CWS Market Review – January 28, 2025

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On Monday, Wall Street got knocked back thanks to the emergence of a Chinese artificial intelligence product called DeepSeek. If the hype is real, then DeepSeek is a far cheaper alternative to the existing AI chatbots.

Marc Andreessen went as far as to call DeepSeek a “Sputnik moment,” referring to the 1957 launch of the world’s first artificial satellite launched by the Soviet Union. The idea is that at one point, America assumed it was in the lead in the Space Race, and it quickly found out that it was not.

Tech stocks got punished hard. On Monday the world’s 500 richest people lost a collective $108 billion.

DeepSeek has apparently built a better and cheaper chatbot. Importantly, DeepSeek doesn’t require nearly as many high-end computer chips as its rivals. Pardon the tired cliché, but this could truly be a game-changer.

The U.S. government has been working hard to restrict the number of high-end chips, like those made by Nvidia, that can be sold to China. The Pentagon, in particular, doesn’t want to see these expensive chips fall into Communist hands.

The effort to quell the spread of these chips may have had a perverse side effect. Namely, it’s forced China to become more creative in its approach to AI technology.

There are a few tests that American AI companies use to see how well these chatbots work, and DeepSeek passed them all. To put this in perspective, DeepSeek said it only needs $6 million in computer power to build its systems. Meta spent 10 times that.

The investment assumption was that no one had pockets deep enough to be able to compete with the American tech companies. As a result, Nvidia was the only game in town. Well, that may not be true.

The top AI companies need at least 16,000 chips for their systems, but DeepSeek said they only need 2,000. Interestingly, DeepSeek has open sourced its AI technologies, so anyone can build it.

As you might gather, some politicians aren’t exactly thrilled with this. The New York Times mentioned a Berkley professor who, with his students, built an AI system called Sku-T1 that does as well as OpenAI but it only needed $450 in computer power.

DeepSeek is run by a quant fund called High Flyer. Since DeepSeek doesn’t make any consumer products, it’s not pinned in by the U.S. government’s regulations.

National security writer John R. Schindler wrote, “If DeepSeek’s innovation is all it’s being sold as, Beijing may have gained a decisive advantage that will enable the PLA to out-think and outmaneuver the U.S. military in any confrontation in the Western Pacific, most likely over Taiwan.”

Nvidia Plunges 17%

DeepSeek’s impact on the market was quick and hard. Shares of Nvidia (NVDA) fell 17% on Monday. That drop erased nearly $600 billion in market value which is the largest one-day loss for a single company in history.

Don’t feel too bad about Nvidia. Monday’s drop is barely a blip compared with its massive rally. The AI frenzy has been driving the market for the last few years, almost to the exclusion of everything else.

On Monday, the Nasdaq lost 3%. Meanwhile, the Dow closed 0.65% higher. That’s an enormous gap, and it was also reflected in the growth-value spread. On Monday, the S&P 500 Value ETF was up 1.03% while the S&P 500 Growth ETF was down 3.59%.

Broadcom (AVGO) lost 17.4% yesterday. Oracle (ORCL) was off by 13.79%. One of our Buy List stocks, American Water Works (AWK) was the top-performing stock in the S&P 500 with a gain of 6.84%. Here’s a stat that says it all: On Monday, the S&P 500 lost 1.5% or about $1 trillion even though 70% of the stocks in the index closed higher.

Two of our Buy List stocks got caught up in the DeepSeek selling. IESC Holdings (IESC) lost 24.57% and Amphenol (APH) fell 12.57%. Despite those hits, our Buy List outperformed the rest of the market by 79 basis points.

Nvidia gained back about 9% in today’s trading. Many of the other big-cap tech names also did well today. Growth beat value and the Nasdaq outpaced the S&P 500. That’s to be expected the day after such a dramatic move.

What will happen from here? Mihir A. Desai, a Harvard professor, said in the New York Times that Nvidia’s drop may only be the beginning. He claims that “Big Tech is eating itself alive” by chasing after companies that will deliver lower and lower returns.

Consider that even after Monday’s rout, the Magnificent Seven still make up over 30% of the S&P 500’s market cap. Ten years ago, it was just 10%. Desai writes, “our tech Goliaths trade at ratios that are two to three times those of the Unmagnificent 493.”

He thinks that investors have come to think of the Mag 7 as low-risk investments and that’s why they aren’t bothered by the high valuations. After all, the future belongs to them, right? Well….

The problem is that the Mag 7 have used their cash flows to buy similar firms also at elevated valuations, if not more so. This has created an investment echo chamber where a small group of companies are buying themselves with little regard to anyone outside the cool kids club. Nvidia gets nearly half its revenue from the other Mag 6 stocks. “In the past three fiscal years, Apple, Alphabet, Meta, Microsoft and Nvidia have bought back a total of over $600 billion of their own stock.”

Just because the price of a product is plunging doesn’t mean that it’s bad news for the industry. In a tweet, Satya Nadella, the CEO of Microsoft, raised the issue of the “Jevons paradox.”

This is the idea observed by the 19th century English economist William Stanley Jevons. He noticed that as coal got cheaper, the overall demand increased, and people started to use coal in other applications. A drop in price can lead to an increase in revenue.

Perhaps as AI costs drop, the demand will soar. Hey, it happened for coal!

Don’t Expect a Fed Rate Cut Tomorrow

The Federal Reserve began its two-day meeting today. The policy statement will be due out tomorrow afternoon. Spoiler alert: Don’t expect to see a rate cut. The futures market currently thinks there’s a 0.5% chance of a rate cut, but what comes next?

That’s still up in the air, but I suspect that the Fed has rolled back its plans for rate cuts this year. What’s the rush? The economy appears to be healthy and corporate earnings are growing, although there are some concerns. For example, inflation isn’t fading away so fast.

The Fed is probably set to pause for a few months. For the Fed’s March meeting, traders think there’s only a 30% chance of a rate cut, and for the May meeting, the odds are right at 50-50. There’s a very good chance that for all of this year, the Fed will only cut interest rates twice. I don’t know if that’s right, but it’s a big change in outlook from a few months ago.

Earlier today, the Commerce Department released its report on durable goods. With this report, economists like to look at core capital goods which excludes aircraft and military orders. That data can be very volatile.

For December, core capital goods orders rose by 0.5%. This number is often seen as a good proxy for investment in equipment. The data for November was revised higher to 0.9%.

The full report said that durable goods fell by 2.2% last month, but if you don’t count aircraft and other transportation equipment, then orders rose 0.3%.

On Thursday, we’ll get our first look at the Q4 GDP report. The consensus on Wall Street is that the U.S. economy grew in real annualized terms of 2.7%. If that’s correct, then it will be the final data point on a good year for the economy. If the GDP report comes in above expectations, then it would be another indicator that the Fed doesn’t need to be in a hurry to cut interest rates.

That’s all for now. I’ll have more for you in the next issue of CWS Market Review.

– Eddy

Posted by on January 28th, 2025 at 6:50 pm


The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.