Stocks Rally as Market Leadership Shifts in Early 2025

Monthly Client Letter
Written By Jonathan M. Elliott, CPWA®, CRPC®, CDFA®, ChSNC®, CPFA™, RMA®

Photo Credit: Valdemaras D, Unsplash

Monthly Market Summary

  • The S&P 500 Index returned +2.7%, marginally outperforming the Russell 2000 Index’s +2.5% return. Seven of the eleven S&P 500 sectors outperformed the index, as AI-related news led to a sell-off in Technology stocks.

  • Corporate investment-grade bonds produced a +0.6% total return as Treasury yields edged lower but underperformed corporate high-yield’s +1.4% total return as corporate credit spreads tightened further.

  • International stock returns were mixed. The MSCI EAFE developed market stock index returned +4.8% and outperformed the S&P 500 due to strength in Europe, while the MSCI Emerging Market Index returned +2.2%.


Stocks Trade Higher as Market Leadership Rotates After 2024’s Gains

Stocks traded higher to start 2025, but there was a change in market leadership as the rally broadened. Large Cap Value, which underperformed over the past 12 months, outperformed Large Cap Growth by over +2.5% in January. Likewise, the Dow Jones Index traded back toward its all-time high in early December after finishing the year in a downtrend. In contrast, the Growth factor, Nasdaq 100, and Technology sector each underperformed the S&P 500 after propelling the index higher throughout most of 2024. The catalyst: AI-related news from China raised concerns about US AI leadership and could affect broad US stock market indices.


Technology Stocks Sell-Off After Chinese Startup Unveils Lower Cost AI Model

In January, a major artificial intelligence (AI) development has potential implications for the industry and the US stock market. Chinese startup DeepSeek unveiled an AI model that claims to be able to compete with top US models, such as ChatGPT, but at a fraction of the cost. The model was developed using cheaper, less advanced chips, challenging the view that cutting-edge AI requires significant investment in high-performance, expensive hardware. If other companies follow suit and develop lower-cost models, it could influence the AI technology landscape and impact US leadership.

DeepSeek’s AI model release triggered a sell-off in US tech stocks that AI growth prospects had boosted. The model’s lower development cost raised questions about the risk of reduced demand for the high-end chips used to train AI models. The news was especially relevant for companies like Nvidia, a key supplier of the high-end, high-cost hardware favored by AI firms. The company lost nearly $600 billion in market capitalization, one of the largest single-day losses for a U.S. company. The selling pressure also extended to Microsoft, Alphabet, and Meta, reflecting broader concerns over the expensive valuations of AI-related stocks. While the news impacted a small subset of companies, the high weights of AI-related companies in the S&P 500 caused the index to trade lower on the announcement. Given the S&P 500’s high exposure to AI stocks, the market will closely monitor developments in the AI industry in the coming months.

US Sector Returns (January in %)

US Sector Returns (YTD in %)

 

Important Disclosures
This material is provided for general and educational purposes only and is not investment advice. Your investments should correspond to your financial needs, goals, and risk tolerance. Please consult an investment professional before making any investment or financial decisions or purchasing any financial, securities, or investment-related service or product, including any investment product or service described in these materials.

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Stocks Rally as Market Leadership Shifts in Early 2025
Stocks Rally as Market Leadership Shifts in Early 2025

Stocks traded higher to start 2025, but there was a change in market leadership as the rally broadened. Large Cap Value, which underperformed over the past 12 months, outperformed Large Cap Growth by over +2.5% in January. Likewise, the Dow Jones Index traded back toward its all-time high from early December after finishing the year in a downtrend. In contrast, the Growth factor, Nasdaq 100, and Technology sector each underperformed the S&P 500 after propelling the index higher throughout most of 2024.

Labor and Inflation Data Generate Opposing Market Reactions
Labor and Inflation Data Generate Opposing Market Reactions

This week, there was limited dispersion across markets for the second consecutive week despite the volatile response to economic data. The Russell 2000 slightly outperformed the S&P 500, while the Nasdaq and international stocks were flat. Underneath the surface, factor trends saw Momentum, Value, and Equal Weight outperform the S&P 500. Notably, the Magnificent 7 underperformed, dragging down the Growth factor and Tech sector. Sectors experienced significant dispersion. Energy gained +5.8% as oil prices rose, with the Material and Industrial sectors close behind. Bonds ended the week with modest gains despite the round trip in Treasury yields.

Long-Term Perspective: Understanding How Valuations Impact Portfolio Returns
Long-Term Perspective: Understanding How Valuations Impact Portfolio Returns

The S&P 500 currently trades at over 21 times its next 12-month earnings estimate, a level not seen outside of periods like the late-1990s tech boom and the recent post-COVID recovery, when interest rates were near zero. Why do high valuations matter? History shows that while valuations have a limited impact on short-term returns, they play a critical role in determining long-term performance.

Jonathan M. Elliott, CPWA®, CRPC®, CDFA®, ChSNC®, CPFA™, RMA®

I am currently the Managing Partner for our independent investment advisory firm, Optima Capital Management. Together with my business partners, Todd Bendell CFP® and Clinton Steinhoff, we founded Optima Capital in 2019 as a forward-thinking wealth management firm that serves as an investment fiduciary and family office for high-net-worth individuals and families. In addition to being the Chief Compliance Officer, my role at Optima Capital is portfolio management. I have over 18 years of experience in managing investment strategies and portfolios. I specialize in using fundamental and technical analysis to build custom portfolios that utilize individual equities, bonds, and exchange-traded funds (ETFs). I began my financial services career with Merrill Lynch in 2003. At Merrill, I served in the leadership roles of Market Sales Manager and Senior Resident Director for the Scottsdale West Valley Market in Arizona. On Wall Street Magazine recognized me as one of the Top 100 Branch Managers in 2017. I am originally from Saginaw, Michigan, and a marketing graduate from the W.P. Carey School of Business at Arizona State University. I am a Certified Private Wealth Advisor® professional. The CPWA® certification program is an advanced credential created specifically for wealth managers who work with high net worth clients, focusing on the life cycle of wealth: accumulation, preservation, and distribution. In addition, I hold the following designations - Chartered Retirement Planning Counselor (CRPC®), Certified Divorce Financial Analyst (CDFA®), Certified Plan Fiduciary Advisor (CPFA), and Retirement Management Advisor (RMA®). In the community, I am a member of the Central Arizona Estate Planning Council (CAEPC) and serve as an alumni advisor and mentor to student organizations at Arizona State University. My interests include traveling, outdoors, fitness, leadership, entrepreneurship, minimalism, and computer science.

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Labor and Inflation Data Generate Opposing Market Reactions