AI Frostbite. Disruption from AI paves way for assets outside of U.S. large cap.
KEY OBSERVATIONS
The rally continues – Global markets started the year strong and were broadly positive across most asset classes.
AI at the helm – Concerns of potential disruption from new AI tools wreaked havoc on select sub-sectors such as software. Areas such as U.S. small cap and emerging market equities benefited from a rotation away from U.S. large cap.
Nomination – President Trump nominated Kevin Warsh to be the 17th chair of the Federal Reserve. Markets initially viewed this as “hawkish” but his views on inflation and productivity could lay the groundwork for more rate cuts.
RECAP
January opened the year with a confident tone across global markets. Investors were focused on the path of monetary policy, early corporate earnings signals and geopolitical developments that shaped sentiment throughout the month. Equity markets generally advanced and commodity markets rallied sharply. The combination created a constructive backdrop that helped most major asset classes deliver positive returns to start the year.
Large-cap U.S. equities posted a modest opening month. The S&P 500 Index gained nearly 1.5%, supported by pockets of strength in energy and communication services, along with steady demand for higher quality large cap companies within consumer staples. Small cap stocks performed even better as concerns grew about the impact generative AI might have on software-related companies and investors rotated into more attractively valued areas of the market. The Russell 2000 Index rose 5.4% in January. Softer inflation, improving business surveys and an overall economic backdrop that remains resilient helped fuel the asset class.
Non-U.S. developed equities outpaced U.S. large caps. The MSCI EAFE Index advanced 5.2%, helped by broad strength across Europe and Japan. European equities found support from central bank communication that pointed to stable policy in the near term, while inflation remains moderate. Japanese equities rose as well. Investor concerns surrounding geopolitical tensions in the Middle East and Eastern Europe remained present but did not dampen the regional rally. A weakening U.S. dollar further helped the space. Emerging markets delivered the strongest equity performance in January. The MSCI Emerging Markets Index climbed 8.9%, led by strong gains in South Korea, Mexico and Brazil. Technology shares in Asia rebounded sharply, supported by improving semiconductor demand and favorable trade expectations tied to early conversations about reopening supply channels between major economies.
Fixed income markets generated modest gains as interest rate volatility remained. The Bloomberg U.S. Aggregate Bond Index returned 0.1% for the month. Treasury yields moved modestly higher during the period as the expectation for the number of rate cuts in 2026 diminished and the markets digested the announcement of Kevin Warsh as the next Fed Chair nominee. Credit markets extended the positive tone. High yield bonds, measured by the Bloomberg U.S. Corporate High Yield Index, rose 0.5%, supported by narrowing spreads, resilient corporate fundamentals and a favorable economic backdrop.
Diversifying areas of the markets such as REITs and commodities also opened the year in positive territory. U.S. Equity REITs gained 2.8% during January. The sector benefited from early signs of improving fundamentals in data centers, industrial properties and select residential markets. Concerns around office properties persisted, but strength in other areas outweighed the drag. Commodities delivered the most notable performance of the month.
MIXED IMPACT FROM AI
January brought mixed impact from AI during the month. Investor concerns took hold about the potential disruption generative AI would have on software companies following a new tool for Anthropic’s Claude large language model. Shares of Oracle and Salesforce fell over 15% and 19%, respectively, for the month and resulted in the software sector being down 13.1%, wiping out nearly $800 billion in market value. On the other hand, semiconductor companies, particularly abroad, continue to benefit from the demand for chips and flash memory. Emerging markets were a standout during the period with Taiwan Semiconductor, up 14.3% in January, and SK Hynix, up almost 40%.
LOOKING AHEAD
Overall, January provided a constructive start to the year across global markets. The disruption and displacement stemming from AI, is beginning to take shape. Fortunately, we continue to find value in diversifying positions away from U.S. large cap which has proven beneficial to start the year (small-cap U.S. equities and non-U.S. equities in particular). The nomination of Kevin Warsh to be the 17th chair of the Federal Reserve will take center stage in the weeks ahead. If confirmed by the Senate, Warsh would take the lead seat in mid-May when Powell’s term as chair ends. It is important to note that Powell’s term on the board of governors does not end until 2028, unless he voluntarily steps down, and that Warsh would be replacing Stephen Miran. Regardless, a resilient economy and strong corporate fundamentals are providing a healthy underpinning for record market prices. That said, we remain mindful of current valuations, market concentration and the uncertainty created by geopolitical events.