The fallout from DeepSeek continues

As we wrote about last week, Chinese AI startup DeepSeek unveiled its AI model, R1, which rivals leading models like OpenAI's ChatGPT but was developed at a fraction of the cost and using less advanced hardware. This development led to a significant market reaction. Nvidia's stock experienced a historic 17% drop on Monday, erasing nearly $600 billion in market value—the largest single-day loss in U.S. history. Investors expressed concerns that DeepSeek's efficient approach could diminish the demand for Nvidia's high-end GPUs, which are integral to many AI applications. However, some analysts argue that increased efficiency might boost overall AI adoption, potentially leading to greater demand for advanced processors in the long run. Overall, while DeepSeek's emergence has introduced new dynamics into the AI industry, Nvidia remains a key player, and the long-term implications of this development are still unfolding.

• As new information is discovered, it seems like DeepSeek did cost significantly more than what was initially reported
• However, it also seems the company was able to utilize more efficient training techniques, which should serve as a lesson for US AI companies going forward
• There have been lots of comparisons of Nvidia’s chips used for AI to the fiber optic cable buildout during the early days of the internet
• As we now know with hindsight, companies overbuild fiber optic network supply given initial demand, and prices crashed (and so did stocks)
• However, that supply was eventually utilized as new services such as Netflix streaming came online
• It isn't clear yet if the current situation with Nvidia chips is similar to the telecom overbuild in the 1990’s
• Some main points of contrast are that it seems we are still early in AI adoption, and the Nvidia GPUs are proprietary and evolving technology
• That said, if Nvidia’s customers begin to scale back their level of purchases as they discover they can use less compute for their models and use cases, it could put pressure on the company’s valuation

US economy diverges from Europe

The U.S. economy expanded at an annualized rate of 2.3% in the fourth quarter of 2024, marking a slowdown from the previous quarter’s 3.1% growth but still demonstrating resilience driven by consumer spending and government expenditures. In contrast, the eurozone’s economy stagnated, with GDP remaining flat in Q4 and Germany even contracting by 0.2%, underscoring continued economic weakness across the region. While the U.S. has managed to sustain moderate growth despite high interest rates, Europe is grappling with sluggish demand and structural challenges that have kept its recovery subdued. This divergence highlights the relative strength of the American economy, while Europe faces persistent headwinds heading into 2025.

• The strength of the US economy, in particular relative to Europe, is going to make it hard for the Federal Reserve to continue cutting interest rates
• Relatedly, this week, the Fed met and kept rates steady as they adjusted their stance to be slightly more “hawkish” (less willing to cut)
• In contrast, the European Central Bank (ECB) cut interest rates yet again this week
• The difference in the absolute level of interest rates will have an effect on the value of the US dollar, particularly versus countries and regions that are lowering interest rates
• A stronger US dollar is a headwind to our trade deficit as US goods and services become relatively more expensive
• It will also have a negative effect on US based muti-national corporations as they repatriate profits back from weaker currency regions

Housing market challenges

Recent data indicates that the U.S. housing market experienced a significant decline in transactions during 2024. Existing-home sales fell to 4.06 million units, marking the lowest level since 1995. This downturn is attributed to persistently high mortgage rates, elevated home prices, and a prolonged shortage of available homes. Despite these challenges, the median existing-home price increased by 4.7% year-over-year, reaching a record $407,500 in December 2024. The limited inventory has kept prices elevated, making homeownership increasingly out of reach for many, especially first-time buyers. In contrast, new single-family home sales showed resilience, rising by 3.6% in December 2024 to a seasonally adjusted annual rate of 698,000 units. For the entire year, new home sales totaled 683,000, a 2.5% increase from 2023. The median sales price for new houses sold in December was $427,000. Overall, while the existing-home market faces significant hurdles, the new home segment has demonstrated some strength, potentially offering opportunities for buyers navigating the current housing landscape.

• There is no denying that housing has become increasingly unaffordable
• This will continue as interest rates and relatedly, mortgage rates remain elevated
• Many existing homeowners with low mortgage rates find it uneconomic to sell, given even a comparably priced home will cost them significantly more
• On the flip side, prospective homebuyers are locked out of a market at all-time high values with mortgage rates at multi-decade highs
• This has, and will likely continue to be a boon to homebuilders, who are able to incentivize buyers with teaser rates
• This will also continue to be a boon for owners of rentable single and multi-family housing, as rent is a more economical option
• This will likely persist until the job market (and the economy) begins to show signs of weakness

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