02/03/2025 Market Strategy
It Don’t Come Easy
Competition in AI and Tariff Concerns Are Latest Issues to Worry Investors
Key Takeaways
- With just over a third of the firms in the S&P 500 index having reported, results look promising for the Q4 season with earnings reported so far rising 7.4% from a year earlier on 4.5% revenue growth. Prior to the start of the season, Bloomberg put analysts’ expected earnings growth at 7.3% from a year earlier.
- Among the sectors, seven are seeing earnings growth, with four at double-digit rates. Four sectors are seeing earnings declines.
- This week 131 companies are scheduled to report including financial firms as well as major names in technology and consumer discretionary. Another 79 firms report the week after.
- This week also brings the first reports of January activity as the ISM surveys and nonfarm payroll reports are due.
Last week’s action in the markets served to remind investors that long journeys and bull markets are subject to detours along the way that can challenge the courage of one’s convictions.
Stocks got jostled early last week on news from China tied to a claim of progress in AI development at substantially lower cost that could pose a competitive challenge to US leadership in AI. By the end of the week, questions about the veracity of the claim and how the AI process referenced had been sourced along with what looked to us to be some market acceptance at mid-week of the Fed’s FOMC rate decision (no change) along with comments by the Fed Chair found stocks regaining some of their lost ground.
In our view, last week’s overreaction to China’s AI announcement provided traders the opportunity to trade and investors an opportunity to “catch some babies tossed out with the bathwater.” At the end of the day stateside innovation remains the global standard in a world where technology is deeply embedded in the lives of business and the consumer with both segments tied to the upgrade cycle, whether we like it or not.
On Tuesday, market participants will find trade policy likely playing an elevated role in establishing the tenor of the markets as investors consider the likelihood that tariffs of 25% will be levied by the Trump Administration on goods from Mexico and Canada along with a 10% tariff on imports from China.
The particulars of the tariffs and any exceptions as well as the responses from the countries to which they apply will capture more than a little attention of the markets this week.
In our view, the interdependencies of the economies impacted will likely press all involved to find seats at the negotiating table to seek resolution to the tariff “war” sooner than later. As global travelers ourselves, the core issues at hand to secure the US borders north and south from illegal immigration and stopping the flow of fentanyl seem not unreasonable to be considered.
Earnings Season Continues
This week will also keep investors engaged as 131 companies of the S&P 500 are scheduled to report Q4 results including widely followed names belonging to the information technology, communications services, consumer discretionary, financials, and energy sectors.
With over 35% of companies in the S&P 500 having reported thus far, earnings are up some 7.4% on back of 4.5% revenue growth. According to FactSet more than 77% of the S&P 500’s companies that have already reported have beaten expectations. Seven sectors have shown positive earnings growth through the end of last week, with four at double-digit rates of growth. Four sectors have shown negative earnings growth, two of which were at double-digit rates.
This week also presents investors with a substantial brace of economic data to parse and ponder that ranges from data pertinent to manufacturing and services, vehicle sales, mortgage applications, the ADP employment change, job postings, productivity, unit labor costs all of which lead up to Friday when the non-farm payroll number, unemployment number, underemployment number, labor force participation number, and consumer sentiment index are released.
Investors will be looking for clues from results and management guidance from key corporates across the sectors reporting this week along with the economic data to determine the direction the markets are likely to take as the month of February gets underway.
Where We Stand Now
We remain positive on equities. The broad rotation which began in the rally from the S&P 500 low on October 27, 2023, has repeatedly deflected volatility, evidenced on a day-to-day and week-to-week basis since the lows in early August.
Recent pullbacks have mostly looked like “trims” and “haircuts” for the S&P 500 whenever bears, skeptics, and nervous investors have found a catalyst to take near-term profits without FOMO (fear of missing out) midst what appears to us like a very much intact bull market.
Drivers of the bull market that in our view have provided resilience in the intermittent downdrafts that occurred in 2024 include the success the Fed has had in pursuing tighter monetary policy that has reduced the pace of inflation since March of 2022 aided by consumer resilience, earnings, and job growth which have provided support for the US economy and the markets.
Even with the Fed having taken its benchmark interest rate from a band of 0–0.25% to 5.25– 5.50% from March of 2022 through mid-September of 2024 the economy did not dip into recession.
With the unemployment rate having inched up to the higher end of a band of 3–4%, the Fed Chair has said the Fed is focusing on the full employment mandate part of its dual mandate while remaining cognizant of the need to avoid a blow back in inflation should it begin to cut rates at too fast a pace. The 50-bps rate cut rather than a 25-bps cut on September 18 in some part appeared to us designed to address the Fed’s mandate and keep the employment factor from softening too much.
Technology deeply embedded in the lives of business and the consumer creating greater efficiencies of execution has contributed significantly this cycle to the degree of economic resilience stateside that exists to date. We persist in thinking that technology today (including AI) is likely parallel to the automobile in the early 20th century after Henry Ford had mechanized the assembly line and reduced the cost of the automobile while raising the overall quality of vehicles while increasing levels of production resulting in a change in the way business could execute, and consumers could manage their lives.
Our favorite sectors remain information technology, communications services, consumer discretionary, financials, and industrials.
While having favorite sectors for emphasis on security selection, we believe in diversification across all 11 sectors with technology likely to share center stage going forward with specific companies across the sectors that use technology to execute more efficiently.
We continue to expect that small and midcap stocks could begin to experience more sustainable rallies now that the Fed has begun to cut its benchmark rate.
While we favor equities over fixed income, we continue to find fixed income to be complementary to equities and other asset classes within diversified portfolios when duration is matched to investor goals, objectives, and tolerances to risk.
We suggest investors look for “babies that get thrown out with the bathwater” when market downdrafts occur in the markets.
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