Global equity markets had a strong start to the year, as investors reacted positively to lower than expected inflation figures which bodes well for risk assets. Over the month of January, the S&P 500 rose 2.8%, the MSCI World Index increased by 3.5%, and the ASX 200 Index rose 4.6%. Despite the market’s robust performance early in the month, volatility emerged in late January 2024, driven by two key factors: concerns over U.S. trade policy, particularly President Trump’s approach to tariffs, and uncertainty in the technology sector. The latter stemmed from investor scrutiny of R&D expenditure and valuations among U.S. technology companies, following Chinese AI firm DeepSeek’s release of a new large language model that demonstrated advanced capabilities.
Global inflation on track
Core inflation data for key economies, including the U.S., UK, and Australia, came in better than expected, reinforcing the view that inflationary pressures are easing. In the U.S., core inflation for December increased by 0.2% month-on-month, bringing the year-on-year rate to 3.2%—a deceleration after four consecutive months of 0.3% increases. Factors contributing to the slowdown included lower hotel accommodation prices, a modest rise in medical service costs, and a stabilization in rental inflation. Despite the fall in inflation, it remains above the Fed’s 2% inflation target. Following the Fed’s 50bps cut in November 2024, combined with trade policy uncertainty, it seems unlikely further cuts are occurring in the US soon.
In the UK, core inflation fell more than expected to 3.2% year-on-year in December 2024, driven by weaker consumer spending and lower energy prices. Meanwhile, in Australia, underlying inflation for the December quarter came in at 2.7%, marking the first time in over two years that inflation has fallen within the Reserve Bank of Australia’s (RBA) target band of 2-3%. The decline was largely attributed to slower wage growth, easing pressures in the housing market, and softer demand for discretionary goods and services. This clears the path to a rate cut at the next RBA meeting, with bond markets pricing in a 90% probability of a rate cut in February 2025.
Trumponomics – Trade Policy
President Trump’s return to office has been characterised by swift action to fulfill key campaign pledges, with trade policy taking centre stage. The January 31st announcement of proposed tariffs – 10% on Chinese imports and 25% on Canadian and Mexican goods – initially sparked market uncertainty. However, the administration’s subsequent decision to postpone the North American tariffs by one month, following commitments from Mexico and Canada to enhance border security measures, suggests a more nuanced approach to trade negotiations.
While tariffs appear to be primarily serving as diplomatic leverage to strengthen the U.S. trade position and secure concessions, a shift toward a more permanent tariff regime could have significant economic implications. Given the substantial volume of U.S. imports from China in particular, sustained tariffs would likely result in either reduced consumption or higher costs passed on to consumers, potentially creating an inflationary impulse that could complicate the Federal Reserve’s monetary policy decisions. The trajectory of these trade discussions over the coming months will therefore be crucial not only for international relations but also for domestic economic stability.
DeepSeek’s AI debut
January saw the emergence of DeepSeek, a Chinese AI firm that has rapidly gained attention as a formidable competitor to industry giants such as OpenAI, Google DeepMind, and Anthropic. The company, backed by CCP government and private funding, unveiled its latest AI model, DeepSeek R1. It boasts capabilities rivalling the most advanced AI models currently available as seen below in Chart 2. However, DeepSeek’s model claims to have materially lower training costs on the order of single-digit millions, instead of the hundreds of millions from leading U.S. AI models, whilst being trained with less advanced chips.
DeepSeek’s entry into the market has sparked excitement as well as concerns, particularly regarding AI competition, regulation, and the geopolitical ramifications of AI development. Analysts highlight that the company’s rapid technological advancements could intensify the ongoing AI arms race, particularly between the U.S. and China. While DeepSeek’s debut has led to increased volatility in AI-related stocks, with NVIDIA plunging 17% in one day, there are broader economic implications at play. The surge in AI development has raised concerns about potential malinvestment across multiple sectors, from escalating R&D expenditures and talent costs to massive investments in data centre infrastructure and energy production capacity. However, these investments may ultimately prove beneficial through a phenomenon known as the Jevons paradox, where technological efficiency improvements can drive increased overall usage and economic activity. Despite these mixed signals, the NASDAQ index maintained its upward trajectory in January, ending 1.6% higher.
Looking ahead, the impact of DeepSeek on the broader AI industry remains to be seen. Investors will be closely watching regulatory responses, potential partnerships, and market adoption rates to gauge the long-term implications of DeepSeek’s rise.
Notes: Scores are out of 100. The AI models for each company that are measured: for OpenAI, o1; for Alibaba, Qwen 2.5 72B; for Meta, Llama 3.1 405B; for Anthropic, Claude 3.5 Sonnet.
Portfolio Positioning
While near-term volatility is likely to persist as markets adjust to the new Trump policy environment, we maintain our disciplined approach to portfolio construction, focusing on long-term wealth preservation and income generation. Historical evidence consistently demonstrates the challenges of attempting to time markets, which is why we maintain a steady asset allocation in our reference portfolio through this period. We believe this disciplined approach, focused on building portfolios resilient to various market environments, offers long-term investors the highest likelihood of achieving their investment goals over time. We prefer for any portfolio adjustments to instead be led by the client-specific circumstances, in collaboration with their adviser.
As risk assets continue to perform robustly following Trump’s return, we remain committed to our strategic asset allocation, taking comfort in our exposures to private markets. Our allocation to private debt continues to provide attractive risk-adjusted returns through senior secured positions, while private equity offers valuable diversification, particularly by reducing concentration risk in US mega-cap technology stocks that have dominated listed equity markets. Additionally, real assets such as private infrastructure serve as strong inflation hedges, reinforcing portfolio resilience during periods of heightened volatility.
We remain cautious in domestic real-estate backed lending, where we observe an oversupply of capital relative to demand and an increasing amount of new entrants to the space. Whilst we remain allocated to the sector, we favour international direct lending opportunities which offer greater diversification with similar return potential. Meanwhile, alternative strategies such as royalties, managed futures and multi-strategy hedge funds remain key diversifiers within our reference portfolio.
This article has been prepared by Lipman Burgon & Partners AFSL No. 234972 for information purposes only; is not a recommendation or endorsement to acquire any interest in a financial product and, does not otherwise constitute advice. By its nature, it does not take your personal objectives, financial situation or needs into account. While we use all reasonable attempts to ensure its accuracy and completeness, to the extent permitted by law, we make no warranty regarding this information. The information is subject to change without notice and all content is subject to the website terms of use.