Deepseek Rattles Markets

Welcome to this week's Forward Thesis, where we analyze the technological and market developments shaping our future. This week has been particularly eventful, with major policy shifts, AI breakthroughs, and market turbulence creating ripple effects across the global economy.

Let's dive into the key stories moving markets.

Understanding the Impact

President Trump has launched his most aggressive trade action yet, announcing sweeping tariffs on multiple fronts:

• 25% tariffs on goods from Canada and Mexico

• 10% tariffs on Chinese imports

• Special 10% rate for Canadian energy resources

These tariffs carry significant implications across industries and borders. The energy sector looks particularly vulnerable - Canadian crude oil imports, which supply over 4 million barrels daily to U.S. refineries, could see immediate price impacts. Analysts estimate gasoline prices could jump $0.30-0.70 per gallon in affected regions.

Notably, Midwest refineries are uniquely exposed, with 62% of their crude coming from Canada. The specialized nature of these facilities means they can't easily switch suppliers - they're designed specifically for Canadian heavy crude. This creates an interesting dynamic where Trump's core voter base could feel the most acute economic impact.

Key industries in the crosshairs:

• Automotive: New vehicle prices estimated to rise $3,000 on average

• Technology: Semiconductor and electronics supply chains face disruption

• Agriculture: Mexico and Canada likely to implement retaliatory tariffs

• Energy: Refined products and natural gas face cost pressures

The timing and implementation remain somewhat uncertain. While initially announced for February 1st, some measures may be delayed as negotiations continue. The administration has indicated it's "not looking for concessions," suggesting these may be more than just negotiating tactics.

Reading Between the Lines

The Federal Reserve maintained its pause on rate movements this week, keeping the target range at 4.25-4.50%. More interesting than the hold itself was the subtle shift in language around inflation concerns.

The statement dropped references to "progress on inflation," signaling increased focus on price stability. While Chair Powell attempted to downplay this change as "cleaning up language," the market's whipsaw reaction highlighted its significance.

Key data points influencing the Fed's stance:

• GDP growth: Q4 came in at 2.3%, below 2.6% consensus

• Consumer spending: Remained robust at 4.2%

• Initial jobless claims: Showed significant improvement

• Core PCE inflation: Holding at 2.8% year-over-year

The probability of a March rate cut has dropped to 18% from 27% last week, according to CME's FedWatch tool. Markets are now pricing in a more patient Fed, particularly given uncertainty around tariff impacts on inflation.

The combination of steady rates and strong consumer spending data has created an interesting dynamic in equity markets. Growth stocks, particularly in tech, have shown sensitivity to these developments, while financial sector stocks have remained relatively stable. The steepening yield curve suggests markets are pricing in a "higher for longer" scenario, which historically has benefited value stocks over growth names.

Separating Signal from Noise

The market's violent reaction to DeepSeek's AI breakthrough - wiping out over $1 trillion in tech market cap - deserves careful analysis. While initial reports focused on the claimed $6 million development cost, deeper investigation reveals a more complex picture.

The U.S. Commerce Department is now investigating whether DeepSeek accessed restricted U.S. chips through third countries. Sources suggest the company may have accumulated over 50,000 Nvidia GPUs before sanctions, significantly higher than their claimed 2,048 chips.

Market impact by the numbers:

• Nvidia: -17% drop (-$589B) Monday, +11% (+$260B) Tuesday

• Energy stocks: -20% average decline post-announcement

• Broader tech sector: Average -12% decline before partial recovery

Anthropic CEO Dario Amodei noted the following.

This growing skepticism about DeepSeek's claims has helped restore some confidence in U.S. AI companies' massive infrastructure investments.

If achieving state-of-the-art AI performance truly requires the kind of extensive compute resources and sophisticated infrastructure that companies like Microsoft, OpenAI, and Google have built, it validates their aggressive capital expenditure strategies.

Big Tech Shows Resilience

Despite market turbulence, Q4 earnings have largely exceeded expectations:

Standout performers:

• Nvidia: Beat by 18.32% ($5.16 EPS)

• Meta: Beat by 10.12% ($5.33 EPS)

• Microsoft: Beat by 3.83% ($3.23 EPS)

Notable misses:

• Boeing: Missed by 96.8% (-$5.90 EPS)

• Tesla: Missed by 8.97% ($0.71 EPS)

Looking ahead to next week's key reports:

• Google/Alphabet (Tuesday): Est. $2.12 EPS

• Amazon (Thursday): Est. $1.49 EPS

• Disney (Wednesday): Est. $1.43 EPS

ECB Rate Cut: Melting Savings

While the Fed holds steady, the European Central Bank (ECB) made a notable policy shift this week, cutting its deposit rate to 2.75%. This move marks a significant milestone: for the first time since September 2023, the ECB's deposit rate has fallen below Germany's inflation rate, currently at 2.80%.

This creates a challenging dynamic for European savers. When interest rates fall below inflation, real returns turn negative, effectively eroding the purchasing power of saved capital. After accounting for taxes on interest income, the effective erosion of purchasing power becomes even more pronounced.For example, a 2.75% return on deposits, further reduced by taxes, fails to keep pace with 2.80% inflation, meaning European savers are effectively losing wealth in real terms.

While the Fed maintains a cautious stance on rate cuts, European policymakers appear more willing to risk negative real rates to support economic growth. This policy divergence could have significant implications for currency markets and global capital flows in the coming months.

This monetary environment creates a significant dilemma for conservative investors and retirees who traditionally rely on interest-bearing accounts to preserve capital. But may present market opportunities in the coming months.

Several significant product launches caught our attention:

1. OpenAI's Government Push

   The company launched ChatGPT Gov, targeting U.S. government agencies with enhanced security features. Although many are proponents of an efficient government, the use of AI to replace jobs remains controversial. The timing aligns with growing concerns about Chinese AI advancement.

2. OpenAI Operator

   A new AI agent capable of automating web tasks launched in beta. Instead of chatting with a bot to answer questions, Operator will have their own browser, capable of completing complex tasks for you. While showing promise, early reviews note significant limitations and required user oversight.

3. Apple-Starlink Partnership

   Apple quietly added Starlink satellite connectivity to iOS 18.3, marking a significant shift in mobile connectivity options. The service initially focuses on emergency messaging with plans for voice and data expansion.

As we navigate these complex market dynamics, it's becoming increasingly clear that the intersection of policy, technology, and market sentiment is creating both challenges and opportunities that are important to understand.

But that’s why you read The Forward Thesis.

Until next time.