Key Takeaways
- Markets Rally Last Week But Premarket Selloff Erodes Gains Amid AI Concerns.
- Earnings And Economic Data Create High-Stakes Week For Market Direction.
- Geopolitical And Political Uncertainty Add Volatility, Investors Eye Bonds And Key Developments
Markets posted strong gains last week with the S&P 500 reaching a new high and closing up 1.8% on the week. The Nasdaq Composite added 1.7% while the Russell 2000 and Dow Jones Industrial Average added 1.8% and 2%, respectively. However, those gains have been washed away in premarket trading and ahead of what will be a very busy week.
This morning’s selloff is being attributed to a Chinese Artificial Intelligence (AI) app called, DeepSeek. The app is currently the top app on Apple’s App Store and has very positive reviews. For investors, the concern is that despite AI chip trade restrictions, China has managed to develop an AI platform that appears to work very well and could threaten U.S. dominance in the AI space. It is also being reported that the model being used was developed at a significantly reduced cost and that brings up an issue I’ve spoken about which is the cost/benefit companies are getting for their AI investments. That is why some of the biggest losers in premarket are stocks such as Amazon, Meta, Microsoft and Nvidia. Interestingly, shares of Intel are up slightly. While that company has been left out in the cold during the AI hype, it’s also not suffering from today’s news. While this is certainly a development worth watching, I have a hard time believing this is the only reason markets are down.
Last week I mentioned the broad strength we’re seeing in the market. The rally was not simply being driven by just a few stocks and that’s a good thing. At the same time, however, valuations are at levels that are tough to sustain. As of the close on Friday, the 12-month forward-looking P/E ratio for the S&P 500 stood at 22.2. That compares with the 5-year average of 19.7 and 10-year average of 18.2. This month alone, the ratio has jumped from 21.5 back in December. Therefore, one can make the argument the market is pricing in a strong earnings season and if companies fail to deliver, we could see a decent pullback.
Through last Friday, 16% of the S&P 500 companies have reported earnings. Based on those reports, earnings are tracking to increase 12.7% according to FactSet. This week, 102 companies will report their earnings. Among those companies are some of the biggest names, including Apple, Meta Platforms, Microsoft, Starbucks and Tesla, to name but a few. And if we didn’t have enough on the earnings calendar, it’s also a heavy week for economic data.
Tomorrow, the most recent report on Durable Goods will be released. That will be followed on Wednesday by the Federal Reserve Open Market Committee (FOMC) meeting, at which the overwhelming expectation is for rates to be left unchanged. GDP will be announced on Thursday and then on Friday, the Personal Consumption Expenditures (PCE) report is due out.
To say this week will be busy is putting it mildly. I’ve covered the list of things scheduled for this week and one could argue part of this morning’s selloff is being driven by profit taking ahead of everything on the calendar. But I also believe part of what we’re seeing is a reaction to uncertainty with respect to geopolitical events and the sensitivity of markets to that uncertainty.
Over the weekend, President Trump threatened tariffs on Colombia of 25% with a vow to increase them to 50% by next week over Colombia’s refusal to accept deported illegal immigrants from the U.S. Colombia then threatened the U.S. with retaliatory tariffs. Late Sunday night, an agreement was reached regarding those immigrants, and the threat of tariffs was taken off the board, for now.
Markets do not like uncertainty. That is why we see volatility increase as binary events such as earnings approach. But markets can be equally sensitive to political uncertainty as well. The difference between earnings and political uncertainty is that we know the date earnings will be announced and investors have an opportunity to position themselves. With political uncertainty, it’s more difficult to forecast and therefore, sensitivity to unexpected developments can have significant impact.
For today, I want to see if the premarket selloff continues or if investors see this as an opportunity and start buying the dip. Two things I’ll be closely watching as I monitor equity prices will be volatility and interest rates. In premarket trading, the VIX is up over 20, which is a 40% increase from Friday. A beneficiary of the equity selling could be bonds and already in premarket activity, the rate on 10-year notes has dropped to 4.52. That’s a full 25 basis points lower than where 10-year yields were at just a little over a couple weeks ago. Also, I’m going to be listening for any talk of the DeepSeek app becoming a TikTok-type situation where it faces threats of being banned in the U.S. If that does happen, I’m curious how Nvidia and the like respond. As always, I would stick with your investing plan and long-term objectives.
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