Shifting Tides

Deepseek and its Low Cost Claims The final week of January was a whirlwind for the stock market, with tech stocks taking center stage. On Monday, the Nasdaq saw its sharpest decline in over a month following news from China about DeepSeek, a ChatGPT competitor. NVIDIA, a dominant force in AI infrastructure, faced a staggering setback, losing nearly $600 billion in market value - the largest single-day dollar loss in U.S. stock market history. DeepSeek claims to operate at a fraction of the cost of U.S. competitors, requiring less processing memory to train and run. While the long-term implications remain uncertain, this development introduces increased volatility and uncertainty in the near term. Earnings Sensitivity Last week also brought earnings reports from four of the Magnificent Seven, along with other key U.S. companies. So far, 77% of S&P 500 companies that have reported Q4 2024 earnings have exceeded expectations, while 63% have surpassed revenue estimates (FACTSET). Historically, positive earnings surprises have led to modest stock price increases, while negative surprises resulted in declines. However, recent quarters have shown heightened market sensitivity to earnings results. For example, IBM exceeded expectations and issued a strong outlook, leading to a 13% one-day gain. Conversely, Lockheed Martin fell 9% after reporting lower-than-expected revenue and offering cautious guidance. Recently, S&P 500 companies that beat both sales and earnings expectations saw an average stock price gain of 3.6% post-announcement, well above the five-year average of 0.9%. Meanwhile, companies that missed estimates saw an average 5% decline, compared to the historical average of 3.1%. Market Concentration With the S&P 500 trading at above-average earnings multiples, investors are watching earnings reports closely. All 11 sectors of the index are expected to see earnings growth in 2024. Why does this matter? The Magnificent Seven currently make up 30% of the S&P 500’s value and accounted for 50% of the index’s gains in 2024. To sustain market growth, the remaining 493 companies will need to contribute more significantly. While the market has reached new highs over the past two years, those gains have been driven by a small group of companies. For context, the only other time such a limited number of stocks dominated performance over a two-year period was during the late-90s dot-com bubble. This narrow market leadership presents a double-edged sword. On one hand, it raises concerns about whether a handful of companies can continue to outperform. On the other, it creates an opportunity for broader market participation, with the rest of the S&P 500 looking more attractive from a valuation and diversification perspective. Periods of concentrated market leadership often lead to increased volatility as investors weigh sticking with what has worked - the Magnificent Seven - versus diversifying to reduce risk. The S&P 500 is currently top-heavy, with its 10 largest companies accounting for 30% of the index. January managed to post gains, but not without some turbulence. We expect market volatility to rise in 2025, compared to the relative calm of the past two years. Last but not Least - Tariffs Additionally, tariffs have recently moved to the forefront. While new tariffs on Mexico and Canada were announced and then delayed by a month, the U.S. moved forward with tariffs on China. The uncertainty surrounding potential tariff impacts adds another layer of market unpredictability. In summary, markets face increasing uncertainty from new AI competition, earnings sensitivity, narrow leadership, and trade policy developments. While diversification may not have been "in style" in recent years, it remains a valuable tool for managing volatility. As always, investors should maintain a long-term perspective and avoid getting caught up in short-term market swings. If you have questions or concerns about your individual situation, please don’t hesitate to contact us.

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