Monthly Market Update – January 2025

Key Points

• COUNTER TRENDS Financial markets finished January broadly higher and saw some notable counter trend moves for the month. Technology stocks, one of the dominant 2024 leaders, was the only negative sector in January, and Health Care, a 2024 laggard, was the best sector in January. Value stocks also beat Growth stocks and non-U.S. outperformed U.S. stocks, in contrast to the trend for the last several years. 
• THE JANUARY BAROMETER The “January Barometer” is a market theory that suggests when the performance of the S&P 500 in January is positive, the rest of the year is positive. According to historical data, since 1953, the S&P 500 has been positive in January in 42 of the years. For those positive January years, the median rest-of-year performance for the index was a gain of +13.5%, with positive returns 86% of the time.
• DEEP(SEEK) DISTURBENCE Stocks suffered a sharp sell-off on January 27 after claims that Chinese AI firm DeepSeek had produced generative AI capability comparable to the U.S. AI market leaders but at a fraction of the cost. This potentially called into question the valuations AI-related companies were commanding and the demand for elevated investment in advanced AI chips and data center capacity.  
• TARIFF TURBULENCE Currently, the U.S. has some of the lowest tariffs globally (an average rate of about 2.0% on industrial goods). However, if some of the tariffs proposed by the Trump Administration were to be fully implemented, the U.S. could quickly rise to one of the highest tariff countries. Those proposed levels aren’t expected to be fully implemented though, but markets will likely have to contend with the headline risks.
• EARNINGS EXUBERANCE Tariffs are a potential headwind for multinational companies, but Corporate America has a lot of tailwinds behind it. Interest rates, tax rates and regulatory burdens are all expected to decline in 2025, and consumer spending continues to be strong. The S&P hasn’t seen double digit earnings growth since 2021 and hasn’t seen all 11 sectors with positive earnings growth since 2018, but both are expected in 2025.
• PROFIT MARGIN RESET Profit margins may have permanently reset higher due to structural changes such as 1) lower debt costs from refinancing during near-zero interest rates, 2) reduced corporate tax rates from the 2017 Tax Cuts and Jobs Act, and 3) massive fiscal stimulus from the covid era. Also, advancements from AI and quantum computing have led to significant productivity gains, further boosting profit margins. 
• EMPLOYMENT COSTS EASING The Employment Cost Index (ECI) edged up in the fourth quarter, but importantly it decelerated on a year-over-year basis for the third straight quarter. The ECI is the Fed’s preferred measure of wage gains, and the current annual rate is the slowest since the third quarter of 2021. The Fed would like to see even lower, but it is headed in the right direction to get the Fed back to cutting rates.

Market Summary

Asset Class Total Returns

Source: Bloomberg, as of January 31, 2025. Performance figures are index total returns: US Bonds (Barclays US Aggregate Bond TR), US High Yield (Barclays US HY 2% Issuer-Capped TR), International Bonds (Barclays Global Aggregate ex USD TR), Large Caps (S&P 500 TR), Small Caps (Russell 2000 TR), Developed Markets (MSCI EAFE NR USD), Emerging Markets (MSCI EM NR USD), Real Estate (FTSE NAREIT All Equity REITS TR).

Despite a couple bumps in the road, financial markets finished the first month of 2025 broadly higher. Most major asset classes notched gains in January after suffering broad-based pullbacks in December, and there were some notable changes in the leaders and laggards of January’s rebound rally. For U.S. equity investors, the headline S&P 500 Index gained +2.7% for the month. It was the 10th month in the last 12 that the index has been positive and 10 of the 11 S&P 500 sectors were also positive, highlighting the broad-based nature of the rally. Conspicuously, the Technology sector was the lone negative sector, falling -2.9% for the month. Technology was up +36.6% in 2024, so some profit-taking is not surprising, but the fact that it trailed the S&P 500 by the widest margin since April 2016 was eye-catching. The top performing sector in January was Health Care, up +6.6%, after being the second lowest performer in 2024 with a mere 1% return for the whole year. 

A stronger than expected jobs report in the first week of the month reignited inflation fears and concerns the Federal Reserve (the Fed) would abandon its pivot to lowering interest rates. Yet barely two weeks later, on January 23rd, the S&P 500 was back to setting new all-time highs. But just two days after that, the market suffered a blow by a new foe… Chinese Artificial Intelligence (AI) app DeepSeek. A sharp sell-off on January 27th developed following news of China’s DeepSeek app appearing to outperform U.S. AI models but claimed to use dramatically less resources and costly processors. The day’s selloff was the primary contributor to the Tech sector’s underperformance for the month as it dropped nearly -6% just that Monday. DeepSeek’s claims eventually began to be questioned, however, particularly the extremely low development cost without high-end semiconductor chips that most other top AI competitors are spending enormous sums on. 

Equity markets began to regain their footing in the following days, but once again, on the final day of the month, another brick in the wall of worry was tossed in. Since Donald Trump was elected President in November, many Wall Street strategists and D.C. beltway analysts had discussed the possibility that trade policy uncertainty could disrupt the market’s momentum. On Friday, January 31st, that possibility became reality when President Trump signed orders for tariffs of up to 25% to be levied on goods from Mexico and Canada, as well as a 10% levy on Chinese goods. But even with the announcement of tariffs targeting the U.S.’s three largest trading partners, the S&P 500 only lost -0.5% on the day to maintain the +2.8% total return for the month. 

Helping to take the sting out of the DeepSeek-related technology losses, and the hits to the U.S. stocks most impacted by trade with Mexico, Canada, and China, was a broad-based rotation rally that lifted groups like large-cap value as well as mid-caps. The Russell 1000 Value Index (large cap value stocks) returned +4.6% in January, more than twice the +2.0% for the Russell 1000 Growth Index (large cap growth stocks). It was the first time the value index outperformed the growth index since August 2024. Likewise, the S&P 400 Index (mid cap stocks) outperformed the S&P 500 Index, +3.9% to +2.8% respectively. Similarly, the S&P 500 Equal Weight Index outperformed the headline capitalization weighted S&P 500 by +3.5% to +2.8%. That was the largest outperformance for the equal-weight index since July 2024.

Another notable counter-trend dynamic in January was the outperformance of U.S. stocks by non-U.S. stocks. Developed market international stocks (as measured by the MSCI EAFE Index) were up +5.3% in January, nearly twice the S&P 500 gains. That was the best month of outperformance for the MSCI EAFE since December 2022. For diversified investors who hold international stocks, that was a welcome result.

In bond markets, yields drifted modestly lower for short and intermediate maturities (the 2-year and 10-year U.S. Treasury yields were up +4 and +3 basis points, respectively) but inched up for long-term maturities (the 30-year U.S. Treasury yield was up +1 basis point). The benchmark 10-year Treasury yield climbed to 4.8% on January 14—its highest level since November 2023—but eased back to close the month at 4.54%. The widely tracked Bloomberg U.S. Aggregate Bond Index (the Agg), which includes investment-grade corporate bonds and mortgage-backed securities as well as Treasurys, returned +0.5% in January. It was the 7th month in the last 9 that the U.S. bond benchmark has risen. Gains were robust with all major fixed income sectors positive. Non-U.S. bonds also gained ground in January with the Bloomberg Global Aggregate ex-US Bond Index up +0.6%.

Source: Bloomberg. Data as of January 31, 2025.
Price Returns for Equity, Total Returns for Bonds.
* The term basis points (bps) refers to a common unit of measure for interest rates and other percentages in finance. One basis point is equal to 0.01%. Bond prices and bond yields are inversely related. As the price of a bond goes up, the yield decreases.

Quick Takes

THE JANUARY BAROMETER

Popularized by the Stock Trader’s Almanac, the January Barometer claims that as January goes, so goes the full year. Based solely on the past performance of the US market, an up January has generally been bullish for stocks. January 2025 saw a strong start for financial markets, with the S&P 500 index rising +2.7%. According to Bespoke Investment Group, since 1953, the S&P 500 has been positive in January in 42 of those years. In those positive January years, the median rest-of-year performance for the index was a gain of +13.5%, with positive returns 86% of the time. That compares to stocks finishing up 71% of the time in all years since 1945 (with an average gain of +9.2%). Keep in mind that the January Barometer is just one indicator, and it doesn’t always work. Ultimately, factors such as economic conditions, interest rates, and geopolitical events, will also significantly impact market performance. While the strong January performance is a positive sign, it’s not a guarantee that we will get a third straight year of positive stock market returns.

So Goes January, So Goes the Year?

The January Barometer Suggests a Positive January for Stocks Leads to Gains for the Year

Source: Fidelity.

DEEP(SEEK) DISTURBENCE

Stocks suffered a sharp sell-off on Monday, January 27, after DeepSeek, a Chinese artificial intelligence (AI) startup, claimed shocking new advances in the field of AI. DeepSeek reportedly developed large language models (LLMs) comparable to U.S. AI market leaders, but at significantly lower training and compute costs. If accurate, this could imply greatly reduced demand for high-performance semiconductors required for the computational workloads associated with training and processing AI models. The implications are pronounced for the technology sector, given that the AI theme has powered the Technology sector, and markets overall, in recent years. The tech-heavy Nasdaq Composite Index fell -3% that Monday alone and shares of some AI-related companies were down much more. However, that conclusion hinges on whether DeepSeek’s cost data is truly comparable to the incumbent players. A lot of uncertainties remain that need to be resolved. Many analysts are questioning DeepSeek’s claimed cost structure and cheaper infrastructure spending. There will be heightened focus on this topic in the weeks and months ahead as investors evaluate the high valuations being paid for AI-related stocks and the massive amount of capital expenditures they’re making to remain relevant in the generative AI technology race.

Mentions of Al on Earnings Calls Over Time

January 2015 – February 5, 2025

Source: Goldman Sachs Global Investment Research.

TARIFF TURBULENCE

On January 31st, President Trump signed executive orders for significant tariffs on the U.S.’s three largest trading partners: 25% on Mexico, 25% on Canadian non-energy goods, 10% on Canadian energy, and a 10% increase on Chinese goods. These tariffs potentially cover 43% of U.S. imports and nearly 5% of GDP (according to Smith Capital Partners using 2023 data). Currently the U.S. has one of the lowest tariff rates, at under 3%, but if fully implemented, the average U.S. tariff rate would rise over 10%, one of the highest. That has the potential to cause supply shocks given the interconnectedness of global trade. However, as of February 3rd, Mexico and Canada both secured a one-month delay for the levies. The trade imbalance with the U.S. is considerable for both Canada (14% of their GDP and 77% of their exports) and Mexico (16% of their GDP and 84% of their exports) compared to the US (1.3% of GDP for Canada and 1.2% of GDP for Mexico, and single-digit export levels to both) so a trade war would disproportionately harm them. U.S. markets reacted to the tariffs with a quick pullback at the open on Monday, February 3, but at its lowest the S&P 500 never exceeded a -2% decline – a pronounced, but not atypical daily decline and less than the prior Monday’s DeepSeek-induced decline. By the end of the day, with the Mexico and Canada one-month delays secured, the S&P 500 closed down about -0.75%, a routine down day for the market. Lost in the Mexico/Canada/China headlines was that India, one the highest tariff countries in the world, cut tariffs effective February 2, ahead of any Trump-related tariffs aimed at them. India cut tariffs on a wide range of products ranging from electronics to textiles and removed the current 5% import tariffs on critical minerals such as cobalt, zinc and lead. Tariffs on machinery used in manufacturing lithium-ion batteries of electric vehicles and mobile phones will also be scrapped. Markets will likely be subject to additional tariff headline turbulence in the weeks and months to come. Goldman Sachs thinks the current U.S. tariff levels on imports from Canada and Mexico are likely to generally hold, but that the threat tariffs is likely to remain on the table until at least mid-2026 when the USMCA trade agreement review is slated to be completed. The February 3 executive orders suspending the tariffs until March 4 state that if the border situation worsens or Mexico and Canada fail to take sufficient action, the tariffs will be implemented.

The U.S. Currently Has Some of the Lowest Tariff Rates in the World

But potential imposed tariffs could quickly put them among the highest global rates

Source: Bank of America. Tariff rate: Most Favored Nation and Applied Rate weighted means, 2022.

EARNINGS EXUBERANCE

The threat of tariffs notwithstanding, Corporate America has a lot of tailwinds behind it. Interest rates, tax rates and regulatory burdens are all expected to decline in 2025, and consumer spending continues to be strong. In 2024, Wall Street analysts consistently underestimated S&P 500 company earnings, resulting in better-than-expected earnings seasons and relatively uninterrupted market rally. On almost any valuation metric, the S&P 500 appears rich relative to historical levels, but if Wall Street expectations for double-digit earnings growth are realized, it will help alleviate the valuation concerns and help sustain the two-year bull market. As the chart below shows, the S&P hasn’t seen double digit earnings growth since 2021 and hasn’t seen all 11 sectors with positive earnings growth since 2018.

S&P Earnings Growth and Sector Breadth

Growth and Breadth for Corporate Earnings are Looking Up

Source: Yahoo!Finance, Ritholtz Wealth Management, Bloomberg.

PROFIT MARGIN RESET

Wall Street has long theorized that profit margins are mean-reverting because extremely profitable industries will attract new entrants, which increases competition, which drives profits down. Conversely, less profitable industries will see companies exiting, reducing competition and boosting margins. While this theory has held in the past, U.S. profit margins have remained high for several years, prompting a reevaluation of the factors at play.  Several structural changes have contributed to the sustained high profit margins:

1. Lower Debt Costs: Many companies refinanced their debt at near-zero interest rates between 2020 and 2022, reducing debt service costs and extending maturity dates.
2. Tax Cuts: The Tax Cuts and Jobs Act of 2017 reduced corporate tax rates to 21%, providing a permanent boost to profit margins.
3. Fiscal Stimulus: Massive fiscal stimulus over the past four years has supported corporate profits directly through government programs and indirectly through increased consumer spending.

Additionally, advancements in technology, particularly artificial intelligence and quantum computing, have led to significant productivity gains. AI can handle large workloads and enhance efficiency, while smart manufacturing technologies reduce production delays and costs, further boosting profit margins. Despite high aggregate profit margins, individual company margins will vary based on factors such as business strategy, management talent, and industry position. Elevated future profit margins may also be reflected in higher market valuations which have persisted for years now and remain at historical highs.

Have U.S. Profit Margins Reset Higher?

S&P 500 Net Profit Margins, November 2004 – October 2024

Source: TradingView.

EMPLOYMENT COSTS EASING

The Employment Cost Index (ECI) edged up to a seasonally adjusted +0.9% in the fourth quarter. That was in line with Wall Street expectations and up a tick from a +0.8% unrevised rate of the third quarter. The ECI is the Federal Reserve’s preferred measure of wage gains. Importantly, on a year-over-year basis, the index decelerated slightly to a seasonally adjusted +3.8% from a +3.9% annual rate the prior quarter. That is the third straight quarter of the annual rate declining and the slowest annual rate since the third quarter of 2021. Still the Fed wants to see costs slow even further. Wages and benefits rose an average of +2.7% a year in the three years prior to the pandemic. Wages and Salaries account for about 70% of compensation costs. The annual Wages and Salaries rate fell to +3.8%, down from +3.9% the prior quarter, which is the lowest annual rate since the second quarter of 2021. Continued progress on wage inflation would help the Fed get back to cutting rates and provide a further tailwind to earnings growth and the sustainability of higher profit margins.

The Employment Cost Index Inched Up in Q4 but Declined on an Annual Basis

The ECI is the Fed’s Preferred Measure of Wage Gains

Source: Bureau of Labor Statistics, Bloomberg.

Asset Class Performance

The Importance of Diversification. Diversification mitigates the risk of relying on any single investment. It offers many long-term benefits, such as lowering portfolio volatility, improving risk-adjusted returns, and helping investments to compound more effectively.

Source: Bloomberg.

Asset‐class performance is presented by using market returns from an exchange‐traded fund (ETF) proxy that best represents its respective broad asset class. Returns shown are net of fund fees for and do not necessarily represent performance of specific mutual funds and/or exchange-traded funds recommended by The Retirement Planning Group. The performance of those funds may be substantially different from the performance of the broad asset classes and to proxy ETFs represented here. US Bonds (iShares Core US Aggregate Bond ETF); High‐Yield Bond (iShares iBoxx $ High Yield Corporate Bond ETF); Intl Bonds (SPDR® Bloomberg Barclays International Corporate Bond ETF); Large Growth (iShares Russell 1000 Growth ETF); Large Value (iShares Russell 1000 Value ETF); Mid Growth (iShares Russell Mid-Cap Growth ETF); Mid Value (iShares Russell Mid-Cap Value ETF); Small Growth (iShares Russell 2000 Growth ETF); Small Value (iShares Russell 2000 Value ETF); Intl Equity (iShares MSCI EAFE ETF); Emg Markets (iShares MSCI Emerging Markets ETF); and Real Estate (iShares US Real Estate ETF). The return displayed as “60/40 Allocation” is a weighted average of the ETF proxies shown as represented by: 30% US Bonds, 5% International Bonds, 5% High Yield Bonds, 10% Large Growth, 10% Large Value, 4% Mid Growth, 4% Mid Value, 2% Small Growth, 2% Small Value, 18% International Stock, 7% Emerging Markets, 3% Real Estate.

* The term basis points (bps) refers to a common unit of measure for interest rates and other percentages in finance. One basis point is equal to 0.01%. Bond prices and bond yields are inversely related. As the price of a bond goes up, the yield decreases.

Chris Bouffard is CIO of The Retirement Planning Group (TRPG), a Registered Investment Adviser. He has oversight of investments for the advisory services offered through TRPG.

Disclaimer: Information provided is for educational purposes only and does not constitute investment, legal or tax advice. All examples are hypothetical and for illustrative purposes only. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable but is not guaranteed. Please contact TRPG for more complete information based on your personal circumstances and to obtain personal individual investment advice.