Bulls take January

E*TRADE from Morgan Stanley

02/03/25

US stocks notched a positive first month of 2025, although concerns about interest rates early in January, and AI disruption and tariffs toward the end of it, made for an occasionally bumpy ride.

Stronger-than-expected jobs data early in the first full week of the month appeared to exacerbate concerns the Fed would leave interest rates higher for longer to avoid overheating the economy and refueling inflation, but the S&P 500 (SPX) rebounded to close at a record high less than two weeks later.

However, that milestone was soon followed by a sharp sell-off as news of China’s DeepSeek AI app appeared to potentially undermine, at least temporarily, the idea of US dominance in the artificial intelligence arena. Finally, on the last day of January, the SPX retreated from another potential record high after news that the White House planned to slap tariffs on Canada, Mexico, and China over the weekend:

Chart 1: S&P 500 (SPX), 1/2/25–1/31/25.

Source: Power E*TRADE. (For illustrative purposes. Not a recommendation. It is not possible to invest directly in an index.)


There are still more questions than answers surrounding DeepSeek. For example, Morgan Stanley & Co. analysts cast doubt on DeepSeek’s claims to have developed its model for $6 million, and without high-end semiconductors. That said, they expect DeepSeek to be “a viable competitor,” although they don’t necessarily think it will dramatically alter the spending behavior in the AI space. They also remain positive on AI semiconductors, noting “the underlying demand for NVIDIA Blackwell—and other AI products—remains very strong.”1

The tariff story is also likely in early innings. In the wake of President Trump’s inauguration last month, Morgan Stanley & Co. analysts discussed the possibility that trade policy uncertainty—that is, potential tariffs—could contribute to volatility in the financial markets.2 That possibility became a reality on the final day of January. But it remains to be seen whether the announced tariffs are a non-negotiable policy or a bargaining tactic.

The S&P 500 outperformed the MSCI Emerging Markets Index in January, but trailed the MSCI Developed Markets Index by nearly two percentage points.

“Tech” had a bit of a split personality last month. The tech-centric communication services sector was the strongest S&P 500 sector—by far—but the S&P tech sector proper was the weakest, weighed down by the DeepSeek-fueled sell-off in semiconductors.

Bond yields ended January slightly lower after surging early in the month. The benchmark 10-year Treasury yield climbed to 4.8% on January 14—its highest level since November 2023—before pulling back to end the month down 0.02% at 4.55%.

January 2025 Market Recap: Monthly and year-to-date returns

Data source: Power E*TRADE and FactSet. (For illustrative purposes. Not a recommendation. It is not possible to invest directly in an index.) Note: crude oil, gold, and U.S. Dollar Index data reflect spot-market prices. BPS (basis point) = 0.01%. MSCI Index of Developed Markets and MSCI Emerging Markets Index represent “total-return” performance (index change including dividend reinvestment).


Lofty levels notwithstanding, the market hasn’t necessarily reached peak optimism. While acknowledging stock valuations are historically high and investor optimism is elevated, Morgan Stanley & Co. strategists point out that corporate optimism, in contrast, is still relatively low. An increase in corporate confidence, combined with a potential deregulatory push, means “corporate activity and aggressiveness have room to rise,” which could provide tailwinds for the market.3

While last month’s inflation readings were relatively moderate, the Fed paused its rate-cutting campaign. Citing uncertainty surrounding trade policy (read: tariffs) and still-sticky inflation, the Fed appeared to be more comfortable taking a wait-and-see approach. At the end of January, the market-based odds that the Fed would cut rates in March were below 20%.4

Financials, media/entertainment, and software stocks may be attractive, in part because they have less exposure to tariffs than some other areas of the market.

Insight of the month: Pay attention to industries with strong relative earnings revisions. Morgan Stanley & Co. strategists recently noted financials, media/entertainment, and software look potentially attractive in this regard, while also noting these groups represent services-oriented industries with “more limited potential tariff exposure, which adds to the constructive case.”5

February market history. Historically, February has been one of the weaker months for US stocks. Over the past 34 years, the S&P 500 had a positive February return in 29 years (57% of the time), which was the fourth-lowest percentage of positive returns for any month. It also had the fourth-lowest median return (0.8%) of all months during this period. The S&P had a positive net return in 10 of the past 20 Februaries.6

Key December dates: Employment Report (2/7), CPI (2/12), retail sales (2/14), Presidents Day (2/17), FOMC minutes (2/19), second estimate of Q4 GDP (2/27), PCE Price Index (2/28).

 


MorganStanley.com. Latest thoughts on DeepSeek and other concerns; why we remain positive on AI semis. 1/28/25.
MorganStanley.com. Potential Economic Consequences of Trump’s Executive Orders. 1/22/25.
MorganStanley.com. Have Markets Hit Peak Optimism? 1/24/25.
CMEGroup.com. FedWatch Tool. 1/31/25.
MorganStanley.com. Weekly Warm-up: EPS Revisions, Pricing Power and Policy Inform Our Industry Preferences. 1/27/25.
Figures reflect S&P 500 (SPX) monthly closing prices, 1957–2024. Supporting document available upon request.

 

 

Because of their narrow focus, sector investments tend to be more volatile than investments that diversify across many sectors and companies. Technology stocks may be especially volatile. Risks applicable to companies in the energy and natural resources sectors include commodity pricing risk, supply and demand risk, depletion risk and exploration risk. Health care sector stocks are subject to government regulation, as well as government approval of products and services, which can significantly impact price and availability, and which can also be significantly affected by rapid obsolescence and patent expirations.

 

Yields are subject to change with economic conditions. Yield is only one factor that should be considered when making an investment decision.

 

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