January 2025: Volatility returns, but markets keep pushing higher

The month at a glance

Stock and bond markets posted positive returns in January, shrugging off a sluggish start and a deep tech sell off in the final week.¹ A hot December employment report — combined with an uptick in recent inflation measures — caused investors to ratchet down expectations for interest rate cuts over 2025.² The Fed confirmed that stance when it made no change to policy rates at its January 29th meeting, indicating that the labor markets remained “solid” and inflation remained “somewhat elevated”.³

After a year of relative calm in equity markets, volatility returned in January as investors wrestled with the path of inflation and interest rates, the likely impact of emerging tariff policies, and the potential lower trajectory for earnings growth for the artificial intelligence sector. Still, the US economy continued to grow steadily and early Q4 earnings reports generally topped expectations.⁴ Growth in the US also continues to far outpace rates seen in most other countries. On the interest rate front, the Fed’s “higher for longer” path continued to fuel rising longer term yields for the first half of January, but 10-year rates declined steadily after a relatively favorable CPI report on January 15th.

• The S&P 500 rose 2.8%, hitting an all-time high a week before month end.⁵
• International developed market stocks led the markets for the month.⁶
• Early Q4 earnings for the S&P show 80% beating estimates.⁷
• AI related technology stocks fell sharply at the end of the month on competition from Chinese startup DeepSeek, which says its AI models perform as well as current models at a fraction of the cost.⁸
• US GDP grew 2.3% in Q4, down from prior quarters, partly due to the strike at Boeing.⁹
• Consumer spending grew at its fastest pace in two years.¹⁰
• Inflation releases were mixed, with the CPI rising more than expected while the PCE index was in line with forecasts . ^{11 12}
• The Fed kept rates unchanged in January, indicating that its “employment and inflation goals are roughly in balance”.¹³
• The yield on 10-year Treasuries spiked to 4.79% on January 13th but ended the month at 4.58%, unchanged from the end of 2024.¹⁴

Stocks rise despite increased volatility

‍Stocks weathered shifting inflation, interest rate outlooks, and technology sector weakness to post widespread gains for January. There was a rotation in leadership to international and small cap stocks from the US large cap growth and technology sectors that have set the pace over much of the last two years. While the change in market leadership was not dramatic, the result was notable given there has been only a handful of months in the past two years where US large cap growth stocks have not led the pack.

• Developed international markets posted the best returns but remain far behind US stocks over the past year.¹⁵
  
  • Returns were especially strong in Europe with Germany up over 9%.¹⁶
• The NASDAQ posted the weakest returns for the month on challenges from DeepSeek.¹⁷
• Emerging market stocks saw relatively subdued returns as China lagged other markets.¹⁸
• All sectors except technology posted positive returns for the month.¹⁹
  
  • The consumer discretionary sector (which contains Amazon and Tesla) led for the month, just as it has done for the past year.
  • Healthcare stocks rebounded from a very weak December and full year 2024.
  • Technology stocks fell sharply due to increased competition in the AI segment.

Rates ease in second half of January

‍The Fed’s message of a “higher for longer” path for interest rates over 2025 has kept longer-term yields high despite cuts at the short end of the curve. That path pushed the 10-year rate up to 4.79% in mid-January, up 116 basis points from the time of last September’s rate cut, before retreating to 4.58% to end the month.²⁴ Inflation concerns helped boost returns for inflation protected bonds. Credit spreads remain historically tight, but that has not hurt investor enthusiasm for high yield bonds.

• Fixed income returns were positive across the board in January.²⁵
• Riskier sectors (high yield, emerging markets and preferred stocks) posted the strongest returns.
• Inflation fears, stoked higher by feared tariff impacts, boosted TIPS returns.
• International bonds fared better than average in January, a welcome result given the extremely weak returns over the past year.

DeepSeek drags down tech, but fundamentals remain strong

‍Technology stocks, particularly those linked to artificial intelligence development, declined over the month following news that Chinese company DeepSeek had developed a potentially much cheaper method for deploying large language models, which power many AI applications. Nvidia, the market leader most associated with AI related hardware and software components, fell 17% on January 27th after the DeepSeek announcement, the largest one-day dollar decline in US stock market history.²⁶ Nvidia and other related stocks stabilized during the remainder of the month as investors assessed how much the development would impact the exceptional forecasted earnings growth built into the stock prices of these companies.

There is still much to understand about the actual impact the innovation from DeepSeek will have on the existing AI companies. Competition to find more efficient ways of developing AI applications should serve to bring down outsized profits for the market leaders. That is precisely how competitive markets are supposed to function. While this process may not end up unseating the current market leaders, it certainly makes it more difficult for investors to pick the eventual winners within the AI sector.

At the same time, lower costs to implement AI applications would likely quicken the pace of development and adoption of the technology by corporate and individual consumers. In that scenario, while the persistence of outsized profits from a single company may be less likely, the profits of the entire sector may expand rapidly.

Ultimately, investors care most about the earnings these companies deliver. On that front, things are expected to continue to go well, at least for the sector as a whole. As the chart below shows, earnings growth for the technology sector has far outpaced other sectors. The chart includes analyst estimates through the end of 2025. Even acknowledging analysts' tendency to be overly optimistic about fast growing companies and sectors, the almost vertical trajectory of annual earnings growth is impressive. And, if achieved, may be enough to justify the current lofty valuations. Any reconsideration of that growth path, like we saw on the DeepSeek news, would force a sell off to adjust to a new earnings reality.

Tariffs have arrived ... or have they?

‍History suggests that over time, politics do not significantly influence market returns, but in the near-term investors often react strongly to proposed government policies. Since the election, there has been much attention on tariffs that have been a consistent priority for President Trump. Most of that discussion led to a reminder that campaign rhetoric can be very different from actual policy. On the last day of the month, the words became actions. With an executive order, the President imposed 25% tariffs on Mexican and Canadian goods and an additional 10% levy on Chinese imports. This spooked investors, increasing concerns that the policies would disrupt supply chains, raise prices and potentially lower economic growth. Just as fast as they were announced, however, deals were struck with Mexico and Canada that paused the implementation of the tariffs which relieved investors but also underscored the reality of policy related uncertainty. 

The way that these initial tariffs played out supports the narrative that the initial tariffs were negotiating tactics to force those countries to devote resources to combat immigration and fentanyl concerns raised by the Trump administration. Presumably, investors will learn more about what any tariffs will be over the coming 30 day pause period. Investors tend to not like uncertainty, so delaying implementation of actual tariff rules may cause increased market volatility. But, investors also showed through market prices that they like actual tariffs on our top 3 trading partners even less, fearing a rekindling of inflation and potentially slower economic growth. Some of these fears may be overstated as companies find alternative sources for inputs and consumers substitute lower cost products, but these adjustments can take time.

While we all await clarity, it is informative to note the size and focus of our trade with the three initially targeted countries. Both imports and exports from Mexico, Canada and China make up about 40% of the US total trade in both directions. On that score alone, changing the trading rules for these three countries will have a large impact on the cost and availability of the things we buy and sell. Retaliatory actions from the three countries to us would make things even more difficult. There may be longer-term desired policy outcomes from the tariffs, but most observers (and it seems investors) believe they will put upward pressure on prices and potentially lower economic growth.

While the impact of tariffs are most often discussed at the macroeconomic level, looking at the mix of imports and exports from Mexico, Canada and China illustrates the possible micro effects. The US imports a large portion of our consumer electronics from China. In the tariffs imposed in the first Trump administration, many technology companies shifted manufacturing to other countries in Asia. In addition, in the last round, some companies were able to get exemptions for their products. Apple, for example, was able to remove tariffs for the iPhone.³⁰ For Canada, tariffs were already reduced from 25% to 10% for energy imports. Cars and auto parts that we import from Mexico are part of a complicated supply chain that finds auto related products crossing the border multiple times before the end product is completed. Several large computer manufacturers, HP for example, have assembly plants in Mexico.

The US also sells a substantial amount of goods to these three countries which would be affected by retaliatory tariffs that each of the three countries has threatened. The top US  export to China is soybeans and a likely product that China would target in any trade war. The US also exports almost $10B of semiconductors to China, but shipments of higher end memory chips have been increasingly restricted in the past several years. Our exports to Mexico and Canada are a mix of refined petroleum and auto related products.

While all of these micro level sector and product impacts are important, the biggest concern investors face is that high and broad tariffs imposed on our largest trading partners will increase inflation and lower growth. That is what ultimately matters for broader asset class returns. Most forecasts suggest that the US is not likely to fall into recession from the tariffs alone (although recessions in Mexico, Canada and China are more likely if the full tariffs go into place).³³ Still, the speed and magnitude of the economic impact is hard to predict. Add to that the underlying uncertainty regarding what the ultimate tariff policy will be after rounds of negotiations and the possible retaliatory actions, and you can see the challenges to investors. While it is tempting to try to predict winners and losers from any trade wars, given the uncertainty surrounding the policies and their impact, it seems wise for investors to keep their portfolios focused on longer-term goals.

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Atomi Financial Group, Inc. dba Compound Planning (“Compound Planning”) is an investment adviser registered with the Securities and Exchange Commission and based out of New York. The views expressed in this material are the views of Compound Planning through the period ended February 3, 2025 and are subject to change based on market and other conditions.

This document contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.

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Compound Planning is not, by means of this publication, rendering legal, tax, accounting, consulting, securities, real estate or other professional advice or services, and this publication should not be used as a basis for any investment decision or as a substitute for consultation with professional advisors. Compound Planning shall not be held responsible for any loss sustained by any person that relies on information contained in this publication.

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