Strength in AI investment should continue through 2025
Review the latest Weekly Headings by CIO Larry Adam.
Key Takeaways
- Next week’s data should confirm the economy remains on solid footing
- The broadening in earnings beyond mega-cap tech is finally occurring
- Strength in AI investment should continue through 2025
Will the Groundhog See His Shadow This Weekend? After last week's cold snap blanketed much of the nation, many are eagerly hoping that Punxsutawney Phil won't see his shadow on February 2. Why? Because according to folklore dating back to 1886, if Phil doesn't see his shadow in the morning, spring will arrive early! However, if he does see his shadow, we're in for six more weeks of wintery weather. Just as weather forecasters anxiously await Phil's annual prediction, investors are on edge, trying to gauge how the Federal Reserve (Fed), economy, and financial markets will react to growing uncertainties. With many questions surrounding the economy's health, the impact of the Trump administration’s policy decisions like tariffs, the outlook for earnings and AI investment in 4Q and into 2025, let's explore whether the economy and markets will see their shadows and face an extended period of increased uncertainty.
- Policy Uncertainty Has Made Fed Rate Path A Little ‘Cloudy’ | Robust growth and Trump policy uncertainty kept the Fed on the sidelines at this week’s FOMC meeting. While caution appears warranted until there is more clarity, could the Fed’s easing cycle get derailed?
Our View: With the economy showing strong momentum heading into the new year, there is no immediate need for the Fed to cut rates further, especially given the policy uncertainties (e.g., tariffs, taxes, and Trumponomics) on the horizon. From a policymaker's perspective, the best course of action is to stand pat while awaiting more clarity. This means an extended pause is likely, which is well-priced into the market and aligns with our view that the first rate cut in 2025 has been pushed back until June. However, with growth likely to moderate in 2025 (RJ forecast: 2.4%), gradually easing inflation pressures (PCE likely to fall to 2% in early 2025), and Powell’s view that policy rates are “meaningfully” restrictive, the Fed’s easing cycle should not be derailed. While the economy’s momentum suggests the Fed can afford to be patient, we believe the easing cycle remains intact and expect policymakers to have an opportunity to deliver two additional rate cuts in 2025.
- ‘No Winter Blues’ In Recent Economic Data | The US economy continues to defy expectations of a slowdown. Despite a brief scare last year, economic growth and the labor market have remained resilient. What will next week’s heavy dose of economic data bring?
Our View: Next week will bring a slew of economic data, including the ISM Manufacturing and Service reports, the JOLTs job openings survey, and the all-important payroll report at the end of the week (RJ estimate: +160k). The recent improvement in regional Fed manufacturing surveys, particularly in business capex spending plans, suggests ISM manufacturing could move higher. The labor market has also shown resilience after last summer's brief scare. Last month’s impressive jobs report (+256k jobs added) indicated that the labor market remained strong at the end of 2024, with 2.2 million jobs added, fully dispelling fears of an impending slowdown in the jobs market. This resilience, combined with healthy wage gains and improving household wealth, continues to support consumption. Bottom line: next week’s economic data should confirm that the economic expansion remains intact.
- ‘Early Signs’ That Earnings Are Broadening Beyond Mega-Cap Tech | While mega-cap tech earnings have been up 87% since the end of 2022, earnings for the rest of the S&P 500 have been hiding (up only 0.1% over the same period). Will they finally emerge in 4Q24?
Our View: While mega-cap tech earnings have remained solid (MAGMAN* 4Q24 EPS +20% YoY), the long-awaited broadening beyond tech is finally taking place. S&P 500 earnings excluding MAGMAN are on track to rise 8.8% YoY in 4Q24, marking the best quarter of growth since 2Q22. Additionally, 74% of these companies are beating estimates by ~5%. Notably, this broad strength in earnings is expected to continue through 2025 and for the first time since 2018 all eleven sectors of the S&P 500 are projected to see positive EPS growth in 2025. This broadening in EPS growth should support a broadening of market performance, with Health Care, Industrials, and mid-cap equities expected to benefit.
- Will New China AI Cast A ‘Shadow’ On Tech? | AI investment has driven the market in recent years, with tech-related capital expenditures rising significantly since late 2022. However, with cheaper AI models emerging in China, can the US AI spending boom continue?
Our View: The release of a purportedly cheaper Chinese AI model, due to the use of lower-cost chips, led the tech-heavy NASDAQ to underperform this week. We view this negative price action as overdone and expect the AI investment cycle to continue for several reasons. First, Chinese companies have a history of developing and scaling lower-cost alternatives (e.g., COVID vaccines, EVs) to premium-priced US or European products, often targeting end users in emerging markets. With the new AI models already facing regulatory scrutiny (i.e., banned from app stores), they may not gain much traction in the US. Second, this release could prompt the US government to further emphasize increasing AI investment to maintain its leadership. Third, as 4Q24 earnings highlight the broadening monetization of AI-related products, we expect corporate CEOs to still prioritize AI spending. In addition, as both Meta and Microsoft highlighted this week, they are maintaining their ramp-up in capex to further build out AI infrastructure. As AI investment continues, we remain overweight on the Tech sector.
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