Last week ended with global equities little changed in both local currency and sterling terms. Meanwhile, bonds were up a little over the period, as was the dollar. But these moves convey nothing of the dramas of the week, which both started and ended with a shock.
First off was the news that the Chinese AI App DeepSeek had managed to produce an AI model almost as good as the best of them at a fraction of the cost. This cast doubt on whether Nvidia’s pricey and top of the range AI chips are quite as necessary as had been assumed. The news came almost out of the blue and triggered a 16% decline in the share price of Nvidia and a $500bn loss in its market capitalisation, the largest ever one day fall.
Whereas Nvidia ended the week down around 16%, the rest of the Magnificent Seven tech stocks were little affected. Although DeepSeek casts some doubt on the merit of the likes of Microsoft, Amazon, Alphabet and Meta shelling out quite as much money as they have on building their AI capabilities, the increased functionality of much cheaper AI chips does hold out the positive prospect of greater adoption of AI in the wider economy.
Instead, their price moves were more dictated by their fourth quarter earnings results. Microsoft ended the week down 6% whereas Apple and Meta were both up 6%.
At this stage, it is hard to know the full extent of the ramifications of Deepseek. But at the very least, it highlights two points. First, the businesses of the Magnificent Seven are not quite as impregnable to new competition as many had assumed. Second, the exalted valuations of some of these companies mean their share prices are very vulnerable to any bad news.
Before we move onto the week’s other shock news, we should mention the Fed and ECB meetings on Wednesday and Thursday. The former was rather a non-event with the Fed leaving rates unchanged as expected, although arguably it did turn slightly more hawkish. The Fed noted that inflation remained somewhat elevated and it was not in a hurry to change policy. Still, the market continues to expect rates to be cut a further 0.25% over the summer.
The Fed’s attempt to be as uncontentious as possible was made a little easier by its meeting conveniently occurring before, rather than after, Trump’s tariff announcements. Even so, this failed to prevent a torrent of abuse from President Trump over its failure to cut rates.
Meanwhile, the latest inflation numbers fitted the Fed’s description with its favourite measure edging higher in December to 2.6%. On the activity front, US growth in the fourth quarter came in a bit below expectations at an annualised 2.3%, down from 3.1% in the previous quarter. However, the guts of the report were firm and all the signs are that for the moment growth is continuing to run at the robust 2.5-3% pace seen over the past year.
If only the same could be said for the Eurozone, where growth unexpectedly ground to a halt in the fourth quarter. France and Germany both saw small declines in output in contrast to Spain, which for a change is living up to its sunny reputation and saw continued strong growth.
As was fully expected, the ECB cut rates by a further 0.25% to 2.75% and is anticipated to reduce them by a further 1% over the coming year. Even though this morning’s numbers showed core inflation remaining above target at 2.6%, concerns over the stagnating economy will very likely trigger further easing, particularly with US tariff hikes looming.
The EU may not have been first in Trump’s firing line but he has made it very clear that tariff hikes are coming its way. Trump is more ambiguous about his intentions regarding the UK which looks rather better placed. At least according to American if not UK data, it is not running a trade deficit with the US, unlike the EU. Also, whereas Trump has been antagonistic towards the EU, he has rather surprisingly been complimentary of the UK PM.
But it is Mexico, Canada and China which are in Trump’s immediate headlights. From tomorrow, tariffs will be raised by 25% on imports from Mexico and Canada (10% for Canadian oil exports) and by 10% on imports from China.
The immediacy of the measures has rather taken the markets by surprise as it had been thought likely that the US Administration would give some room for negotiation before imposing such large hikes on Mexico and Canada. Equities have duly retreated but not excessively. The European markets are down some 1.5% this morning and the futures point to a similar decline in the US when it opens later today.
The risk of a trade war has clearly grown, to state the blindingly obvious, with Canada and Mexico promising retaliation. That said, it is still far from clear for how long these tariffs will be imposed and to what extent this will trigger a process of tit-for-tat retaliation.
The recent Colombian experience, which saw Trump’s 25% hike on its imports prompt concessions from Colombia and last only days, is encouraging but only up to a point. It should prove rather harder to resolve these latest disputes, not least because it is far from clear whether fentanyl, immigration or trade deficits are the main rationale and what concessions would be needed to secure the removal of the tariffs.
Higher tariffs are most likely to mean somewhat higher inflation and lower growth than otherwise for all concerned – despite tariff man’s claims to the contrary. However, we believe the danger of this turning into an all-out trade war, which derails the global economic recovery, remains quite small.
Other countries are undoubtedly more vulnerable to tariff hikes than the US because they are more dependent on trade. But even the US is not immune to developments overseas with close to 30% of the revenues of large US companies coming from overseas.
In our commentary on the market outlook on 13 January, we concluded that the backdrop for equities and fixed income remained reasonably positive but various factors were likely to create volatility along the way, if not a sustained sell-off. We stick to this view and believe, more so than ever, that a well-diversified portfolio at every level – not only at the asset class level but also within equities in terms of regions, sectors and companies – is crucial to minimise the risks.
This coming week, highlights will be the Bank of England meeting on Thursday (which should see rates cut a further 0.25% to 4.5%), US payroll data on Friday, further corporate earnings reports and last, but far from least, the next developments on tariffs.
Rupert Thompson – Chief Economist