Bob’s Journal for 1/30
Some Initial Thoughts on the DeepSeek AI Shock
It’s probably fitting that significant doubts were raised about the recent boom in artificial intelligence (AI) stocks so close to the 25th anniversary of the technology stock bubble bursting in March 2000.
Many people have drawn comparisons between recent activity in AI stocks and the tech stock bubble. Technology stocks in general and AI-related stocks in particular have earned very high returns since ChatGPT was released to the public in late 2022.
The surge drove the technology sector to become more than 35% of the S&P 500 Index. Since most of the leading tech stocks are U.S.-based, U.S. stocks rose to about 67% of global stock indexes.
Many in the media spent last weekend discussing details of the new AI model, R1, from China-based company DeepSeek. The model delivered results better than or comparable to those of the established AI models, and at a much lower cost.
Markets quickly revalued the major AI stocks over the weekend. On Monday, the stocks quickly lost value. U.S. stocks were estimated to decline by $1 trillion for the day, with Nvidia alone losing $600 billion.
The episode demonstrates again the value of diversification and balance and the risks of concentration. Concentrating a portfolio in a narrow range of investments is great when the investor calls market trends correctly. But it is painful when market trends shift.
Many concentrated investors believe they’ll exit their positions before the peak, but the peak often arrives quickly and with little or no warning.
Index investing isn’t always the safe, diversified bet people think it is. In capitalization-weighted indexes, such as the S&P 500, when the biggest stocks continue to become bigger they take up a larger share of the index. The diversification of the index is reduced, and the investors are making big bets on a few stocks or sectors.
Index investors can lose quite a bit of money when markets suddenly lose confidence in the big companies that were favorites a few days earlier.
For example, the S&P 500 lost 1.41% on Monday, and the Nasdaq 100 declined dropped 2.91%. But the equal-weighted S&P 500 gained 0.07% on Monday and the smaller company Russell 2000 fell only 0.96%.
Despite the losses in the major indexes, more stocks rose than fell on Monday. In the S&P 500, 351 stocks advanced while 152 declined. Only three sectors in the index were down for the day.
If the results of DeepSeek’s model hold up and its stated cost is accurate (and some people say those aren’t certainties), there are some longer-term implications.
For the economy, and most companies, it’s very good news.
AI will be less expensive and more readily available than previously projected. More businesses will be able to use it sooner to increase productivity, lower costs and increase profits.
Economic growth in both the United States and the world should increase.
The DeepSeek news also makes it less likely that one or a few companies will dominate and reap most of the profits in AI.
DeepSeek released the model’s details to the public, making it an open-source model. Other companies can use it, improve it, and customize it without having to pay for the basic model.
That could be bad news for the companies that were expected to benefit from large capital expenditures on AI, Nvidia being foremost among them. But other producers of microchips, energy, and other AI infrastructure also could be in trouble. Many of their stocks lost more than 20% on Monday.
The news also indicates the United States might no longer dominate AI and might not have the proprietary technology edge many believed.
Another lesson for investors is that it doesn’t take much for highly valued investments to lose a lot of their value in a hurry.
AI stocks soared to extreme valuations and brought the S&P 500 Index near its highest-ever valuations. Those valuations were said to be justified by the fundamentals, especially the growth in AI investments.
The support for those valuations disappeared quickly along with a lot of investor wealth. Even with index funds, an investor must look into the details and realize the risks that are being taken.
How Will Congress Reduce the Budget Deficits?
Elected officials are quick to talk about ideas to reduce taxes and increase spending. But there’s less chatter about how to do these things while reducing the federal budget deficits.
But there are some clues. The House Ways and Means Committee recently released to its members a summary of more than 200 ideas for reducing the deficits.
The ideas are separated by policy area (health, energy, tax, etc.). Each idea has a rough estimate of how much it would reduce spending or increase tax revenue. Some of the ideas indicate they would cost money.
There are brief descriptions of each idea, usually consisting of a sentence or two. The descriptions sometimes don’t make clear what’s being proposed, especially for someone who’s not a wonk in that particular policy area.
The list is worth a review if you want an idea of what at least some in Congress are thinking.
Congress also is said to be looking at some tax-raising ideas that weren’t enacted in the recent past but have a lot of supporters, according to T. Rowe Price’s Director of Congressional Affairs Aliya Robinson.
The ideas were proposed by Democrats in the past. But Robinson indicated that there are enough populists among Republicans who support actions that hurt the wealthy.
One idea Robinson believes is viable is a cap on the value of IRAs. In 2021, a proposal to limit IRA balances to $10 million almost became law. The law would have required anyone with IRAs exceeding $10 million in value to begin taking significant distributions from them each year.
The backdoor Roth IRA also could be targeted for elimination. Taxpayers with incomes above certain levels aren’t allowed to contribute to Roth IRAs. The backdoor strategy allows the higher-income taxpayers to avoid the limits by contributing to a traditional IRA and then converting it to a Roth IRA.
Congress also might consider ending traditional retirement accounts and forcing all future retirement account contributions to be treated as Roth-type accounts, “Rothifying” retirement accounts.
Congress might Rothify all retirement accounts or continue to gradually Rothify them. For example, beginning in 2025 when high-income employees make catch-up contributions to 401(k) plans, those contributions must be made to Roth accounts. There are no up-front tax benefits for the contributions.
Some in Congress want to eliminate catch-up contributions for higher-income taxpayers.
The financial services and retirement community lobbyists are likely to fight all these and other proposals but expect them to be discussed seriously this year.
The Data
The Consumer Sentiment Index from the University of Michigan fell to 71.1 in January from 74.0 at the end of December and 73.2 in mid-January.
Sentiment regarding both expectations and assessments of current conditions declined, with current conditions declining the most.
The Consumer Confidence Index from The Conference Board fell to 104.1 in January from an upwardly revised 109.5 in December. The Present Situation Index fell sharply while the Expectations Index declined less.
The PMI Services Flash Index through mid-January was 52.8, the lowest level since April 2024, down from 56.8 at the end of December.
The PMI Manufacturing Flash Index was 50.1 at mid-January, an improvement from 49.4 at the end of December.
The PMI Composite Flash Index for the economy was 52.4 at mid-January, down from 55.4 at the end of December. The mid-January number is the lowest in nine months.
The Dallas Fed Manufacturing Index rose to 14.1 in January, the highest level since early 2022, from 3.4 in December.
The Richmond Fed Manufacturing Index improved to negative 4 in January from negative 10 in December.
The Kansas City Fed Manufacturing Index dropped to negative 9 in January from negative 6 in December. The index has been positive only twice in the last 12 months.
Durable goods orders fell 2.2% in December after falling 2.0% in November.
Excluding defense and aircraft orders, which is considered a good proxy for business investment, orders of durable goods increased 0.5% in December and 0.9% in November.
The S&P Corelogic Case-Shiller Home Price Index fell 0.1% in November after dropping 0.2% in October.
Over 12 months, the index was up 4.3% through November and 4.2% through October.
The FHFA House Price Index gained 0.3% in November, following a 0.5% rise in October. Over 12 months, the index rose 4.2% through November and 4.5% through October.
New home sales increased another 3.6% in December, following a 9.6% increase in November.
Existing home sales rose 2.2% in December after a 4.8% rise in November. The number of homes sold has increased each of the last three months.
But the total number of existing homes sold in 2024 was the lowest since 1995.
New unemployment claims increased by 6,000 to 223,000 in the latest week.
Continuing claims, which lag a week behind new claims, increased to 1.899 million from 1.853 million.
The Markets
The S&P 500 rose 0.24% for the week ended with Tuesday’s close. The Dow Jones Industrial Average gained 1.89%. The Russell 2000 dropped 1.32%. The All-Country World Index (excluding U.S. stocks) added 0.60%. Emerging market equities fell 0.11%.
Long-term treasuries advanced 0.22% for the week. Investment-grade bonds increased 0.30%. Treasury Inflation-Protected Securities (TIPS) added 0.64%. High-yield bonds gained 0.14%.
On the currency front, the U.S. dollar declined 0.03%.
Energy-based commodities fell 1.51%. Broader-based commodities lost 1.65%. Gold gained 0.81%.
Bob’s News & Updates
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