Market Recap – January 2025: It was a very interesting month, as the market navigated a slew of headlines that, at first glance, seemed to be potential negative game changers for the market. 1) Threat of tariffs, and 2) Ramifications of DeepSeek. Yet, the market continued to rally, after a very strong 2024, as corporate earnings remained strong. The market saw a broadening out in returns, as the stocks that performed well last year underperformed in January, and vice versa. Even International performed well, but, fitful rallies occur, and we need to be reminded of the fundamental story. The market is expecting US GDP to grow at 2.6%, core inflation ending at 2.5%, and S&P earnings growth of 14%. Now stack those against Europe, where GDP is expected to grow just 0.8%, core inflation ending at 2.3%, and EuroStoxx earnings growth of 3%. Overall, January 2025 was characterized by cautious optimism, with markets navigating a delicate balance between economic growth potential and inflationary concerns. Investors continued to monitor central bank policies closely, as interest rate movements and fiscal measures remained key drivers of market performance for the year ahead.
DeepSeek and the Ramifications: The question that the market is trying to decipher is this: Are we going to start witnessing the transition of “Performance-at-all-Cost” to “Optimization“. Here are our knee-jerk reactions to market ramifications:
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- A lot of the sell-off was focused in the areas of the market that have witnessed the largest earnings growth potential or valuation expansion based off of the AI-narrative trade. This tells me that there was a liquidity event where a lot of heavily leveraged players became forced sellers. Meaning that the market weakness may not be a structural narrative shift.
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- Only the AI-focused names were hit the hardest – the rest of the market did fine. In fact, on the day that DeepSeek was announced, over 70% of the S&P 500 were positive. This means that the market has not given up on the AI story. It’s only questioning the amount of capex needed for many of these companies to create efficiency from AI, negating some potential spending in the future (i.e., one company’s capex spend is another company’s revenue). But, the rest of the market responded well, meaning that the market continues to understand the new technology as a way to create more efficiencies for the average company, which should be the largest beneficiary of AGI.
Are Tariffs a Bearish Gamechanger? Not yet. Clearly this is an incremental negative because it’s another case of one of the bullish forces in this market being removed or sidelined. Since December, investors have seen several bullish factors negatively impacted. First, the Fed’s “hawkish cut” in December put a pause on the table and removed the idea of consistent rate cuts. Second, the DeepSeek news dealt a potentially serious blow to AI enthusiasm, so the market may be losing upside momentum from the largest and most important market sector (tech). Now, the market is losing the expectation for pro-growth policy from Washington. Now, tariffs are a not bearish game changer or a reason to reduce equity exposure today because earnings and economic growth (the two most important foundational forces for stocks) are still solid. But the factors that push stocks higher are being weakened or eliminated one by one and the factors that could push stocks lower are being increased and that’s a potential problem for a market so richly valued.
Fed Update: At the beginning of last year, the terminal rate was expected to be ~3.0%, but with the inflation proving to be stickier, and the potential remaining for a re-acceleration, the bar has shifted to a level closer to ~3.8%. Put differently, while fewer-than-expected rate cuts are a disappointment in the near term compared to market expectations, the facts tell us that the rate-cutting cycle is still in place, and, as a result, Fed policy remains supportive for stocks – maybe just less than before.
The Burden of Proof Remains with the Bears: Put simply, while the economy is slowing, the news has not been bad enough yet to cause a sustainable decline in stocks. The Fed’s easing cycle, coupled with “OK” macroeconomic data, has kept earnings forecasts steady.
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- What Bears are Saying: Rising unemployment, weak ISM Manufacturing PMI, and negative earnings guidance hint at challenges ahead. Concerns also include political uncertainty (domestic and global) and geopolitical risks (Russia/Ukraine, Israel/Hamas).
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- What Bulls are Saying: 1) Still “ok” economic data—slowing, but not alarmingly so, 2) The initial market rally due to anticipated Fed rate cuts, 3) Earnings growth, still strong at over 10% year-over-year, and 4) Optimism around AI advancements.
First Year of a New Presidential Cycle: Until recently, it was a decent bet that the second half of a President’s term would be better for market performance than the first. Generally speaking, Presidents would make the hard decisions when their political capital was at its highest and then let it rip as they sought re-election. All that seemed to change with the election of President Obama, the introduction of QE, and the budget deficits that accompanied it. Since 2005, the best year for market returns has been the first year of a Presidential term – and it’s by an enormous margin.
Politics and Markets: The market is not political. It doesn’t care about political retribution, woke or anti-woke campaigns, or DEI initiatives. The market only cares about policies that:
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- Increase (or decrease) earnings, and
- Support growth (or hinder it).
Any political movement or agenda that is viewed by the market as getting in the way of better earnings and growth will be viewed as negative and be a headwind on risk assets, regardless of whether those policies are from Republicans or Democrats. This is the way we must view political coverage over the next year (and likely four years) and this will help us cut through the noise and stay focused on the policies that will impact markets.
S&P 500 EPS: ’25 (Exp.) EPS = $275. ‘24 EPS = $239 (+15.1%). 2023 = $220 (+8.6%). 2022 = $219 (+0.5%). 2021 = $204.*
Valuations: S&P 500 Fwd. P/E (NTM): 22.1x, EAFE: 14.6x, EM: 11.9x, R1V: 17.2x, and R1G: 28.8x. *
*Source: Bloomberg and FactSet, Data as of 1/31/25
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The S&P 500® is widely regarded as the best single gauge of large-cap U.S. equities. There is over USD 11.2 trillion indexed or benchmarked to the index, with indexed assets comprising approximately USD 4.6 trillion of this total. The index includes 500 leading companies and covers approximately 80% of available market capitalization.
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