DeepSeek's explosive growth, tariff increases, and pause on interest rate cuts: Seven questions and answers about the U.S. stock market

1. The latest guidance from the earnings reports of U.S. hyperscalers shows that their CAPEX plans have not been affected by DeepSeek; 2) Under potential tariff impacts, U.S. heavy machinery manufacturing, automotive manufacturers, transportation, and discretionary consumer retail are expected to be the most affected; 3) If Trump's tariffs are non-escalating, the Federal Reserve may again adopt a "see through" stance; 4) Since the election, the earnings expectations for U.S. financial and service consumer sectors for 2025 have been revised upward the most; 5) The valuation of large-cap stocks in the U.S. market is high, but essential consumer, telecommunications, and pharmaceuticals still offer value; 6) Currently, the liquidity in the U.S. banking system remains ample, but the excess liquidity in the financial system is rapidly depleting, with mid-year being an important observation point; 7) Amid many uncertainties, combined with overly optimistic sentiment, we judge that the U.S. stock market will continue to experience high volatility in a range-bound trading pattern in the short term, and we recommend focusing on healthcare, consumer services, brokerage asset management, AI applications and software, traditional telecommunications, and utilities. After issues such as tariff increases and the Federal Reserve's monetary policy path become clearer, if the mid-year debt ceiling issue also transitions smoothly, and the valuation premium is sufficiently digested, we judge that the style of the U.S. stock market will shift back to large-cap stocks.

DeepSeek's explosive rise, tariff increases, and the pause in interest rate cuts lead to significant fluctuations in the U.S. stock market.

During the Chinese New Year, the U.S. stock market experienced significant volatility, primarily driven by DeepSeek's launch of R1, Trump's announcement of tariff increases on certain countries, and investors' expectations regarding the potential impact of tariff policies on the Federal Reserve's policy path. This led to a significant pullback in the information technology, energy, and industrial sectors. Meanwhile, funds clearly shifted towards more defensive sectors such as consumer staples, communication services, and healthcare.

After DeepSeek's emergence, how will it impact the performance expectations and CAPEX of tech giants?

Although AI computing stocks in the U.S. stock market significantly declined in the week of January 27, their earnings expectations for 2025 (Bloomberg consensus expectations) have not shown significant downward adjustments to date. On one hand, the market may not have yet accounted for DeepSeek's impact in the earnings expectations; on the other hand, the guidance for capital expenditures from U.S. tech giants further supports the revenue expectations for AI computing stocks. According to quarterly reports, earnings calls, and Bloomberg consensus expectations, the latest fiscal year capital expenditure guidance from tech giants is significantly higher than market expectations. Historically, the capital expenditures of tech giants have shown a positive correlation with stock prices, reflecting market expectations that their capital expenditures can reasonably translate into earnings growth. Additionally, these tech giants hold differentiated views on the impact that DeepSeek may bring; this innovation has not yet changed the trend of increased investment in AI infrastructure by U.S. tech giants in the medium to short term. However, we suggest paying attention to whether DeepSeek's innovation in reducing AI training costs will break the positive cycle of capital expenditure, earnings conversion, and stock price appreciation for tech giants.

Under the shadow of tariff increases, which sectors in the U.S. stock market may be most impacted?

On February 1, 2025, U.S. President Trump announced the imposition of additional tariff barriers on China, Mexico, and Canada. The goods imported by the U.S. from Mexico, Canada, and China mainly focus on industrial products, discretionary consumer goods, and raw materials. On the first trading day after the U.S. announced the tariff increase, the U.S. stock market saw significant declines in the discretionary consumer sector (-1.3%) and the industrial sector (-1.0%). The U.S. has officially implemented a 10% additional tariff on China, and if tariffs are also imposed on Mexico and Canada in the future, heavy machinery manufacturers that heavily rely on parts imported from Mexico and China, U.S. automakers with production bases outside the U.S., the U.S. transportation industry expecting a reduction in global trade volume due to tariff impacts, and discretionary consumer goods retailers that heavily depend on imported goods may face significant pressure in the short term.

Trump 2.0, how will the Federal Reserve respond?

The first round of U.S.-China trade friction did not lead the Federal Reserve to raise interest rates beyond expectations. Referring to the relevant forecasts in the Federal Reserve's Tealbook from September 2018, it chose a "see through" stance that year. Therefore, if the U.S. adopts a non-stepwise incremental approach to imposing tariffs, we judge that the Federal Reserve will continue to uphold the "see through" stance rather than raising interest rates beyond expectations to address potential inflation risks. The future trajectory of the U.S. labor market may become the main variable determining the Federal Reserve's monetary policy path. Although investors currently generally expect the Federal Reserve to cut interest rates only twice this year, if the Federal Reserve again adopts a "see through" stance and the U.S. employment situation weakens due to the federal government's hiring freeze/layoffs, it cannot be ruled out that the actual rate cuts this year may exceed current market expectations and the guidance from the Federal Reserve's SEP in December last year. In light of this, we suggest that investors pay attention to the changing trends in the U.S. labor market starting in the second quarter.

How has the U.S. stock market's fundamentals evolved since the election?

As of February 6, among the 306 S&P 500 constituent stocks that have disclosed their latest quarterly reports, the proportions of earnings and revenue exceeding expectations were 60% and 23%, respectively. In terms of earnings, both the proportion of stocks exceeding expectations and the overall magnitude of the exceedance have decreased quarter-on-quarter. Since the last election, although the earnings expectations for the S&P 500 in 2024 have been revised upward, those for 2025 have been revised downward, and this trend is more pronounced when excluding MAG7. Among the primary sectors, only the earnings expectations for financials, communication services, and utilities have been revised upward for 2024/25, while the earnings expectations for cyclical upstream resources, industrials, and real estate have been revised downward the most. In terms of sub-sectors, the two-year earnings expectations for entertainment, aviation, banking, brokerage asset management, cruise lines, and diversified finance have been significantly revised upward during this period. On one hand, the benefits of Trump's new policies for the financial sector are gradually being reflected, and on the other hand, the domestic consumption sector is expected to be relatively less affected by tariffs, with strong investor confidence in the context of a resilient U.S. economy

Although US stock valuations are high, which sectors still have attractiveness?

As of February 3, 2025, the dynamic PE of the S&P 500 Index and the Dow Jones Industrial Average has risen to two standard deviations above their historical averages. At the same time, the free cash flow yield and shareholder cash return rate indicate that the current cost-performance ratio of large-cap blue chips in the US stock market is relatively weak. Given that the risk-free interest rate remains high, we believe that the overall valuation level of US stocks is still relatively high. Among the primary sectors in the US stock market, only a few sectors such as real estate, energy, and healthcare currently have relatively low valuations. Since the beginning of the year, the materials and energy sectors have already undergone a significant valuation expansion phase. Looking back at the period of the China-US trade friction in 2018, especially during the significant correction phase in the US stock market, the dynamic PE of essential consumer goods, telecommunications services, and healthcare sectors showed a counter-cyclical expansion trend, reflecting a shift in investor risk appetite against the backdrop of increased market uncertainty brought about by trade friction.

US stock liquidity remains ample, but how long can this situation last?

Since Trump's victory, institutional investors as measured by EPFR and ICI have been continuously net inflowing into US stocks. However, since December of last year, the trend of institutional net inflows has shown signs of slowing down. Meanwhile, the margin loan balance of individual investors in the US surged in November and December of last year, approaching historical highs since 2021. In addition, although the balances of the US Treasury General Account (TGA) and bank reserves remain relatively ample, the Federal Reserve's reverse repurchase balance has significantly decreased to $455.4 billion, down $433 billion since the beginning of the year, indicating that the excess liquidity in the US financial system is rapidly depleting. While the current liquidity situation in the US financial system remains robust, caution is needed regarding the potential siphoning effect on US stock market liquidity after the resolution of the US debt ceiling issue and the Treasury's resumption of bond issuance. Additionally, against the backdrop of diverging monetary policies between the US and Japan, if arbitrage trades reverse again, it could also impact the US stock market. The aforementioned potential liquidity risk events are expected to become important observation points for the market starting in June this year.

Under multiple uncertainties, which industries in the US stock market are worth allocating?

In the first half of this year, the US stock market is facing multiple uncertainties, including Trump's tariff policies, the Federal Reserve's interest rate policies, and the slower-than-expected growth of cloud computing and data center businesses of certain tech giants. Furthermore, the overall valuation of US stocks remains high, and the previous optimistic sentiment regarding the economy "not landing," "tax cuts and deregulation" has been fully priced in, lacking further upward catalytic momentum. Therefore, before these issues are clarified, the US stock market is expected to continue a high-volatility range-bound trading pattern. We recommend focusing on: 1) healthcare with reasonable valuations and strong defensive attributes; 2) service-oriented consumption driven by domestic demand; 3) brokerages and asset management firms with improving industry prosperity; 4) AI applications and software targets benefiting from expected declines in computing costs; 5) traditional telecommunications and utilities with high dividend yields. After the issues of tariffs and the Federal Reserve's monetary policy path are clarified, if the mid-year debt ceiling issue also transitions smoothly and the valuation premium is sufficiently digested, we judge that the style of US stocks will switch back to large-cap blue chips

Risk Factors:

1. Intensified trade frictions between the U.S. and the world; 2) The Federal Reserve's interest rate cuts falling short of expectations or tightening monetary policy beyond expectations; 3) A liquidity crisis erupting in the U.S. financial system; 4) U.S. stock performance generally falling short of expectations.

Authors of this article: Xu Guanghong, Wang Yihan, Source: CITIC Securities Research, Original title: "Overseas Research | DeepSeek's Surge, Tariff Increases, and Seven Questions and Answers After Pausing Interest Rate Cuts."

Xu Guanghong S1010114110085

Wang Yihan S1010522050002

Risk Warning and Disclaimer

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