Monthly Market Summary
- The S&P 500 Index returned +2.7%, marginally outperforming the Russell 2000 Index’s +2.5% return. Seven of the eleven S&P 500 sectors outperformed the index, as AI-related news led to a sell-off in Technology stocks.
- Corporate investment-grade bonds produced a +0.6% total return as Treasury yields edged lower but underperformed corporate high-yield’s +1.4% total return as corporate credit spreads tightened further.
- International stock returns were mixed. The MSCI EAFE developed market stock index returned +4.8% and outperformed the S&P 500 due to strength in Europe, while the MSCI Emerging Market Index returned +2.2%.
Stocks Trade Higher as Market Leadership Rotates After 2024’s Gains
Stocks traded higher to start 2025, but there was a change in market leadership as the rally broadened. Large Cap Value, which underperformed over the past 12 months, outperformed Large Cap Growth by over +2.5% in January. Likewise, the Dow Jones Index traded back toward its all-time high from early December after finishing the year in a downtrend. In contrast, the Growth factor, Nasdaq 100, and Technology sector each underperformed the S&P 500 after propelling the index higher throughout most of 2024. The catalyst: AI-related news from China, which raised concerns about U.S. AI-leadership and could have implications for broad U.S. stock market indices.
Fixed Income Generated Positive Returns As Spreads Compressed and Rates Fell
Municipals returned +0.8% (+0.8% YTD), the Bloomberg Aggregate Index returned +0.5% (+0.5% YTD), and investment grade corporates returned +0.6% (+0.6% YTD). High yield bonds returned +1.4% (+1.4% YTD) as spreads compressed 26bps while leveraged loans returned +0.7% (+0.7% YTD) during the month. Emerging Market debt returned +1.6% (+1.6% YTD) as US dollar fell 0.1%.
Rates Spiked Across the Curve Then Declined
Rates increased amid strong economic data and lower expectations for Fed Rate Cuts. However, rates closed the month lower across the curve except for the long bond due to better-than- expected inflation data and expectations that tariffs, when implemented, may be more measured than feared. The recession-watch 3M-10Y spread was unchanged and closed the month at +24. The 2Y-10Y spread widened 1bp to +34. Rates rose slightly in other developed markets except or the U.K. The spread between Italian and German 10Y bonds compressed 6bps to 1.10%. 5-year breakeven inflation expectations rose 21bps and now sit at 2.60%, its highest level since March 2023 (low of 1.88% on Sept 10); 10-year breakeven inflation expectations rose 9bps and now sit at 2.43% (recent low of 2.03% on Sept 10); the 10Y real yield fell 12bps to 2.11%. T The market now expects between one and two cuts in 2025 vs the Fed’s guidance of two cuts. At year-end 2025, the market expects the Fed Funds rate to be 3.9% vs. the Fed’s guidance of 3.75%-4.00%.
Currencies/Commodities
The dollar index fell 0.1% as rates eased and tariff fears abated through the month. The commodities complex rose 3.3% with energy prices rising 2.6%. Brent prices rose 2.8% to $77/bbl. US natural gas prices fell 16.2% due to expectations for warmer weather in February. European gas rose 5.2% amid expectations for cooler weather.
Market monitors
Volatility ended the month lower for equities and rose for bonds (VIX = 16, MOVE = 92). The 10- year average for each is VIX=18, MOVE = 78. Market sentiment, which at one point had swung from -15 (pessimistic) to +14 (optimistic) in a single week ended the month at +7, relatively not far from +4 where it has started the month.
Technology Stocks Sell-Off After Chinese Startup Unveils Lower Cost AI Model
In January, there was a major artificial intelligence (AI) development that has potential implications for both the industry and the U.S. stock market. Chinese startup DeepSeek unveiled an AI model it claims can compete with top U.S. models, such as ChatGPT, but at a fraction of the cost. The model was developed using cheaper, less advanced chips, challenging the view that cutting-edge AI requires significant investment in high-performance, expensive hardware. If other companies follow suit and develop lower-cost models, it could influence the AI technology landscape and impact U.S. leadership.
DeepSeek’s AI model release triggered a sell-off in U.S. tech stocks that had been boosted by AI growth prospects. The model’s lower development cost raised questions about the risk of reduced demand for the high-end chips used to train AI models. The news was especially relevant for companies like Nvidia, a key supplier of the high-end, high-cost hardware favored by AI firms. The company lost nearly $600 billion in market capitalization, one of the largest single-day losses for a U.S. company. The selling pressure also extended to Microsoft, Alphabet, and Meta, reflecting broader concerns over the expensive valuations of AI-related stocks. While the news impacted a small subset of companies, the high weights of AI-related companies in the S&P 500 caused the index to trade lower on the announcement. Given the S&P 500’s high exposure to AI stocks, the market will be closely monitoring developments in the AI industry in the coming months.
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