistic picture, I’d be remiss if I didn’t mention the potential 25% tariff on Canada and Mexico that could begin tomorrow. President Trump has again reiterated his concerns over border security as the primary reason behind the tariffs. Universal tariffs would put upward pressure on inflation and could spark retaliatory tariffs on U.S. goods into Canada and Mexico. Canada accounts for roughly 60% of U.S. crude oil imports in 2023, with about 24% of U.S. refinery throughput coming from Canadian crude oil imports. If key imports such as energy and automobile parts are exempted, there would likely be a more limited impact.
In closing, I came across an eye-watering number that had me wondering. It seems that the cost of advertising during the Super Bowl has reached a new all-time high at $8 million for a 30-second spot. Over 123 million people tuned into the Super Bowl last year, making it the most-watched U.S. broadcast on record. I imagine companies wouldn’t spend that kind of money if they didn’t expect a return on their investment. Then again, we all remember this Pets.com ad or perhaps this one shortly before the company went under. Anyway, aside from the usual cast of characters, be on the lookout for some newcomers, including Coffee Mate, Instacart, Haagen-Daz, and Ritz. And in case you aren’t a football fan, the Super Bowl is on February 9th. Now you know.
Bruce J. Mason, MBA