Key Private Bank Investment Brief

Key Takeaways:

What is DeepSeek and why is it attracting so much attention?

DeepSeek is a Chinese artificial intelligence (AI) startup founded in 2023. Its new model (a.k.a. R1, released last week) has reportedly performed exceptionally well at significantly lower costs than its rivals.

The details on the underlying model are sparse. It is unclear how much computing power is needed to run DeepSeek models; however, it does appear that DeepSeek has released significant innovation into the marketplace.

The AI world is in a state of shock this morning. Mega-cap technology stocks are under significant pressure, as the industry is experiencing a large capital expenditure cycle whose benefits are being called into question. Investors are concerned that the new DeepSeek models could upend the sector with their efficiency. We will be watching this area carefully for investing implications. At first blush, we don’t think the dominance that America’s technology companies have enjoyed for the past ten-plus years is over; but it is possibly facing renewed competition, and we continue to believe investors are best served when maintaining a diversified portfolio.

The Trump administration sprang into action last week. Economic data was light.

Last week, unemployment claims remained low, S&P 500 earnings nudged higher, and bond yields were little changed. Home prices continued to reach record highs, but home sales finished 2024 at the slowest pace since 1995.

President Trump released a series of executive orders upon assuming the Presidency. Market participants breathed a sigh of relief when no immediate tariffs were announced, but we believe tariffs are a question of “when”, not “if”.

As of January 25, at 10:00am ET, in his first week in office, President Trump had issued 51 executive actions according to whitehouse.gov and data from CNN. The past 10 presidents signed an average of 266 executive orders per four-year term, or 66 per year according to the Federal Register.

Areas of executive action focus included immigration, government employment/personnel efficiency, energy, trade, and AI/crypto.

For context, federal workers make up less than 2% of the entire US labor market (approximately 3 million people). Of those, 60% work in the Department of Defense, Department of Veterans Affairs, and the Post Office.

Approximately 74% of government spending is allocated towards mandatory spending programs (Social Security, Medicare, Medicaid and interest payments). It may be difficult for the incoming administration to significantly cut spending.

Volatility is common in the stock market. Investors should stay focused on long-term results.

In the past 45 years, the S&P 500 has posted an intra-year decline of 14% on average. The index posted a positive year 76% of the time during this period, showing that patience is generally rewarded.

The largest market drawdowns typically occur during recessions. As noted in recent weeks, US economic growth remains solid and unemployment claims remain low. The data does not show signs of an imminent recession.

Bottom Line:

We remain Neutral to Risk. The rally in the S&P 500 off the late 2022 lows has led to one of the strongest two-year periods in history, and it would not be surprising to see a pullback. Key Wealth remains a proponent of periodic rebalancing in accordance with long-term financial planning.

Stocks and bonds are once again moving together and have become positively correlated. Bonds may not provide their typical diversification benefits amidst continued strong economic growth and sticky inflation.

New Tools, such as alternatives, real assets, and hedge funds, provide additional important diversification in the current environment. These types of strategies can also offer downside protection during periods of market stress.

Equity Takeaways:

Stocks fell in early Monday trading as investors began to digest the DeepSeek news referenced above. The S&P 500 fell approximately 1.65%, to 6002, while the tech-heavy Nasdaq 100 fell approximately 2.75%. Small caps were essentially flat. International shares were mixed.

Prior to this morning’s selloff, the S&P 500 was in the midst of a strong bounce-back rally. Near-term support is likely in the 5700-5800 range, which corresponds with the early January lows.

Fourth quarter 2024 earnings season has begun and is off to a solid start, but it is still too early to draw any decisive conclusions. Many of the S&P 500’s largest companies have yet to report.

The S&P 500 remains expensive with a price/earnings (P/E) ratio of approximately 22x. When the market is expensive, air pockets can develop amidst uncertainty, and we saw such an event play out this Monday morning.

Breadth is another area of concern. The NYSE cumulative advance/decline line did not make a new high during the latest rally, implying that the recent rally was driven by relatively narrow leadership.

Fixed-Income Takeaways:

Treasury yields moved slightly lower last week and were falling again in early Monday trading. Investors were moving towards the safety of Treasuries on Monday as technology shares sold off.

In early Monday trading, 2-year Treasuries were yielding 4.22%, 5-year Treasuries 4.35%, and 10-year Treasuries 4.54%. Yields were 6-10 basis points lower across the curve.

The Federal Reserve (Fed) will meet this week with the press conference on Wednesday and is expected to leave the Fed Funds rate unchanged. Inflation remains above the Fed’s long-term target of 2.0%, and tariff policy could put upward pressure on prices. The current Fed Funds rate is the range of 4.25% to 4.50%.

Investment-grade (IG) corporate bond spreads widened about 3-5 basis points in early Monday trading but remain at very tight levels. Trading activity remains robust, and investors continue to show high demand for the sector. The ease of trading has increased, which has been another tailwind for corporate bonds.

Private credit remains an attractive diversifying asset class. Over the past 20 years, private credit has delivered higher returns than both the high-yield corporate bond and leveraged loan indexes, according to data from Bloomberg, Morningstar, and Morgan Stanley.

Key Takeaways:

Trump version 2.0 is underway. Investors should remain disciplined and diversified. The only certainty may be greater uncertainty in the year(s) ahead.

In his inauguration speech, contrary to prior reports, President Trump expressed a desire to quickly implement certain tariffs. Details remain murky. Investors will need to look through these types of headlines in the coming years.

The US economy begins Trump’s second administration on solid footing. Unemployment remains low by historic standards, and real GDP growth remains strong. Despite strength in the economy, challenges remain. Trump inherits a different situation than he did in 2017.

Compared to the start of Trump’s first term, inflation, interest rates, and federal deficits are higher. It might be difficult for Trump to implement his full agenda in this environment.

The range of outcomes is wide. Trump’s proposals (not yet policies) are likely to be slightly positive for growth, modestly inflationary, and will enlarge the federal budget deficit.

With valuations high and risk premiums low, the current environment augurs for caution. What signs would make us more bearish / bullish?

Continued strength in the labor market would make us more bullish, and vice versa. For example, initial weekly jobless claims were 217,000 last week, a low number that still suggests a healthy labor market. Initial claims typically rise above 325,000 prior to a recession.

Credit spreads are a coincident indicator that can change quickly. When credit spreads rise, risk is generally rising. In the current environment, spreads remain low, suggesting low recession risk.

An inverted yield curve is generally bearish, but this cycle has been unusual. How the curve un-inverts matters. In this cycle, 10-year Treasury yields have been rising faster than 2-year Treasury yields (a “bear steepener”). In prior cycles, the 2-year yield led yields lower (a “bull steepener”).

A “bull steepener” implies weakening economic growth and higher recession risk. Conversely, a “bear steepener”, as we are currently experiencing, can coexist with strong economic growth, and implies that market participants remain concerned about inflation.

The earnings outlook for next 5-6 quarters remains upbeat, but valuations remain high. Today is not a time to get bearish, but not a time to get overly bullish either.

Bottom Line:

We remain Neutral to Risk. The rally in the S&P 500 off the late 2022 lows has led to one of the strongest two-year periods in history, and it would not be surprising to see a pullback. Key Wealth remains a proponent of periodic rebalancing in accordance with long-term financial planning.

Stocks and bonds are once again moving together and have become positively correlated. Bonds may not provide their typical diversification benefits amidst continued strong economic growth and sticky inflation.

“New Tools,” such as alternatives, real assets, and hedge funds, provide additional important diversification in the current environment. These types of strategies can also offer downside protection during periods of market stress.

Equity Takeaways:

Stocks rose in early Tuesday trading. The S&P 500 rose approximately 0.4%, to 6017, while small caps rose approximately 1.2%. International shares were generally higher.

Despite a pullback off the December 2024 highs, the S&P 500 remains in a defined uptrend. Earnings growth remains solid, which should support equities over an intermediate- to long-term time horizon.

Our internally managed Key Wealth equity strategies remain overweight bank stocks, which have performed well and have become a leadership sector. Since 2023, the yield curve has been steepening, which is a tailwind for banks. 

We believe banks remain well-positioned and are likely to improve on 2024 gains. Valuations remain attractive and the regulatory environment should become friendlier under Trump 2.0. Lower financial regulations could also result in higher Merger & Acquisition (M&A) activity, as well as higher loan demand and an increased number of Initial Public Offerings (IPOs), all which support bank earnings.

The stock market has reached levels of concentration not seen since the 1950s (aka the “Nifty Fifties”), according to data from Bloomberg, Morningstar and JPMorgan. This environment may lead to larger dispersion underneath the surface, creating opportunity for active managers to outperform the indexes.

Fixed-Income Takeaways:

Treasury yields fell 10-15 basis points across the curve last week. Core Consumer Price Index (CPI) inflation data was slightly lower than expected, bolstering bond prices.

Early on Tuesday, yields were lower once again by 2-5 basis points. Despite the rhetoric in Trump’s Monday inauguration speech, no immediate tariffs were announced, to the relief of bond investors.

In early Tuesday trading, 2-year Treasuries were yielding 4.28%, 5-year Treasuries 4.40%, and 10-year Treasuries 4.57%.

Despite rising yields over the past four months, volatility in the Treasury market, as measured by the MOVE index, has been declining. Typically, as yields rise, volatility rises as well. Long-term investors seem to be adding bonds as yields rise, dampening volatility.

As Treasury yields dropped last week, spreads tightened, especially in high-yield credit. New issue supply remains heavy and is being absorbed by yield-hungry investors. Demand remains strong for both investment-grade and high-yield paper.

Key Takeaways

Bond yields rose sharply late last week in response to strong jobs data. Stocks fell.

Rising interest rates are a risk to the stock market. After recent economic data, the likelihood of further Federal Reserve (Fed) rate cuts has diminished.

Bond yields may rise further, which could spark additional volatility. Stock market indexes remain concentrated, while valuations remain extended.

Near-term recession risks remain low, as evidenced by tight credit spreads, but risks of sticky inflation remain high.

Clients should remain Neutral to Risk and seek broader diversification via “New Tools,” such as alternatives and real assets, where appropriate.

The labor market regained momentum in December.

The labor market is strong, but there are pockets of softness. Nonfarm payrolls increased by 256,000 in December, above expectations, and the highest monthly reading since last spring. The unemployment rate fell from 4.2% to 4.1% (cycle low was 3.4% in early 2023).

The median duration of unemployment has been slowly increasing since late 2023, and the quit rate continues to decline. Both are signs of softness that suggest less upward pressure on wages.

Interest rates are rising globally. The era of “free money” is over, consistent with our secular view that we’re on the path toward the “Old Normal”.

Since the lows of last summer, yields have risen sharply across the globe. US 10-year yields have risen 114 basis points (bps) from trough to peak; German 10-year yields 54 bps; Japanese 10-year yields 65 bps; and UK 10-year yields 118 bps, according to Evercore ISI.

These higher rates are being driven by continued inflation fears. The Fed is likely to be cautious regarding further rate cuts – the Fed has no desire to see a repeat of the 1970s, where inflation spiked and receded on several occasions.

Bottom Line:

The rally in the S&P 500 off the late 2022 lows has led to one of the strongest two-year periods in history, and it is not surprising to see a pullback. Key Wealth remains a proponent of periodic rebalancing in accordance with long-term financial planning.

Stocks and bonds are once again moving together and have become positively correlated. Bonds may not provide their typical diversification benefits amidst continued strong economic growth and sticky inflation.

“New Tools,” such as alternatives, real assets, and hedge funds, provide additional important diversification in the current environment. These types of strategies can also offer downside protection during periods of market stress.

Equity Takeaways:

Stocks dipped in early Monday trading. The S&P 500 fell approximately 0.5%, to 5797, while small caps dropped approximately 0.4%. International shares were generally lower.

The stock market does not like higher bond yields. As yields rose sharply late last year into early this year, the S&P 500 entered a short-term topping pattern.

Support for the S&P 500 is around 5700, which corresponds to the summer highs and is also near the 200-day moving average. The S&P 500 is likely to test this technical support level in the coming days or weeks.

S&P 500 breadth remains weak, and the market is oversold. Only approximately 20% of S&P 500 constituents are trading above their 50-day moving averages, while the headline index is only approximately 3% below its all-time high. Large-cap technology stocks are holding up the market.

Crude oil has been in a 2-year long downtrend. In recent months, crude has showed a basing pattern and is trying to break out. We continue to watch oil prices closely.

Fixed-Income Takeaways:

Ten-year US Treasury yields have continued their relentless march higher and have risen more than 100 basis points since the Fed began its easing cycle last September 2024. Higher Treasury yields have been a major theme this year and have had an impact on all asset prices.

Longer-Term Treasury yields rose faster than short-term yields last week, resulting in a “bear steepener”. In early Monday trading, 2-year Treasuries were yielding 4.40%, 5-year Treasuries 4.60%, and 10-year Treasuries 4.79%.

After the recent data on economic growth and inflation, market expectations are for just 25 basis points of Fed rate cuts in calendar year 2025. The next rate cut is not expected until October 2025. The current Fed Funds rate is the range of 4.25% to 4.50%.

Despite rising Treasury yields and heavy new corporate bond issuance, credit spreads remain very narrow. Economic growth remains strong and near-term recession risk is low. Investors continue to gravitate towards the high all-in yields of corporate bonds.

Key Takeaways

Three major themes drove the markets in 2024.

1) Tech / artificial intelligence (AI) and Nvidia – especially in the first quarter following Nvidia’s major earnings report and later when the company reached $3 trillion in market capitalization.

2) Interest rates and Federal Reserve (Fed) policy. The Fed began cutting interest rates in September 2024, with major influence on assets across the globe.

3) The Election. Much optimism (perhaps an unwarranted amount) was priced into the markets after the election regarding tax cuts and deregulation. A level of uncertainty was also removed.

In 2025, similar forces may drive the markets, but there are risks to all three.

1) Markets remain concentrated, with the largest companies having outsized influence in both the stock market and the overall economy. Any hiccup in the AI narrative could be disruptive.

2) Intermediate- to longer-term interest rates have moved sharply higher since the Fed’s “jumbo” 50 basis point rate cut in September 2024. If the 10-year Treasury yield moves toward and through 5.00%, the broader markets could suffer.

3) Politics = pyrotechnics. Geopolitics and policy issues writ large are always a potential source of risk.

Economic growth is slowing but not stalling. In December, the Fed increased their projections for 2025 growth and inflation.

The Atlanta Fed’s GDPNow estimate for Q4:2024 real GDP is currently 2.4%, down from as high as 3.4% in mid-December. Growth expectations remain solid but have slowed in recent weeks.

In their December 2024 Summary of Economic Projections (SEP), the Fed raised expectations for both growth and inflation. Intermediate- to long-term interest rates have risen as a result, which has put modest pressure on asset prices in recent weeks.

While initial jobless claims remain low, the Fed should not forget about the labor market. On the margin, the labor market has been slowly weakening in recent months. The Fed is predicting a 4.3% unemployment rate at the end of 2025, versus 4.2% at the end of 2024.

Equity Takeaways:

Stocks rose in early Monday trading. The S&P 500 rose approximately 1.0%, to 6003, while small caps rose approximately 0.8%. International shares were generally higher.

The S&P 500 did not have a December to remember. Typically, December is a strong seasonal period. When seasonal strength fails to appear, investors should take note – such price action marks a change in tenor.

Earnings growth remains a fundamental tailwind for the stock market. The trajectory of earnings growth in 2025 will hold the key to market performance in our view. If earnings expectations downshift in the first half of 2025, the market could experience some choppiness.

Near-term, the market feels like it wants to work lower on the back of inflation fears and higher-than-expected interest rates. We still expect a solid year overall, as earnings growth should support stocks over an intermediate time horizon.

In recent weeks, the Nasdaq 100 has benefited from a rotation into “defensive growth” stocks. These days, defensive investors tend to rotate into large cap growth when the overall market gets turbulent. In the past, sectors such as health care, utilities, and consumer staples were the preferred safe havens.

The best sectors in 2024 were heavily influenced by the AI theme and included communication services, technology, and consumer discretionary. Financials also had a strong 2024. On a factor basis, momentum significantly outperformed.

Momentum can reverse quickly, especially when markets are concentrated. Growth stocks have outperformed the broader markets significantly over the past 10+ years. Periodic portfolio rebalancing to reduce growth stock weightings may be appropriate.

Indeed, we expect broader market participation in 2025. Whereas most earnings growth was concentrated in the top-10 companies in 2024, a wider variety of companies should experience earnings growth in 2025.

Despite much negative news flow, crude oil has moved higher in recent weeks. Price action contrary to news headlines is always something to watch. If interest rates continue higher, we think crude oil could also move higher.

Fixed-Income Takeaways:

As we enter 2025, spreads remain very tight. Some investors are extending duration as longer-term interest rates have risen over the past few months. New corporate bond supply remains heavy, and deals remain well oversubscribed, showing continued demand even at tight spreads.

Market participants remain focused on Fed policy. Current expectations are for fewer than 50 basis points of rate cuts in 2025. Investors are expecting fewer rate cuts going forward than they were several months ago. The current Fed Funds rate is the range of 4.25% to 4.50%.

Inflation remains sticky and economic growth continues to hold up well. Both dynamics are influencing investor behavior regarding interest rates.

As intermediate- to longer-term interest rates have risen relative to short-term rates, the yield curve has steepened in recent weeks. In early Monday trading, 2-year Treasuries were yielding 4.29%, 5-year Treasuries 4.43%, and 10-year Treasuries 4.62%.