US stocks offer upside despite tariffs, DeepSeek challenges

While import tariffs may challenge high US stock valuations in the near term, corporate tax cuts and a recovery in non-consumption driven sectors should support earnings growth this year. DeepSeek developments may act as an additional short-term market headwind as investors distinguish potential winners and losers in the tech sector, but will prove positive in the long run as they accelerate AI adoption in general, and so support the AI value chain.

The new Trump administration’s pro-growth policies, the strength of consumer spending, and a nascent recovery in manufacturing should drive US corporate earnings growth in 2025. We expect US earnings to grow by 12%, acting as a key market performance driver, and see around 10% upside in the S&P 500 from its current level over the next 12 months. While valuations remain high, revenue growth and margin expansion retain the potential to drive further gains, similar to scenarios of the last three years.

DeepSeek and tech outlook

DeepSeek, an artificial intelligence (AI) model, made waves in the global technology industry by challenging markets’ assumptions about the strategic dominance of US tech firms, their equity valuations, and the need for massive infrastructure investments. By leveraging existing investments and breakthroughs, DeepSeek has developed a reasoning AI model that outperforms its rivals, reportedly at a lower cost. While DeepSeek is a significant step forward, and has the potential to lower prices and thus accelerate the wider adoption of AI, its ‘R1’ model in our view appears to be the product of creative fine-tuning of the existing technology , rather than of deeper innovation. This is because it leans on large language models (LLMs) built by US firms at great cost. It has not – so far – altered the broader path of planned capital expenditure by US mega-cap stocks for 2025. The combined US capital expenditure of the largest ‘hyperscalers’ (Amazon, Microsoft, Alphabet/Google, and Meta Platforms) in faster chips, data centres, and other infrastructure is estimated to increase this year by around one-fifth, compared with 2024, to almost USD 290 billion. We therefore view DeepSeek as an evolutionary rather than revolutionary step. Its open-source approach should also help advance the technology, as US pioneers like Open AI, Llama (Meta Platforms) and Gemini (Alphabet/Google) analyse the Chinese firm’s work and fine-tune their own models.

We hold a neutral view on the technology sector, which is determinant for the US market more broadly

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Following DeepSeek’s emergence, Nvidia, the world’s biggest AI chipmaker, experienced a record drop in market capitalisation on 27 January. There was not, however, a broad sell-off, and price action was specific even among AI-related stocks, suggesting that investors are differentiating within the tech sector. For example, lower AI compute costs could benefit software companies and consumer electronics producers (e.g. smartphone and personal computers) through increased AI adoption. Hyperscalers could also gain, as inference volume (the number of decisions or predictions a model makes once trained) rises and they monetise AI advancements through existing distribution channels and product offerings. By contrast, semiconductor manufacturers and other AI-related hardware component firms face greater uncertainty over the need for infrastructure spending, as their stock market performance has shown.

While lower costs may boost AI adoption and chip demand, investors will question the need for sustained infrastructure spending from here, and how far high valuation multiples need to fall to account for these uncertainties. Nvidia’s valuation has fallen from a five-year average of 35 times forward earnings, to around 28 times. That compares to the MSCI World semiconductor sector, for example, which trades at around 25 times forward earnings compared with a long-term average of 16 times. Overall, we hold a neutral view on the technology sector, which is determinant for the US market more broadly.

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Equity market outlook 2025

Equity market returns are likely to stay limited in the near term as DeepSeek and tariff uncertainties linger, especially as AI has been a key narrative for many large-capitalisation stocks in non-tech sectors such as industrials and utilities.

That said, we do not believe this will lead to significant outperformance of small caps, despite their consistent underperformance over the past two years. Consensus forecasts point to the gap between large and small caps’ earnings growth narrowing in 2025, but we expect the market to be disappointed again, as seen in recent revisions to earnings-per-share (EPS) expectations. We prefer to maintain a neutral positioning in large caps versus small caps, as we see selective opportunities in the large cap technology sector, while higher interest rates create headwinds for smaller caps.

The US continues to deliver strong corporate earnings and is rapidly pricing in the Trump administration’s supportive policy environment

The US continues to deliver strong corporate earnings and is rapidly pricing in the Trump administration’s supportive policy environment. The latest Institute for Supply Management manufacturing report was robust, fuelling optimism regarding a recovery in traditional, non-AI cyclical sectors such as materials and industrials. Japan, with its lower exposure to AI and the tech sector, offers promising domestic economic growth for the first time in more than a generation, but can act also as a portfolio diversifier. The country’s underperformance so far this year seems unjustified, in our opinion, given the superior EPS revision momentum, and we see this as a buying opportunity. The speed of reform is picking up, and we think this will lead to an improvement in corporate profitability compared to the cost of capital. This should help to attract foreign investment back to Japan for the first time since 2013.

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The stock market sell-off in Taiwan that followed DeepSeek’s launch – particularly for the biggest chipmaker, TSMC (Taiwan Semiconductor Manufacturing Company) – looks overdone as non-AI chips still account for majority of its revenues, and its dominant market position continues to strengthen.

In contrast, euro area equities have staged a technical rebound after a long period of underperformance. Earnings revisions for many cyclical sectors remain negative however, in spite of more expected monetary easing by the European Central Bank. Further, financial sector estimates are starting to see modest downgrades as the tailwind from higher interest rates is coming to an end. A weaker euro supports European exports but US tariff uncertainty may still create headwinds.

Capital expenditure planned by US firms, along with their proprietary data, still means the barriers to entry are substantial

Outlook for China equities improving

The immediate implications of DeepSeek were not lost on US President Donald Trump, who described the development as a strategic wake-up call. We believe that while the competitive landscape may shift towards specific solutions and creative approaches, fundamental innovation still requires substantial investment. The capital expenditure planned by US firms, along with their proprietary data, still means the barriers to entry are substantial.

That said, the revival of the Chinese tech sector in recent years, from telecom giant Huawei to DeepSeek and other contenders, suggests that US tariffs and export restrictions may only buy time in the two nations’ strategic competition. US measures have also forced Chinese firms to innovate, and that may have masked some US sectors’ inability to compete without government support. Given China’s ability to innovate and compete, and early signs of a recovery in its property market, the outlook for Chinese equities could be improving.