Weekly Thoughts: January 27, 2025

A stellar week for capital markets as the strong kick-off for 2025 continued, with an S&P rally of +1.74%, and the Nasdaq +1.65%. Even international developed equites were strong, with the MSCI EAFE ETF, EFA popping +3.19%, aided by a -1.72% decline in the dollar index. [.DXY] Rate market yields rose a handful of basis points as the 10-year closed at 4.617%, up from last weeks 4.57%. Nonetheless, the recent bond rally from the 4.80% high was able to consolidate, a positive sign for those concerned about inflation driving bond yields higher.

Certainly, the main news story of the week was the inauguration of President Trump for his second term. As expected, there were an immediate bevy of executive orders and policy plans announced—most expected. While planned for some time, the Stargate Announcement on the 21st is a joint venture for investing $500 billion for infrastructure tied to artificial intelligence by a new partnership with OpenAI, Oracle & Softbank. The building of data centers and electricity generation that is needed for further development of AI was taken by the market as a continuation of the significance of the AI trend. While the term infrastructure covers multiple areas of our economy, which the Biden Administration also addressed with the Infrastructure Act, left markets in a positive state. We, too, believe in the need for retooling our power generation capacity and see excellent investment opportunities. However, we would caution that no matter which side of the aisle a program is initiated, even when a sound idea, the devil is in the details meaning will it be delivered efficiently and without waste? That is rarely the case as governments consistently leave us wanting when it comes to efficiency.

In addition to the AI electricity generation initiative, Trump’s campaign promise of “drill baby drill” may have added to downward pressure on oil prices but we are a believer in market forces ultimately driving prices. The bully pulpit is powerful, however, oil companies across the complex will most likely respond to true demand and not necessarily invest to create more supply if markets are flush with the commodity. In short, US supply is currently strong and until imbalances emerge, a massive new amount of drilling is not likely. However, the regulations slashed and general environment the Administration is attempting to address will make it more efficient when companies decide to search for new supply. Moreover, LNG exports, a tremendous opportunity of our economy as we have plentiful Nat Gas supply that much of the developed world would buy is an excellent opportunity. It has geopolitical ramifications. Additionally, Nat Gas will continue to replace coal in electrification, a positive for the environment and economy.

Not surprisingly, Trump versus Fed salvos have also begun. Publicly saying that “I will demand lower rates” is not a solid plan as the Fed independence is paramount to our system. Certainly, all presidents write letters and have private phone calls to Fed chairs, but “demanding lower rates” is antithetical to free markets and Fed independence. While it is generally known even by ardent supporters that the president’s style is unique and dare, we say “bombastic” we do not believe these statements will aid his goal of lower rates.

Shifting back to market data and fundamentals, we will receive a multitude of Q4 earnings reports this week. Earnings season began two weeks ago with strong performance by major banks and other financials. Due to this, industry analysts have raised their consensus Q4 earnings growth rate for the S&P 500 from +8.2% to +9.1% YOY. Big names such as Microsoft, Meta, Tesla, Amazon & Apple all report. While the backward view of Q4 will most likely look fine, what their outlook for 2025 is along with more debate whether their capital spending on AI soaring faster than revenues is sustainable. Of course, the answer is their must be a payoff data as in the interim, profit margins logically will eventually get squeezed. We would note that the profit margins of the Mag-7 group have soared since the start of 2023, a contributor to their epic stock price performance. However, investors will ultimately require a “pay-off” from this extraordinary amount of investment.

The coming week for markets will begin with sour price performance as a challenge to US AI supremacy has emerged. Over the weekend, China’s start-up DeepSeek sparked concerns over competitiveness as the recently launched free, open-source large language model with the claim it was developed in just two months at a modest cost of $6 million. On Sunday evenings, Nasdaq & S&P futures were down hard as tech stocks are getting hit on the news. Time will tell the true significance but our 2025 narrative of a more volatile year for a multitude of reasons is in place.

This week in the macro data category will of course be focused on the FOMC meeting and their decision on rates Wednesday. Our belief is the Fed will leave rates unchanged and thus the statement and Q&A by Chair Powell will be parsed on a word-by-word basis by economists. Other releases include Durable Goods, New Home Sales, consumer confidence, inventories, all capped off by the all-important PCE & Core PCE Index. With the market at all-time highs any wobbles in data could lead to quick reaction, as we are experiencing with the aforementioned DeepSeek situation in the Sunday evening pre-market trading.