There was a changing of the guard in January, with one presidential administration exiting office and another entering. And even though it comes with a different regulatory agenda and trade policy outlook, the macro backdrop remained mostly unchanged. GDP growth in the fourth quarter was solid at 2.3%, while private domestic demand grew 3.2% on the back of the fastest consumer spending growth in nearly two years. The robust economic momentum was apparent in earnings results, too, with S&P 500 constituents beating consensus EPS estimates by 6%.
Macro
• The Fed left the fed funds rate unchanged at a target range of 4.25%-4.50%, citing a stabilized labor market as a reason to slow the pace of interest rate cuts.
• The unemployment rate fell more than expected, declining from 4.2% to 4.1% in December, below expectations.
• In what was a seasonally warm December, housing starts spiked 15.8% versus expectations of a more muted 3.0% increase.
• Q4 GDP growth came in slightly below consensus at an annualized rate of 2.3%, with both consumer spending growing at the fastest rate since Q1 2023.
• The U.S. Dollar Index snapped its three-month streak of appreciation in a volatile January that saw it up as much as 1.4% and down as much as -1.1%, before ending the month marginally lower.
Equities
• Information Technology underperformed the broader S&P 500 by 5.6 percentage points, its largest underperformance since April 2016 and third largest in over two decades.
• Cyclical U.S. stocks underperformed defensives by 3.2 percentage points, the most since June 2022.
• Forward 12-month earnings expectations and the 12-month P/E ratio rose 0.6% and 2.1%, respectively, in January.
• Buoyed by a weaker dollar and a favorable sector mix, European stocks outperformed U.S. stocks by 4.3 percentage points, the most since December 2022.
• A $500 billion AI infrastructure investment joint venture called Stargate Project was announced on January 21, with companies such as OpenAI, SoftBank, Oracle, MGX, Arm, NVIDIA and Microsoft participating.
Fixed Income
• Treasury yields rose 15-25 basis points through mid-January (led by longer-term maturities) before falling below where they began the month.
• 10-year breakeven inflation expectations rose from 2.34% to 2.43%, while the real (i.e. inflation-adjusted) yield fell from 2.23% to 2.11%.
• High yield bonds outperformed Treasurys by 0.9 percentage points, the sixth straight month of outperformance.
Trade Policy Uncertainty Surges
The inauguration of President Trump on January 20 launched a sea change in the regulatory and trade landscape. Markets had been initially brushing off the idea of major tariffs as simply negotiating tactics, though it soon became clear that a more aggressive trade policy stance was not just bluster, even if there was little in the way of specifics on the tariff rates or their timing. The heightened uncertainty has now become a primary concern for investors.
Historical precedent from the 2018 trade war between the United States and China provides a rough framework, when tariffs on China led to significant strengthening of the U.S. dollar, growth fears and market volatility. Unlike then, the possible first wave isn’t just additional tariffs on China, but also key trading partners such as Canada, Mexico, and possibly even the European Union. Assuming the administration follows through with all of its latest announcements, the blended tariff rate would rise to its highest level since at least the 1940s.
Also, unlike the macro backdrop of 2018, inflation is not as subdued as it once was. This fundamental difference suggests that the Federal Reserve may not look through trade-related economic shocks the way it did then, especially if other countries retaliate. That could lead to slower interest rate cuts, or even the possibility of rate hikes.
Project Stargate and DeepSeek
January was a month of highs and lows for the artificial intelligence theme. The first half saw continued momentum for AI-related stocks, with major technology companies maintaining their strong performance from late 2024. This optimism culminated in the announcement of Project Stargate, a substantial $500 billion infrastructure investment aimed at securing the United States’ future in artificial intelligence.
Positive momentum didn’t last long, however, as the investors began to worry about Chinese startup DeepSeek’s R1 model announcement. It appeared to demonstrate performance comparable to leading AI models while being developed at a reported fraction of the typical cost. While that might sound broadly beneficial for consumers and businesses, it suggested that U.S. tech companies had less of a moat than previously thought. AI-exposed stocks initially fell 10% in the immediate aftermath, though losses have pared some.
The episode has highlighted potential risk of overspending on AI development. Market volatility underscored the shift in the mindset of investors: Initially worried about companies falling behind on innovation, investors are increasingly focusing on how the hundreds of billions of investment dollars will add to companies’ bottom lines.
photo credit: iStock/Phototechno
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