Executive Summary
January was a good month for stocks and bonds; however, stock markets are facing greater uncertainty as the Artificial Intelligence (AI) capex trade that has powered markets higher in 2023 and 2024 is now being challenged by the emergence of DeepSeek and its lower-cost development model. Another source of uncertainty is the intensification of the trade wars as the US looks to potentially impose higher tariffs on its major trading partners. How is the uncertainty likely to impact stocks, and are there any bright spots for our portfolios?
January Performance
It might be an understatement to say that the past few weeks have been fairly exciting for the markets, with a couple of tumultuous events giving investors lots of food for thought on where things are headed in 2025 and beyond.
We might have seemed prescient when we talked about expecting uncertainty and turbulence in our previous market review, however, the truth is, there is always volatility and uncertainty in markets, as no one is able to see the future with any certainty.
Cutting Out the Noise
The major events that have given investors pause are:
- Doubts about the Artificial Intelligence (AI) capex trade due to the emergence of DeepSeek, and
- The likelihood that the US trade policy will become more protectionist, with higher tariffs on all trading partners.
However, it really all boils down to the one measure that investors care about when investing in stocks, and that is future earnings and how that is factored into the current valuation.
The AI Capex Trade
This theme has been the key driver of stocks for the past one and a half years, making Nvidia a $3 trillion company and driving a large part of the gains for the S&P 500 and US equities in 2024. The basis of the investment theme has been that:
- AI is the future and there is a need to develop the AI models that will power it.
- These models need to be trained and run on very sophisticated chips designed by Nvidia.
- Therefore, the continued sustained demand for Nvidia chips will deliver lots of future earnings for Nvidia, and the companies that make the chips and the supply chain supporting it, along with companies that deliver data centre solutions for the end users of the chips.
This has been supported by the capex spend from the US tech giants that are the key drivers of AI model development.
Exhibit 1 – US Tech Giant Annual Capex (USD Billions)
As we can see from the data, the capex of the major tech software companies has been steadily increasing from 2023, by some fairly large numbers. Year on year we see 37%-74% increase in capex from 2023 to 2024, and we even larger numbers estimated for 2025 (as provided by the companies in their recent results announcements).
This increased capex is mostly on AI, with a large part spent on Nvidia chips (and data centre capacity) to power the AI models.
This has pushed up Nvidia stock as its revenue has increased at a stratospheric rate.
Exhibit 2 – Nvidia Revenue (USD Billions)
From the chart above, its FY 2025 reporting is only three quarters, and it has already delivered revenues that are 50% of FY 2024.
So, we can see that investors are expecting this earnings velocity to continue as we can see from the forecasts, MSFT, GOOG, META and AMZN are expecting to spend a combined US$330 billion on capex this year.
This has not just boosted NVDA stock, but it has also boosted the stock price of TSMC, maker of the Nvidia chips, ASML, the maker of the equipment that TSMC uses to make Nvidia chips, data centre stocks and energy stocks (as data centres require lots of energy).
Why has DeepSeek turned this trade on its head? It’s because the estimated cost to build and train DeepSeek at around US$6 million is far lower than what the tech giants have been estimating to build their own models (For e.g., Open AI might cost upwards of US$3 billion to train). This has started to call into question the estimates for AI capex spend, and its impact on Nvidia revenues and earnings. If it is possible to do AI at a lower cost, then maybe less Nvidia chips are required. Thus, we saw a 20% fall in the stock price in just one day when the DeepSeek news broke.
However, markets have since stabilised as the companies have come out to continue to forecast high capex spend into 2025.
The Impact of Tariffs
The other challenge markets have been facing is the prospect of tariffs being placed or increased with major trading partners of the US. As of writing, tariffs have increased by 10% on goods from China, and the new regulations have closed the “de minimis” loophole that consumers were using to buy low-cost items from China. This exemption allowed items worth less than $800 and shipped directly to individuals to avoid standard tariffs. Planned tariffs on Mexico and Canada of up to 25% were postponed for 30 days.
Tariffs have a huge impact on the earnings of companies that are selling into the US as this increases the prices that they must sell their goods at, or increases the cost of manufacturing within the US if the raw materials come from outside.
One of the easier examples to understand these linked supply chains would be the automobile industry. Shares of automakers like Toyota, Volkswagen, Ford and GM, to name a few, fell between 5-7% on the Monday after the proposed tariffs were announced over the weekend.
This is because, due to decades of free trade between the US, Canada and Mexico, many automakers had set up factories in Canada or Mexico to assemble cars for the US market. In many cases, parts would move in and out of the US multiple times as part of the supply chain, however, the final assembly would be done in Canada or Mexico. It is easy to imagine the impact of a 25% tariff on the prices of cars in the US, which would directly impact the bottom line of many of these companies. Multiply this across many industries that source materials and parts from outside the US, and the impact on earnings across the market would be substantial.
We did of course see an initial market reaction where stocks were down about 2% early, but then the tariffs have since been mostly rolled back for a month, so markets have also stabilised since.
It Is All About Earnings
In the end, we can see that it is all about earnings, as that is the end goal of any investor in a company. Events that impact a company’s earnings will be of deep concern to investors, and impact the valuations that investors give to a company.
However, companies are not static entities. They grow and evolve over time. Look back to the period of 2022 when inflation was running high, and companies adjusted by raising prices, which helped them maintain or even grow their earnings.
The word “tariff” was used 140 times in various transcripts of company earnings calls so far for S&P 500 and Stoxx 600 companies that have reported earnings this season. Business executives are aware of the risks and actively working to manage their business and shield them from the worst scenarios.
While the current business environment might be uncertain, businesses will adapt and find ways to thrive. We have seen it previously during the difficult periods of high inflation. Therefore, it is important to keep to a diversified approach to capture the returns of the best-performing companies during different periods.
Diversification Might Be the Only Free Lunch
Exhibit 3 – Year to Date 6 February 2025 Stoxx 600 versus S&P 500 (In USD)
Just this year alone, staying diversified has been beneficial for our portfolios, with Europe (Stoxx 600) outperforming the US by 400 basis points.
Similarly, there are many different themes for AI. Nvidia might be the current market darling, but it is down 7% year to date, while IBM is up 15% (yes, IBM is also benefitting from AI, by implementing it for companies).
These examples highlight that there is no point in chasing past performance, but staying disciplined and diversified will help maintain portfolio returns.
January 2025 Wrap Up
Exhibit 4 – Fund Performance January 2025 (In SGD)
Overall, looking at January’s performance, it has been a good start to the month for us. European stocks have added to returns while US stocks continued with a good start to 2025. Smaller companies and value stocks have done better in January, so we see the Dimensional funds in developed world markets do better. Emerging markets saw the opposite where the MSCI EM Index has done better than Dimensional. Fixed income continues to deliver strong returns in the higher yield environment, with the Dimensional funds outperforming the Global Agg, due to a mixture of <1-year yields staying higher than the rest of the yield curve, supporting the Global Short Fixed Income fund, and Dimensional’s overweight position in duration versus the index benefitting the Global Core Fixed Income as longer yields came in towards the end of January.
We hope that this market review has helped to shed some light on the current situation in financial markets. We will continue to monitor our portfolios and the funds we have invested in diligently, and our Client Advisers are always available should you have any questions or concerns. Thank you for your continued support and trust.
For more related resources, check out:
1. Will the US Mega Tech Stocks Bring About a Dot-Com Bubble Burst?
2. Investing In Stocks? There Is Nothing New Under The Sun
3. Portfolio Returns 101: 2 Essential Building Blocks and 5 Key Considerations
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