DeepSeek Undermines Robust Earnings And Economic Growth

This week is the busiest of the fourth-quarter earnings season, with 130 S&P 500 companies scheduled to report. 77% of S&P 500 firms reported better-than-expected earnings for the quarter. Four of the Magnificent 7 reported earnings last week, with another two coming this week. The Magnificent 7 consists of Microsoft (MSFT), Meta Platforms (META), Amazon.com (AMZN), Apple (AAPL), NVIDIA (NVDA), Alphabet (GOOGL), and Tesla (TSLA).

Despite overall better earnings and resilient U.S. economic growth, the announcement of DeepSeek development and President Trump’s threatened tariffs against China, Canada, and Mexico caused crosscurrents in the markets. The S&P 500 fell 1% for the week, and the Magnificent 7 lost 0.8%.

Market Implications Of DeepSeek

Though DeepSeek’s artificial intelligence large language model (LLM) was released in December 2024, it rattled the technology sector when it became the most downloaded application on the Apple store last week. There remain many unanswered questions about DeepSeek, but there are some crucial investment implications of the technology regardless of the issues.

While DeepSeek almost certainly spent more than disclosed and may have utilized others’ intellectual property, their artificial intelligence model seems to provide competitive performance at a lower development cost using less electricity and less powerful semiconductor chips. Because DeepSeek is a Chinese company, its LLM is not likely to be used directly by U.S. companies. Still, it is open-source, so others here will undoubtedly use its innovations to build their models quickly.

Before DeepSeek, the development of artificial intelligence (AI) was an arms race, with the thought that massive spending on infrastructure, electricity, data, and bleeding-edge semiconductor chips was needed to compete. NVIDIA (NVDA) was the most direct beneficiary of this environment, as the company is dominant in providing the most advanced AI chips.

The innovations from DeepSeek have opened a new path for lower-cost AI models. While these models are less powerful, they could be offered to customers in a low or no-cost model. This has shifted the balance of market power between the developers and suppliers to large language models, and the companies are utilizing those models internally or offering them to consumers to favor the latter more than previously thought. The most striking example of this shift is the decline in NVIDIA (NVDA) last week, while Amazon (AMZN) and Apple (AAPL) rose.

All is not likely lost for companies like NVIDIA, however. There should still be robust demand for NVIDIA’s high-end chips because the most advanced AI applications will still require that computing power. In addition, the lower the price of artificial intelligence services, the more demand there will be over time. The shift is a reminder of capitalism’s creative destruction, especially regarding new technology.

Fourth-Quarter Earnings Results

According to FactSet data, the communication services and technology sectors contributed most significantly to last week’s earnings growth improvement, while the industrials sector was the largest detractor. Meta Platforms (META) was the most significant contributor to communication services, with Microsoft (MSFT) and Apple (AAPL) being the most critical contributors to the technology sector. On the other side of the ledger, earnings misses by Boeing (BA) and Lockheed Martin (LMT) were the most significant detractors within industrials.

The financial sector is expected to show the most rapid year-over-year growth rate in the S&P 500, followed by technology and communications services. The energy sector is at the bottom, with a forecasted almost twenty-nine percent decline in year-over-year earnings.

Sales growth is closely tied to nominal GDP growth, which combines after-inflation economic growth (real GDP) with inflation. At this point in the earnings season, sales growth at 4.6% has met expectations, with the tailwind from 5% year-over-year nominal GDP growth.

Due primarily to the robust earnings growth for communication services and banks, the blended earnings performance improved last week and has outperformed expectations at the end of the quarter. Combining actual results with consensus estimates for companies yet to report, the blended earnings growth rate for the quarter is at +13.2% year-over-year, above the expectation of +11.9% at the end of the quarter.

Magnificent 7 Earnings

Because these companies are a critical driver of earnings growth and a significant percentage of the S&P 500’s market capitalization, the Magnificent 7 remain the group to watch this earnings season. Microsoft (MSFT), Meta Platforms (META), Tesla (TSLA), and Apple (AAPL) reported last week, with all but Tesla besting consensus estimates. Market reaction was more mixed as Microsoft’s cloud earnings growth was disappointing, and the promise of Tesla robotaxis helped cushion the missed earnings. In addition, the DeepSeek introduction added to the difficulty in attributing this week’s price performance to earnings. This week, Alphabet (GOOGL) and Amazon (AMZN) report after the close on Tuesday and Thursday, respectively. The forward earnings guidance and implications for artificial intelligence spending will be watched closely.

Beyond the Magnificent 7, other notable companies reporting are Merck (MRK), Pfizer (PFE), PepsiCo (PEP), Advanced Micro Devices (AMD), Walt Disney (DIS), and Eli Lilly (LLY).

Economic Growth And Outlook

Last week, headline economic growth was reported at a below-consensus 2.3% in the fourth quarter, but the details painted a prettier picture of the economic situation. Final sales to private domestic purchasers, which excludes government spending, exports, and any change in inventories, grew by 3.2%, which is evidence that spending by households and businesses remained robust in the quarter.

As widely expected, the Federal Reserve did not change short-term interest rates. Due to good economic momentum and above-target inflation, the Fed is not expected to alter monetary policy until mid-year. Currently, expectations are for a total of two 25 basis point (0.25%) reductions in 2025.

The monthly jobs report on Friday will be closely watched as jobs are the canary in the coal mine for economic growth. Struggling economic growth outside the U.S. and the possible impacts of tariffs adds further uncertainty to any outlook.

What To Watch This Week

The earnings from technology and communication services didn’t disappoint, but the story was upended by the DeepSeek news. Two more Magnificent 7 companies, Alphabet (GOOGL) and Amazon (AMZN), report earnings this week, and their earnings and forward guidance will be crucial. DeepSeek shows that the end of the artificial intelligence story has not yet been written so that investors will monitor the situation closely. In addition to being the busiest week of the earnings season, the tariffs on China, Canada, and Mexico, along with Friday’s monthly jobs report, could add to the market volatility.