DeepSeek’s deep threats?
The sky may still be the limit, though maybe no longer for US assets only. The latest breakthroughs by Chinese artificial intelligence developer DeepSeek signalled that the US may be exceptional indeed, but is no longer the only game in town.
This week, privately owned DeepSeek surprised markets with its claim that its artificial intelligence (AI) model achieves similar or higher performance on training and inference than Western models while using less advanced chips vs its Western peers. The real innovation is that DeepSeek managed to implement and train, at an allegedly very low cost, a highly complex model that leverages the Mixture of Experts (MoE) architecture. The West has focused on essentially throwing more chips at it, instead of optimising the architecture. Its impact has yet to be tested on congested networks, and social media’s doomsday scenarios on hardware seem far-fetched.
We expect more volatility for Magnificent 7 stocks with high ownership among retail and institutional investors but remain Constructive on the Cloud Computing & AI theme, as we believe it is too early to assess if DeepSeek is a true game changer. For further information on the news, listen to our Moving Markets podcast with the player below or access it via Spotify and Apple Podcasts:
A broadening investment opportunity set
The implications of DeepSeek’s models could be far-reaching, with potential impacts on hyperscalers’ capital expenditures and efficiencies, but also on geopolitics as it comes from China. All of this adds to the idea of a broadening investment opportunities set, as established in our 2025 outlook. For this year, we noted financials, global mid-caps, Chinese stocks (on a tactical basis), and the German DAX Index as prime candidates for a rebalancing of investors’ ’US only’ stance. But as the new year unfolds, we also use this latest development to refine some key investment themes. In the healthcare space, we have named Extended Longevity as a prime opportunity in 2025 and beyond.
Central Banks: Fed and ECB take different paths
Growth and inflation call for different monetary policies in the US and the eurozone. Looser monetary policy by the European Central Bank (ECB) is justified, while the Fed’s scope for rate cuts is limited. The divergent communications from the Fed and the ECB support the view that these central banks will take different paths in 2025.
The US Federal Reserve’s room for further rate cuts in 2025 has narrowed profoundly, with economic growth being supported by an upbeat sentiment following Donald Trump’s inauguration and inflation that is closer to 3% than 2%. Further, the new US administration’s agenda implies more upside risks to US inflation, as threatened tariffs could push up prices, curbing immigration could create upside wage pressure, and extending tax cuts fosters domestic demand to exceed the economy’s speed limit. At the same time, the Federal Open Market Committee members have adopted a rather hawkish tone, suggesting that the Fed acknowledges the solid growth and sticky elevated inflation backdrop. We expect the Fed to leave the Fed funds rate in the current target band of 4.25%–4.5% throughout 2025.
And the European Central Bank (ECB) is in a very different position, with weak economic growth and falling utilisation rates pointing to growing economic slack in the eurozone. At the same time, inflation is closer to 2% than to 3%. Admittedly, inflation measures that focus on sticky inflation remain too high relative to the ECB inflation target of 2%, but underutilisation of the economy points to higher unemployment to come, downwards pressure on wage growth and, ultimately, falling inflation.
The ECB seems to acknowledge this development, with language-processing analysis of ECB Council members’ statements pointing to a prevalence of dovish assessments. We expect the ECB to proceed with further rate cuts at this and following meetings in 2025, and to reduce the deposit rate in successive rate cuts of 25 basis points each, to 1.75% by mid-year 2025. The resulting supportive monetary stance is a suitable tailwind for economic growth in 2026.
A look at earnings
USA
In the US, both the beat rate and aggregate earnings season are above long-term averages, marking a strong start into the Q4 earnings season. Big Tech is due to report results this week. We continue to recommend diversifying into cyclical names amid a broadening earnings growth.
Roughly 16% of S&P 500 companies having reported results already. Expectations have been high going into this season, raising the bar for companies to beat. That said, corporates have largely surpassed them, with 80% of companies beating expectations, higher than the 10-year average of 75%. Communications and materials (both 100%) are surprising most positively, while healthcare and utilities have delivered the lowest beat rate so far. In aggregate, S&P 500 earnings are tracking 7.3% a beat so far, higher than the 10-year average of 6.7%. Financials, especially banks, have been responsible for most of the positive surprises so far, despite the high bar following the US election result.
Europe
Meanwhile, Q4 earnings in the Europe Stoxx 600 Index are expected to show marginal growth due to favourable base effects. We are cautiously optimistic that earnings could surprise to the upside, driven by steady global expansion, improving new orders, and a declining EUR, potentially leading to a higher-than-usual beat rate among European firms.
With 10% of companies expected to report by the end of the month and 40% by mid-February, the oil & gas segment is seen as the major drag on index earnings (since the recent rebound in oil prices happened too late to have an impact), followed by consumer cyclicals (amid concerns about weak demand for automobiles and luxury).
On the other hand, communications stocks and materials are likely to be the primary positive contributors. Given the low hurdle rate after recent guidance cuts and estimate reductions, investors will focus on 2025 outlook clues, since earnings growth has been stagnant last year, capping European equity performance since the second half of 2024. Steady expansionary global PMI levels, improving new orders and inventories, and a sharp decline in the EUR during the last quarter may lead to positive surprises, increasing the chances of beats among European firms.
Euro area economic surprises were slightly negative in Q4 on average, although improving from lower levels, implying EPS beats close to 50% for Stoxx 600 constituents. Further optimism has been emerging from initial reports of luxury stocks, which showed positive revisions in full-year 2025 EPS growth, highlighting the potential for strong positive beats going forward.