Piton January Market Review
After another year of stellar returns for risk assets, December and the year of "AI" came quietly to a close.
Most of the volatility in December was focused on the last Federal Reserve meeting. Stock markets took a pause, and the yield curve continued to shift higher and steeper. While December revealed some weak economic data, inflation numbers were tame, and the job market remained strong. Incoming fiscal policy measures and deficit implications have inflation hawks worried. In addition, the supply of Treasuries and lower demand for long-term US debt continues to normalize (steepen) the yield curve. 2025 began slowly enough, but as the new administration came in, earnings season began, and the Fed calendar began, there was plenty for markets to digest.
In January, equity and fixed income markets finished relatively strong despite anticipating tariff policies and a new headwind to the "AI sector" as the DeepSeek news broke. The Federal Reserve made no changes at their January meeting and made no promises of upcoming rate cuts. Inflation data continues to remain above FOMC targets, while the employment data in the US continues to shine.
US equity markets finished higher in January, with some large sectors rotating during a volatile start to the year. Earnings season was front and center, and many large-cap companies announced positive surprises and upbeat forward guidance (Meta, Apple, IBM). By the month's end, technology sector stocks were the only sector with a negative total return (-2.90%). Communication services soared, up 9.12%. Health care and financials sectors followed, both up over 6%. The S&P ended +2.78%, led by the Dow Jones Industrial Average (+4.78%), and the Nasdaq up 1.66%. The biggest story for US equities was the DeepSeek news that broke over the last weekend of January. On January 27th, the technology-oriented Nasdaq Composite experienced a particularly steep drop, driven by a sell-off in tech stocks in response to the emergence of DeepSeek, a Chinese artificial intelligence (AI) developer. DeepSeek released a new open-source large language model that reportedly requires much less energy and processing power than other leading AI applications, leading to competitive concerns in the broader AI space. The news led to shares of NVIDIA falling nearly 17% on that Monday. This news also created an overall risk-off scenario in broader markets, including bonds.
The US Treasury yield curve saw yields drop modestly across the curve. Only the 30-year sector remained mostly unchanged for the month. The current yield in the marketplace, along with slightly better prices allowed for investment grade bond returns in both broad and intermediate mandates of approximately 50 basis points. Investment grade credit and municipal bonds had similar outcomes. Municipal bonds had specific areas of worry, especially in Southern California, as fires continued to destroy communities. Despite some excellent economic data, bond markets have focused on catalysts such as new fiscal policies, and the possibilities of rising inflation, either from a strong economy or tariff wars. Bonds benefitted in the month due partly to the aforementioned "risk-off" events in the stock market.
Data Recap
The US economy continues to surprise, led by the power of the consumer. The most positive data continues to show up in employment data. While weekly job data remains strong, December's non-farm payroll report increased by 256k jobs, much stronger than economists' predictions of 165k. Logically, consumer confidence remains strong, and the holiday season looked robust with personal consumption elevated in the 4th quarter. Even housing data, including new home sales and new home starts, showed positive surprises last month.
Inflation data remains problematic for the Fed and markets in the longer term. Prices paid in the service sector were elevated last month. Average hourly earnings are at 3.9% year over year. While both CPI and PPI were muted last month, core PCE continues to remain elevated at 2.8%. While much better, it remains a pressure point for the FOMC.
The Federal Reserve met on January 25th and unanimously decided to leave rates at the 4.25%-4.50% level. Investors agreed that the message was more of a stable rate environment and a wait-and-see approach. One noticeable change in their statement was the omission of "inflation moving towards the Fed's 2% target." This was most likely due to the recent strength in economic growth, coupled with possible outcomes of new fiscal policies. The committee has a good number of days and data points before the March 19th meeting. While it looks like rates could be stable for some time, the Fed continues to view the level of Fed funds as restrictive. This has been perceived by investors as a likelihood of 1 to 2 cuts at some point later in 2025. Data dependent!