Wentz Weekly: Risk Off Rotation

Wentz Weekly Insights
Stocks Move Lower on Risk Off Rotation

US stocks were mostly lower last week with the S&P 500, Nasdaq, and Russell 2000 each down for the second straight week. The Dow managed to end with a 1% gain as markets continue to see a risk off rotation. Risk assets saw the largest weekly decline, for example the tech sector fell 4% and Bitcoin fell 12% for its largest weekly decline since August 2023. Markets were faced with a number of rising worries including AI investment inflection point, growth slowdowns, high inflation, and Trump policy uncertainty.

We did see a small rally in Treasuries as yields fell across the curve. The 2-year and 10-year yields each fell around 20 basis points, falling to 4.01% and 4.22%, respectively. But yields are still above where they were for most of the second half of 2024. In addition, spreads on high yield bonds (junk bonds) remain very tight, suggesting worries on the economy remain minimal.

For most of two years, investors have favored technology companies, particularly those involved in artificial intelligence, due to the massive spending by companies to advance their offerings. Leading the way is Nvidia, which develops the chips that are used in data centers to power AI capabilities. Its highly anticipated quarterly earnings report was released last week.

The company said its revenues were $39.33 billion in the quarter, over $1 billion more than expected and rising over $17 billion from $22.10 billion the same quarter a year earlier. Its guidance was just as solid – it said it expects this quarter’s revenues to be around $43 billion, much more than the $42 billion that analysts were expecting.

However, its stock fell 8.5% the first day after its earnings release. It wasn’t that the company had bad results or expected the future to weaken, it was is magnitude of its earnings beat has been narrowing – its guidance that was $1 billion more than expected lagged more recent quarters that were $2 billion more than expectations, leading to worries about an inflection in growth.

Beside margins slightly lower than expected, everything else around the earnings and its call were solid. Demand for the company’s newest and most advanced chip architecture, called Blackwell, was called “extraordinary” by management where production has fully ramped.

This is where some of the largest companies in the world have invested the most. Those like Microsoft, Amazon, Alphabet (Google), and Meta (Facebook) are spending billions each year to build data centers in the race for AI and cloud computing. In recent weeks, these companies have doubled down on their AI spending. Amazon said it expects to spend over $100 billion, Microsoft said it will spend at least $80 billion, Alphabet $75 billion, and Meta $65 billion, on capital spending to continue building out their data centers. This spending consumes about 25% of the collective revenue between the four. The chart below from the Wall Street Journal reflects the quarterly capital spending by each of the top four (as of February 6, 2025).

As we saw several weeks ago, there are worries surfacing in the AI space. The biggest so far was that some are able to replicated the same AI capabilities while spending a fraction of the money. This specifically came from a Chinese company DeepSeek that resulted in a brief selloff.

Another worry is skepticism about the returns on such substantial costs and how companies plan to monetize/profit off these investments in the long run. It will eventually turn into a “show me” story for investors. The four companies above have transitions from cash cows, generating billions in free cash each year, to very capital intensive businesses due to investing in AI. The amount being invested is quite large, especially since very little of that revenue is being driven by AI so far. But the expectation is, with building skepticism, these companies can monetize this soon.

This, among other reasons, have led to recent weakness in the tech sector. Markets have actually seen a rotation in recent weeks, selling off the higher growth sectors like technology, consumer discretionary, and communication services, in favor of defensive sectors like healthcare and consumer staples. In fact, consumer discretionary and technology are the only two sectors negative this year, down 4.30% and 5.44% respectively.

We are not surprised to see the recent weakness for a number of reasons, most of it revolving around heightened uncertainty and valuations. As we mentioned last week, earnings growth expectations have ticked down over the past two months (since earnings season started mid-January). In addition, there are many talks about layoffs in the government sector, headlines about tariffs and government spending cuts, and high inflation, resulting in a sharp drop in consumer confidence. If consumer confidence remains low, the concern is it could lead to cut back in spending and a hit to economic growth.

Week in Review:
Stocks were mostly lower last week outside of defensive sectors like healthcare and consumer staples which led to a gain for the Dow. The major U.S. stock indices finished as follows: Dow +0.95%, S&P 500 -0.98%, Russell 2000 -1.47%, and Nasdaq -3.47%. Treasuries saw a boost as investors moved to risk off mode. The 2-year Treasury yield fell 19 basis points to 4.01% and the 10-year yield fell 21 basis points to 4.22%. The dollar index rose 0.94%, Gold fell 3.43%, while Bitcoin saw its largest weekly decline since August 2023 after falling 12.2%. Oil fell 0.91%.

Recent Economic Data

• Personal income and outlays:
  • Personal income rose at a much faster pace than expected in January, up 0.9% in the month following a 0.4% increase from December. Incomes are now up 4.6% from a year earlier. The larger increase was due to a 2.8% increase in social security benefits, and up 6.0% over the past year, due to cost-of-living adjustments. Wages and salaries, the largest category of income, grew 0.4% in the month and up 4.5% over the past year.
  • Consumer spending decline 0.2%, correlating to the retail sales report which showed a decline in sales, but still up a solid 5.4% from a year ago. The slowdown in spending was due to a 1.2% decline in spending on goods, but somewhat offset by a 0.3% increase in services spending.
  • The personal savings rate remains historically low at 4.6%, well below the pre-covid 10-year average of 7.5%, but moving higher from 3.5% in December.
  • The PCE price index, another closely followed inflation reading, increased 0.3% in January as expected with the annual rate at 2.5%. Core prices rose 0.3% and are up 2.6% from a year ago, also both as expected.

• GDP: Fourth quarter 2024 GDP rose at an annualized pace of 2.3% in the quarter based on the first estimate released last month, and was unrevised in the second estimate based on more complete source data. For the second estimate there was an upward revision in government spending and exports, which were partially offset by downward revisions in consumer spending and investments.

• Case Shiller Home Price Index: Home prices continue to rise in the latest month of data. The S&P Case Shiller home price index showed home prices increased 0.5% in December (after seasonal adjustments, but down 0.1% prior to adjustments), following a 0.4% increase from November. The annual increase was 3.9%, up from the 3.7% annual gain in the previous month, both a little below the historical average of the index. Home prices stalled the second half of 2024 with prices in the West dropping the fastest. In fact, San Francisco is now 11% below its peak May 2022. New York saw the fastest home price gains over the past year, up 7.2% with Tampa the slowest with a 1.1% decline. Since Covid (2020), home prices have risen 8.8% annually, led by Florida, North Carolina, Southern California, and Arizona.

• New Home Sales: Sales of new homes in the U.S. were at a seasonally adjusted annualized rate of 657,000 in January, a 10.5% decline from December, but like the existing home sales report may be due to the colder weather. The sales pace was 1.1% below the level from a year earlier, so overall home sales have seen a lack of improvement. The median price of a new home sold was up 3.7% from last year to $446,300. Inventory of new homes has steadily improved, with a current supply of 495,000 new homes, with most of those coming from completed homes (versus homes not yet constructed), another sign the housing market continues to slow even further.

• Consumer Confidence Index: The headline on the Consumer Confidence index was “pessimism about the future returned.” The confidence index declined by 7 points in February to 98.3 versus the expectation of at least 102. This was the lowest confidence reading since June. The index has declined for three consecutive months and is at the bottom of the range that has prevailed since 2022. The present situations index was slightly better than expected at 136.5, but down 3.4 points from January. The expectations index was a major disappointment, declining 9.3 points to 72.9 for the weakest level since June. A reading below 80 usually signals a recession ahead.

• Durable Goods Orders: Durable goods orders for January increased 3.1%, a quite large monthly increase, better than the 1.9% increase expected, but comes after a 1.8% decline from the month prior. Wide swings in orders are typically due to aircraft orders, which was the case here where nondefense aircraft orders increased 93.9% after a 28.9% and 20.1% decline the two prior months. Excluding transportation, durable goods orders were flat in the month, lower than the 0.4% increase expected. However, the index for core capital goods orders increased a solid 0.8% in the month, nearly double the expectation.

• Jobless Claims: The number of jobless claims for the week ended February 22 increased 22,000 from the prior week to total 242,000 the first sizeable increase in months. The four-week average increased 8.5k to 224,000, still relatively low. The number of continuing claims was 1.862 million, down 5k from the week prior with the four-week average relatively unchanged at 1.865 million.

• Money Supply: The amount of money in circulation, called the money supply which includes cash, deposits at banks and money market balances, increased $12.1 billion in January, smaller than a 0.1% increase for the month, but is up 3.9% over the past year, a relatively high number. Money supply saw a record $6.32 trillion, or 41%, increase from the beginning of the pandemic to 2022, the root cause of inflation. Since then, it moved lower for a brief period but is back to rising at a faster pace than normal, which should keep upward pressure on inflation.

Company News

• Apple: Apple said it plans to spend and invest more than $500 billion in the U.S. over the next four years making it its largest spend commitment ever. The spending will focus on artificial intelligence, silicon engineering, and employment/worker development. The plans include Apple TV production in 20 states, a new factory in Texas, doubling the US Advanced Manufacturing Fund, a manufacturing academy, and accelerated investment in AI and silicon engineering.

• Nippon Steel: Nippon Steel is attempting to work with the government to push through their deal to acquire US Steel. Reuters reported Nippon President said the current deal framework is a starting point for discussions it is planning to start with the Commerce Department. Recall Trump suggested Nippon take a minority stake in US Steel instead of an outright purchase.

• Microsoft: Technology stocks and stocks related to nuclear energy sold off to start the week after a sell side analyst said Microsoft has begun cancelling leases for a significant amount of U.S. datacenter capacity, creating concerns the company is building more data centers/AI computing that it will actually need. The analyst noted, citing inquiries with supply chain providers, Microsoft has voided leases in the U.S. totaling “a couple hundred megawatts” of capacity which is the equivalent of about two data centers. Microsoft responded saying that while it sometimes makes spending adjustments, it remains on track to spend more than $80 billion this year in infrastructure/data centers.

• Nvidia: Reuters reported Chinese tech companies like Alibaba, Tencent, and ByteDance (TikTok) have “significantly increased” orders for Nvidia’s H20 graphic chips that are used to run AI, and which was specifically developed for China to get around export controls, due to rising demand for DeepSeeks lower-cost AI models.

• Meta: The Information reported Meta is in discussions to construct a new data center campus for its AI projects that would potentially cost over $200 billion. It was the most recent earnings report last month that CEO Zuckerberg said the company was planning to spend $65 billion this year on AI infrastructure.

• Meta: CNBC reported Meta is planning on releasing its own standalone app that will focus on an artificial intelligence driven chatbot. The move is in effort to compete with those like OpenAI’s ChatGPT, Google’s Gemini, and others. It is expected to be released in the second quarter. The report added Meta is planning to test a paid subscription for the service.

Other News:

• Semiconductor Export Restrictions: It was reported by Bloomberg the Trump Administration is planning to toughen restrictions on semiconductor exports even more than the Biden-era restrictions, which were already seen as tough. The administration is also holding meetings with key allies on new limits on exports to China to ramp their efforts to toughen restrictions to limit China’s access to advanced chips. The report said the administration is looking at specific things like curbing chip sales from Nvidia that it specifically designed for China to get around previous restrictions, and reducing computing power than can be exported without a license.

• Canada & Mexico Tariffs: Trump said tariffs on Mexico and Canada will go forward as planned March 4, after an agreement was made last month prior to the previous February 1 implementation date to give both sides more time for negotiations.

• Government Layoffs: According to a February 26 memo obtained by the media, the Trump Administration directed U.S. federal agencies to prepare reorganization plans to enact mass layoffs, calling the federal government “costly, inefficient, and deeply in debt.” It added the leaders of departments should “promptly undertake preparations to initiate large-scale reduction in force,” with reorganization plans to be submitted no later than March 13.

• Budget Reconciliation Package: Early in the week the House advanced a budget resolution in a 217-215 vote (with only one Republican voting against) that includes $4.5 trillion in tax cut extensions and $2 trillion reduction in federal spending over a decade, along with addressing immigration and border security, energy deregulation, military spending, and a debt ceiling increase. The resolution now moves to the Senate and if passed, the two chambers can nail down their difference and draft the actual legislation. However, there seems to be a lack of consensus in Congress as the government shutdown deadline of March 14 nears.

• Zelensky & Trump Meeting: Ukraine President Volodymyr Zelensky made a visit to the White House on Friday to meet with the Trump Administration in attempt to strike a deal that would allow the U.S. to share future revenues from the nation’s natural resources in return for security guarantees needed to deter Russia from expanding the war, and that may lead to peace deals with Russia. However, the meeting in the Oval Office turned into a heated exchange with Trump and Vance berating Zelensky with Zelensky leaving the White House with no deal.

• Fed Talk: There were several Fed policymakers making notable comments last week. Kansas City Fed president Schmid said he is less optimistic inflation will come down as expected given the possible tariffs and their impacts. Cleveland’s president Hammack said it is uncertain inflation will come down to the 2% target adding upside risks to inflation remain and that current rates may already be close to neutral. 

WFG News

Tax Documents

Please see this release to understand the timing on when to expect tax documents.