2025 is off to a solid start with both stock and bond markets rising to start the year. The positive returns are noteworthy because they’ve occurred in the face of seemingly bad news. There’s been three clear catalysts that could have led to a market pullback:
- Tariff headlines started as soon as Trump was inaugurated on January 20th
- The emergence of Deepseek, a Chinese ChatGPT competitor, called the AI trade into question
- Inflation reports continue to point to sticky inflation
While each of these catalysts were accompanied by initial sell-offs in the market, they were very short-lived.
To tariff or not to tariff?
Tariffs have made for very noisy headlines this year. But so far, Trump has not implemented the wide scale tariffs investors originally thought might be possible. Instead, he’s used more of a carrot and stick approach… announcing the idea of tariffs, only to walk back the comment or delay implementation. The best example of this noise occurred during the last week of January.
Trump had announced in January that Mexico and Canada would be subject to tariffs beginning February 1st. But on January 29th, Trump’s pick for commerce secretary, Howard Lutnick, stated that the two nations could avoid tariffs altogether. Two days later, Trump said there was nothing the two nations could do to avoid the February 1st tariff implementation. Yet, just two days after that, Trump did indeed delay the tariffs for Mexico and Canada. Just looking at the flow of headlines will make you dizzy.
January 29th
January 31st
February 3rd
Markets went along for the dizzying ride but are higher than where they were when the drama started.
There’s a few takeaways from the early tariff related noise:
- Predicting what Trump is going to actually do on the tariff front is pretty pointless
- Trump seems somewhat sensitive to how the market is reacting to his tariff policy
- The overhang of tariffs may not unsettle the market too much. After all, many of Trump’s tariffs have been in place since 2018 and Biden enacted his own set of tariffs as well.
Lastly, all of this tariff talk seems to be benefitting European and Chinese stock markets, which have avoided much of the tariff talk so far. VEU, which tracks global stocks that exclude the US, and is heavily weighted in Europe and China, is outperforming the US stock market. VEU is up 7.50% on the year, compared to 4% for the S&P 500:
Deepseek takes more wind out of AI
The negative catalyst that made the biggest short-term impact on the market so far this year was DeepSeek, a Chinese ChatGPT competitor. The short version on DeepSeek is that they supposedly created similarly impressive AI technology at a fraction of the costs being touted by US hyperscalers. This resulted in a historic sell-off in Nvidia (NVDA), which has been a key leader for the US stock market over the last few years.
However, even as NVDA fell 20% in two days, the broader market as a whole stayed resilient. Moreover, in the weeks since, NVDA has been able to bounce back and the S&P 500 is at its highest levels of the year.
Even though NVDA stock is no longer out in front of the market, the broader market has kept going higher. We view this as a sign that the market is becoming less reliant on just a few names to power things higher; this is a good sign.
Did bonds bottom on a hot inflation report?
We love signs of capitulation, or an event that marks a major turning point in a market trend. Bond prices have been trending down for the last three years. This has resulted in the worst three year stretch for bond investors in modern history. Yet, we got signs last week that the worst may be behind us.
The latest inflation report showed inflation increased at its fastest pace in more than a year. This is undoubtedly bad news, especially for bond investors, where inflation erodes the value of fixed coupon payments bond investors receive. Even with this bad inflation report, bonds were able to rally last week. Longer-term, more interest-rate sensitive bonds, are up almost 2% on the year. That may not sound like much, but these bonds have fallen 35% over the last three years and fell 8% in 2024. So the positive returns so far this year are a welcome change of trend.
The action in the bond market last week reminded us of when the stock market bottomed in October 2022 on a hotter than expected inflation report. That rally marked the end of 10 month bear market in stocks and we’ve been in a bull market ever since. Perhaps history is rhyming with the bond market this time, more than 2 years later. We’d remind bond investors that your best indicator of your expected return is your starting yield. And with Treasury bond yields currently between 4.20-4.90%, you’re investing at a historically advantageous starting point.
All in all, the market has had plenty of chances to sell-off this year if it wanted to. But the fact markets have kept going higher across the board, (US stocks, non-US stocks, and bonds), is an encouraging sign the trend is still higher.
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