The Price of Admission
A day later... Nvidia is not Pets.com... But there is a price of admission... What a bubble bursting can look like... Sizing up the Fed... Concerning signs in jobs and housing... The No. 1 thing to do with your portfolio in 2025...
It was back to reality today...
The fear that upended seemingly all "AI stocks" yesterday has been exhausted... based on today's market action, anyway.
The tech-heavy Nasdaq Composite Index led all the major U.S. stock indexes, up about 1.6%. Nvidia (NVDA) finished up by almost 9%. Many of yesterday's other biggest losers bounced back, too, like electricity producer Vistra (VST), which gained more than 9%.
Will yesterday go down in market memory as a one-day "DeepSeek panic" – or a significant prick at or near the top of an AI bubble? I (Corey McLaughlin) hesitate to make a prediction, but I suspect it's somewhere in between.
Remember, we just saw the S&P 500 Index achieve back-to-back 20%-plus annual returns for the first time since 1997 and 1998. That was during the run-up and buildup to the dot-com bubble. There's a case to be made that "AI" is an Internet-like market catalyst.
As we've written a few times in the past few months, if the comparison holds, we'd still be in 1999... another year of almost 20% returns before the dot-com bubble burst in 2000.
Today, I don't see too many companies with exorbitant valuations only because they have the letters AI attached to their business models... It's not like the infamous case of Pets.com, which went public near the top in 2000 with a $290 million valuation and zero path to profitability.
Greedy sentiment abounds today, sure. But Nvidia, for example, makes legitimate, in-demand products and is very profitable. And DeepSeek or not, the U.S. energy grid could use updating and investment, and natural gas should be in high demand for a long time to create electricity. Perhaps nuclear power, too, for the same reasons.
Questions with unknowable answers...
Undoubtedly, not all expectations and planned capital expenditures from the ongoing AI boom will come to pass. The thing is, though, nobody can say they know for sure where that money is being spent today, or how much of it is being "wasted."
In the meantime, though, many stocks associated with the emerging technology of AI have been on strong runs in the past two years.
That left the market sensitive to news that threatens the AI story... like a Chinese startup allegedly developing a cheaper, more energy-efficient alternative to current U.S.-based AI tech. Bad news can stoke fear just as quick as excitement did or does about buzzy new tech like OpenAI's ChatGPT.
This uncertainty is the price of admission to the market.
Yet, as we wrote yesterday, any headline claiming the "market" was down across the board wasn't quite true. More than two-thirds of the S&P 500 stocks rose yesterday. Today, the U.S. benchmark index and Dow Jones Industrial Average traded toward all-time highs. And the Nasdaq moved back above its 50-day moving average – a technical measure of a short-term trend.
Is this the beginning of the end of the AI boom? That'll be easier to say in hindsight. But at the very least, I'm thinking of yesterday's dramatic sell-off in seemingly all AI-related stocks as a reminder of what a bubble bursting can look like.
The Fed's on deck...
As we also wrote yesterday, we suspected the dominant market narrative would turn to something else soon. The "Magnificent Seven" begin reporting quarterly earnings after tomorrow's market close.
And tomorrow afternoon will bring another policy announcement from the Federal Reserve. If history is any indication, we can expect some volatility one way or another.
We'll learn the central bank's latest decision on the federal-funds rate. The market expects the Fed to hold steady on rates. But information-starved traders will also scrutinize remarks from Fed Chair Jerome Powell to theorize about policy moving forward.
We expect to hear discussion about the latest trends in inflation numbers (higher for most of the fourth quarter of 2024, but "good" of late)... and questions about the potential economic impacts of Donald Trump's new administration (including tariffs)...
I'll have a report in tomorrow evening's edition on the latest scuttlebutt. But as we look ahead, some other real factors are worth considering too when playing the parlor game of "What Will the Fed Do Next?"...
What the labor and housing markets mean for the Fed...
First, let's look at the labor market.
Remember that "maximum employment" is one half of the Fed's "dual mandate" – stable prices, or inflation, being the other half. On the surface, a 4.1% unemployment rate is low on a historical basis, even if it is higher than the recent low of 3.4% in April 2023. And the economy has added jobs (by the government's data) for 48 straight months.
But under the surface, there are some warning signs. For one, folks are having a harder time finding jobs. Last month, we wrote that...
According to Bloomberg, more than 40% of unemployed Americans have been searching for a job for at least 15 weeks. That's the highest level since the post-pandemic recovery. More importantly, this percentage has been in a steady uptrend since bottoming in 2022.
Along the same lines, the average duration of unemployment hit 24 weeks in December, according to data from Advisor Perspectives (with thanks to Global Markets Investor on X). Put another way, the average unemployed American goes without a job for nearly six months...
This metric peaked at nearly 41 weeks in the wake of the financial crisis and hit 32 weeks in the worst stretch of the pandemic. But aside from those extremes, December's reading is the highest since at least 1945.
At a time when more folks are struggling to pay off their credit cards, and 27% of Americans have no emergency savings at all, six months without a job is a huge problem for the economy.
Put this all together, and we think the Fed would jump at any opportunity to cut interest rates this year.
Now, on to housing...
As you know, as the Fed hiked rates in 2022 and 2023 to "fight" inflation, mortgage rates followed suit. And even after the central bank began cutting rates this past September, the average 30-year mortgage rate now sits at 6.96%. While that's lower than the recent high from 2023 (7.8%), it's still higher than any time going back to 2002.
High mortgage rates, coupled with record home prices, have made affording a home tougher.
According to data from the Federal Reserve Bank of Atlanta, the average qualified income to purchase a home sits at nearly $120,000. But the actual median household income is only around $80,000.
So under the current average conditions, household incomes would need to jump 50% for folks to afford a home. Everyone's situation might be slightly different, but this gap in affordability is hampering home sales...
In 2024, Americans bought just 4.06 million existing homes. That was the lowest level since 1995. And while new-home sales hit the highest level in three years, they were still about 14% below that 2021 level.
Now, the number of homes completed but not yet sold hit the highest level since June 2009...
This signals stress for U.S. consumers. Remember also, this was one of the biggest issues with the homebuilding business during the housing crash...
At that time, homebuilders would buy up lots and build houses, thinking that the high demand would continue. But when demand started to stall, they had sunk a lot of money into empty homes and land. And no one was buying.
We're not calling for another housing crash. Many of the top homebuilders have switched to land-light business models, like the one pioneered by Stansberry Research favorite NVR (NVR).
But this is another sign that cracks might be starting to show in another important part of the U.S. economy. The folks at the Fed, slow to act almost by definition, are paying attention, too.
Their recent 100 basis points of interest-rate cuts haven't made a dent in mortgage rates. So don't expect prospective buyers to surge into the market until the Fed cuts rates by a meaningful amount.
How this impacts tomorrow's Fed decision...
It doesn't. At least not yet.
According to the CME Group's FedWatch Tool, fed-funds futures traders are betting on a 97.3% chance that the Fed leaves rates alone at this month's policy meeting. As we alluded to earlier, the central bank is in wait-and-see mode when it comes to inflation and Trump's new policies and the impact they have on the economy.
Back in 2022, Powell warned of "pain" as rates go up to bring inflation down.
Higher interest rates (relatively speaking to the near-zero levels of the post-financial crisis) are having their impact on the economy. Home sales are hitting decadeslong lows in the face of higher mortgage rates. Folks who are out of work are having a harder time getting a job than any point in the last 80 years, excluding recovery from the two most recent recessions.
As for the consumer, we've highlighted that Americans are falling behind on their credit cards. And the government is even feeling the impact, thanks to a borrowing binge that brings annual interest payments north of $1 trillion.
Inflation has come down but isn't back at the Fed's goal of 2% annualized. The question is, how much longer can the U.S. economy handle this "pain" before the Fed tips us into a recession? The central bank doesn't want to find out.
If the Fed sees room to cut rates this year, it will. This assuredly won't happen tomorrow... but we'll stay tuned to hear clues about Powell and the Fed's future plans.
Remember, the last time the Fed made announcements in December, it projected pulling back on rate cuts in 2025, from four 25-basis-point cuts to two. Central bankers also said they expected high(er) inflation in 2025. The major U.S. stock indexes sold off on the news.
Signs of "status quo" thinking tomorrow could placate the market. Indications of a desire to further juice the economy at any level could be received well. Alternatively, suggestions that the central bank could be "done" all together would likely be a downer.
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New 52-week highs (as of 1/27/25): Abbott Laboratories (ABT), Alpha Architect 1-3 Month Box Fund (BOXX), Cencora (COR), Kellanova (K), Medtronic (MDT), Meta Platforms (META), Markel (MKL), Spotify Technology (SPOT), Stryker (SYK), Twilio (TWLO), Visa (V), VeriSign (VRSN), and Westlake Chemical Partners (WLKP).
In today's mailbag, thoughts on yesterday's edition about the sell-off in AI stocks amid news from Chinese AI startup DeepSeek... Do you have a comment or question? As always, e-mail us at feedback@stansberryresearch.com.
"Feedback to the DeepSeek R1 article... It amazes me how 2-dimensional people can be. China? 'A gift to the world'? A sophisticated system like [a large language model ('LLM')] could be trained to spy... could be a modern 'Trojan Horse'... how would one even detect if its training could potentially support spying. It's not like the answer is in the code to be reviewed by a human. It just amazes me how supposedly intelligent people can be so gullible." – Subscriber Charles V.
All the best,
Corey McLaughlin and Nick Koziol
Baltimore, Maryland
January 28, 2025