Weekly Investment Update (01/31/2025)

Reports that Chinese artificial intelligence (AI) company DeepSeek developed a cheaper model with similar performance to larger, more well known, models such as OpenAI’s ChatGPT, drove volatility higher this week. Interestingly, although the S&P 500 fell 1.5% on Monday, 70% of S&P 500 stocks traded higher and six of 11 sectors were positive. The selloff was mainly in AI-related technology stocks, while other areas of the market continued to advance as fundamentals remain supportive. This is consistent with our expectation for market breadth to improve as earnings growth reaccelerates outside of Big Tech. Broader market participation can serve as a stabilizing mechanism during periods of volatility in specific industries or sectors. We provide more detail on Monday’s price action in our Market Update: Recent Selloff in U.S. Artificial Intelligence Stocks. Overall, we believe any incremental innovation that results from DeepSeek’s model will likely accelerate the adoption and demand for AI. Bessemer's portfolio managers continue to look for opportunities to add exposure to companies, such as Amazon, that are successfully leveraging AI to drive profitability.

Separately, we are watching tariff developments as President Trump doubles down on tariff threats towards Mexico and Canada. He has now imposed a possible effective date of February 1, should each country fail to address various demands. Speculation has emerged that such tariffs could be questionable from a legal standpoint. Ironically, should these tariffs be implemented only to be struck down by the courts, it could serve as a positive catalyst for markets.

The Fed Pauses Its Rate Cut Cycle Amid a Solid Economy and Slower Disinflation

What is happening: The Fed left the Federal Funds Rate unchanged at 4.25% - 4.50% while continuing to reduce its security holdings. The decision to pause reflects solid economic conditions, with inflation nearing the Fed’s 2% target and a broadly balanced labor market. As of December, core PCE inflation stood at 2.8% year-over-year, while December’s unemployment rate was 4.1% — a low relative to historical measures. Indicating additional flexibility to cut rates, Fed Chair Powell acknowledged that the current policy rate remains “meaningfully” above its estimate of the long-term neutral rate.

Why it matters: The Fed’s pause underscores the continued strength of the U.S. economy. Powell emphasized that there is no urgency to implement further cuts, stating, “With our policy stance significantly less restricted than it had been and the economy remaining strong, we do not need to be in a hurry to adjust our policy stance.” However, with the current rate still above the estimated neutral level, additional cuts are expected, as we believe inflation will continue to ease throughout the year. Currently, the market projects two cuts of 25 basis points each for 2025, while we believe there is an opportunity for more cuts. Furthermore, the 10-year Treasury yield has fallen from 4.8% to 4.5%, serving to partly offset this week’s pause in rate cuts.

For now, the Fed is unlikely to preemptively adjust the policy rate to address trade, immigration, or fiscal policy proposals. Until more clarity is gained regarding policy implementation, the Fed will focus on measurable economic indicators to determine its next move.

Meanwhile, rate cuts implemented by other central banks (an additional 25 basis points from the Bank of Canada and European Central Bank) highlight economic weaknesses abroad relative to U.S. strength. This divergence reinforces our overweight position in U.S. equities.

Hyperscalers Report Strong Earnings and Continued Focus on Capex

What is happening: Markets experienced a brief period of volatility this week after the DeepSeek news broke, but robust earnings reports provided a counterbalance later in the week. Fourth quarter earnings for hyperscalers, or large-scale cloud service providers, are off to a solid start, with Meta and Microsoft beating estimates; however, the market’s reaction has been mixed. Meta posted another impressive quarter, with revenue growth of 21% year over year and strong adoption rates of its AI-related tools. Additionally, Meta noted it is too early to tell if the cost-cutting mechanism used by DeepSeek would lead to a reduction in its capex plans.

Microsoft beat earnings estimates, and its revenue run rate from its AI business is up 175% year over year, but shares fell in part due to lighter-than-expected revenue growth of Azure, its cloud computing service. However, Microsoft noted that companies are increasing deployment of AI tools.

Why it matters: Valuations, especially within the technology sector, are well above historical averages, leaving room for increased scrutiny around large AI-related spending plans. While a decline in capex might initially cause concern, reallocating budgets and growing free cash flows with cheaper AI could benefit the global economy in the long run. Efficiency advancements from DeepSeek could increasingly shift capex away from AI training infrastructure and towards inference—a trend that is already underway.

This week, Meta noted that investing heavily in capex and infrastructure will provide a strategic advantage over time and serve as an advantage for quality of service and scale. A key takeaway from Meta's projected $65 billion capex spending for 2025 is that most of it is allocated to Meta's core business, which should ease concerns about AI spending.

Decreasing costs can lead to wider AI adoption, in turn, benefiting more companies and aiding productivity. At the company level, this is likely to lead to a bifurcation of winners and losers. Companies such as Microsoft, can capitalize on cheaper model training and can enhance and drive adoption of their existing products while reducing costs.

Overall, we expect continued strength from AI-related stocks with pockets of volatility, given elevated valuations and heightened investor positioning. We maintain high conviction in our individual technology holdings but have been thoughtful about managing our overall exposure to the sector. For example, Bessemer portfolios have reduced overweight positions in technology from 200 basis points at the start of 2024 to 90 basis points currently.