Highlights:
- The S&P 500 rose 2.8% in January, driven by strong 2024 tailwinds and optimism for continued economic growth in 2025. Real GDP finished at about 2.8% for 2024 and is expected to be another 2-3% in 2025.
- Q4 corporate profits grew 13% year-over-year, the job market remained solid, consumer spending held strong, and manufacturing showed signs of recovery.
- U.S. technology stocks involved in the race to develop artificial intelligence faced a new challenger in January after Chinese-based DeepSeek AI unveiled a new artificial intelligence application, allegedly developed at a fraction of the cost of America's competing technology.
- Tariff policies, immigration crackdowns, and executive actions are adding economic uncertainty, with the Fed balancing inflation, employment, and potential rate cuts.
The tailwinds of a strong 2024 combined with optimism for 2025 gave the stock market a broad boost in January, with the S&P 500 Index up 2.8%. Real GDP growth for 2024 is now projected at about 2.8%, well above the long-term trend of 2%, and for another year of 2%+ growth in 2025. Fourth quarter S&P 500 corporate profits showed a robust 13% year-over-year growth rate. The job market remained solid, consumer spending held strong, and manufacturing, long in contraction, began to slowly work its way back to growth. One contrast to the preceding year was the January decline of Nvidia in the wake of the unveiling of the Chinese-based DeepSeek AI app, which was allegedly developed using older versions of Graphic Processor Units (GPUs) and calls into question the spending needed on high-end GPUs that contributed to Nvidia’s ascent over the past two years. DeepSeek’s announcement may be the catalyst that drives closer scrutiny of return on investment from the capital spending of the other Magnificent Seven mega-cap technology stocks, who collectively have announced plans to spend over $200 billion on development of artificial intelligence in 2025, with a significant portion of that amount spent on GPUs, with little clarity on when this spending will lead to demonstrable profit increases.
One of our takeaways from January revolves around 2025 volatility. While rapid upside market advances are generally welcomed, they can often be followed by the opposite. One need look no further than the current administration's fickle approach to imposing punitive tariffs, which not only have long-term, often unpredictable consequences for the economy, but create uncertainties that can immediately dampen corporate and business activities and expansion plans. Likewise, the crackdown on undocumented workers holds the potential to expose cracks in what has been a positive supply and demand in the labor market.
From their current, if imperiled, perch of independence, the Federal Reserve Chairman and Board must assess the traditional metrics of inflation and employment and then layer in what are looking to be unprecedented executive actions on tariffs, immigration, and federal employment. It's no wonder some of Chairman Powell's most recent declarations appear equivocal. Across January, the bellwether 10-year Treasury remained relatively unchanged at around 4.5%, although it had tripped up to 4.8% intra-month. The futures market expects two more quarter-point Fed cuts but no more over the next two years. As was true for most of 2024, core inflation shows considerable moderation from its recent highs but resistance to dropping to the Fed's 2% target.
Overall, we welcome the strong start to 2025—particularly as it relates to the broadening of the market and outperformance of value over growth. However, we caution against projecting these January returns across the upcoming year as we see too many potential hurdles. The DeepSeek shock to some of the market's high flyers should indicate how sensitive stock prices can be when valuations are stretched. A major part of our stock selection discipline is an analysis of upside potential against downside risk for each of our holdings. While the market, on average, remains at historically high valuations, this is largely driven by the outsized influence of its largest stocks. Underneath these leaders, we continue to find high-quality companies at reasonable valuations, and we believe this is the best way to participate in the world's strongest economy and top-performing stock market.