AI shock takes shine off the Trump Bump - market week

The first few days of the President’s second term have seen markets hit new highs as investors buy into the tax cuts and deregulation narrative that took hold after November’s election.Early signs that his bark may be worse than his bite on tariffs provided a further tailwind. But as the second week of Trump 2.0 began, news of a big Chinese AI breakthrough sent shockwaves through the US tech sector and unsettled markets.

China unveils an AI bombshell

Wall Street reeled at Monday’s opening after big advances in Chinese artificial intelligence cast doubt on US leadership in the technology that has fuelled the market’s recent surge.

The S&P 500 fell 2% at the opening bell, with Nasdaq down 3.5%, after Deepseek, a Chinese AI start-up, released a large language model which appears to match the performance of US rivals OpenAI and Meta - but using far fewer Nvidia chips.

Nvidia, which has by itself been a massive driver of the US stock market’s gains, fell 13%. 

• Get expert insights straight to your inbox with our free investor emails

The falls in the tech sector were the obvious first casualties of the new threat from Chinese AI, but the market sell-off extended into other areas of the market too. Even before the US market had opened, there had been big falls in related European companies. Germany’s Siemens Energy, which supplies hardware to support the AI revolution, fell more than 20%.

The cracks in US tech stocks fuelled a rush for safe havens, and the yield on the benchmark 10-year government bond fell 0.1% to 4.52%. It was one of the best days for safe government bonds in the past year. Prices move inversely to yields.

Peak Trump?

The market volatility is a rude wake-up call for the new US President, just a week into the job. Donald Trump has hit the ground running. He is moving fast, unafraid of breaking things as he goes. And the world is watching in awe as he promotes his America First growth agenda.

The Davos meeting of the world’s business and political elite last week was dominated by the new President, who spoke to the summit by video link. Calling on Saudi Arabia to cut the price of oil, and on the chairman of the Federal Reserve to reduce interest rates, he is making far-reaching pronouncements, blissfully unconcerned about whether he actually has any control over the economic and political outcomes he is seeking to create.

Markets have got used to the new President’s style by now. And investors are looking through his bluster to try and assess what he will actually do. On one front, in particular, they seem less concerned at the end of week one than at the start. Tariffs are clearly a key part of the President’s negotiating armoury, but whether he will actually be able to implement what he is threatening is less clear. 

Having been elected in large part as a reaction to the inflationary surge under the Biden administration, prices are one of his main preoccupations. And he knows that tariffs - and many of his other proposed measures - are fundamentally inflationary. In some ways, he has massively more power than in his first term. In other key ways, however, he has less room for manoeuvre.

Is a bubble inflating?

The Trump Bump has pushed an already expensive US stock market into nearly uncharted territory in terms of valuations. Indeed, some market watchers are saying that the stock market is as highly valued today as it has been at any point since the dot.com bubble a generation ago. Everyone knows that that boom ended badly for investors, so nerves are becoming more frayed as the rally continues.

The so-called earnings yield - profits as a percentage of share prices - has now fallen below 4%, at which level it compares unfavourably with the 4.7% yield available on US government bonds. When bonds offer investors a higher return, for less risk, it becomes harder for investors to justify their preference for shares.

In effect they are today saying that they want exposure to the stock market, and especially the big tech stocks known as the Magnificent Seven, regardless of their valuation. That is the kind of mindset that typically marks the top of the market. The only question is how long the market rally can continue. Shares can remain expensive for extended periods but a left-field event, like the Deepseek announcement, can also derail a fragile rally. 

• Read: My investment plan for an unpredictable presidency

Earnings and interest rates

Two key drivers of where markets go next are corporate earnings and interest rates. On the earnings front, we are well into the fourth quarter results season and so far it’s so good. With about a fifth of big US companies having announced their numbers so far, around four fifths of them have beaten expectations. The estimates of double-digit profit growth for the next couple of years look plausible.

As important, though, is the future trajectory of interest rates. Cheaper borrowing costs are a key part of the bullish case for shares, but some watchers think the Federal Reserve will sit on its hands on rates for the foreseeable future. This week’s rate-setting meeting looks like being the first in four meetings at which the Fed leaves rates on hold at between 4.25% and 4.5%.

New year, same story

Meanwhile in China, the authorities have swung into action ahead of this week’s lunar New Year celebrations to try and galvanize the country’s sagging stock market. Beijing has told state insurers to invest a minimum of 30% of new premiums into local shares and mutual funds have been told to increase their local shareholdings by 10% a year for the next three years. It is the first time that regulators have set explicit targets for investments.

The Chinese stock market has lagged others, notably the US, by a wide margin in recent years. From at high of 5,800 in late 2020, when it looked like China would be first out of the pandemic, the CSI 300 benchmark index had fallen to 3,200 by last autumn. Hope for stimulus has seen it bounce to 3,800, but it remains well below its post-Covid high.

• Read: What next for the US? Three fund ideas
• Read: Is this the moment to invest in the UK? Three fund ideas

Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. Investments in emerging markets can be more volatile than other more developed markets. There is a risk that the issuers of bonds may not be able to repay the money they have borrowed or make interest payments. When interest rates rise, bonds may fall in value. Rising interest rates may cause the value of your investment to fall. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.