In the previous week, global markets found themselves buffeted by a series of conflicting forcesOn one hand, the emergence of DeepSeek—a new AI model from China—generated significant attention, while on the other hand, the implementation of tariffs by the United States rattled investor sentimentsThe U.Sstock market, in the midst of this turmoil, exhibited discernible splits in performance, contrasting sharply with the resilient gains of major European indices which all concluded the week on a high note.

On January 31, the formidable hand of trade tariffs struck Mexico and Canada, leaving Europe temporarily untouchedThe Stoxx Europe 600 index and Germany's DAX 30 index both achieved record highs for four consecutive trading daysSpecifically, the DAX 30 surged by 1.58% over the week, while the UK's FTSE 100 climbed by 2.02%, and France's CAC 40 posted a more modest gain of 0.28%.

Throughout January, European stocks displayed a performance that outshone their American counterparts

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Investors across the Atlantic shifted funds in a bid to hedge against the risks posed by U.Stech stocks, leading to a notable outflow from these markets into more defensible and growth-oriented names in Europe, particularly within banks, pharmaceuticals, and luxury retail sectorsMany analysts and surveyed experts maintain a conviction that DeepSeek will not shake the established faith in AI technology; they argue that the robust results reported by major tech stocks in the U.Scan provide significant support for their valuations as well.

This week, one major focal point in the market is the impending Monetary Policy Committee meeting of the Bank of EnglandThere’s widespread consensus that, under mounting pressure from a stagnant growth outlook, the bank is likely to initiate a 25 basis points rate cutAdditionally, the preliminary consumer price index (CPI) data for the Eurozone in January is anticipated to play a pivotal role in the European Central Bank's (ECB) rate decision in March, especially after comments from two ECB board members suggested a cautious optimism regarding falling inflation figures.

The remarkable recovery of European stocks draws attention for its sharp rise in January, which shattered the gloomy outlook for 2024. The Stoxx 600 index enjoyed a solid uptick over six consecutive weeks, culminating in a 6.3% gain for January alone—its best performance since November 2023. This surge surpasses the previous month’s performance across major U.S

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indices, including the Dow Jones Industrial Average (4.7%), S&P 500 (2.7%), and the NASDAQ (1.6%).

Responsible for this bullish trend in Europe was the European Central Bank’s consecutive rate cuts, which acted as a catalyst for growthNonetheless, the rotation of capital away from U.Sstocks, especially technology names, is seen as the main driving force behind Europe’s resurgence.

According to Bank of America data, January witnessed the largest capital inflow into European stocks from the U.Sin nearly a decade, as investors fled from overvalued tech stocks to seek refuge in European equitiesThe sectors that attracted attention included defensive and growth-oriented stocks that exhibited stability during this volatile periodMohit Kumar, an economist at Jefferies, noted that following the turbulence in U.Stechnology stocks, investors flocked to European markets, where tech exposure is comparatively minimal.

As of last Friday's close, the market capitalization of America's 'Tech Seven' plummeted by a staggering $410 billion compared to the previous week

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A calculation from Société Générale highlighted that the technology sector constituted merely 8% of the Stoxx 600 index, while the S&P 500's technology firms account for about 30%. This insight reveals that the pronounced outflow of capital from U.Stech shares was driven primarily by the bursting bubble in these valuations, amplified by the new AI development from DeepSeek.

For some time now, a sense of caution has enveloped the U.Smarkets, especially regarding the valuations referenced against the S&P 500, which currently stands at a price-to-earnings (P/E) ratio of approximately 30. Amidst such sentiment, investment in U.Sequities has waned, with a shift towards European markets becoming more pronounced.

However, it's important to clarify that the market hasn’t lost faith in American stocks across the board; rather, it has adopted a more prudent approach to an overly concentrated focus on a handful of stocks, notably those dubbed the "Tech Seven." Many experts do not forecast a prolonged trend of underperformance for U.S

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stocks in comparison to European equities.

The unveiling of DeepSeek at the end of January has triggered global discussions and scrutiny regarding the substantial investments made by tech giants in advanced chips and AI infrastructureThis model, which promises significant performance with lower computational requirements, has caught the attention of the investment community and led to a reevaluation of the exorbitant costs associated with traditional AI development.

Despite these shakeups, the European tech stocks remained relatively insulated from the ripple effects of DeepSeek's introductionThe European technology index experienced a notable increase of 2.12% last week, with ASML, a leading player in the sector, reporting a staggering 169% quarter-over-quarter increase in net bookings for Q4, driving its stock price up by 11.7% in a single weekFirms like BE Semiconductor and ASM International also recorded solid gains over the week.

ASML's CEO, Peter Wennink, described DeepSeek as a "blessing" for the industry

He emphasized that advancements towards lowering costs will bolster the adoption and integration of AI across various applications, leading to increased demand for semiconductorsGiven ASML's role in supplying equipment to chip manufacturers, its business model stands to benefit significantly as usage of chips becomes more widespread.

Investors should be prepared for a potential reevaluation of earnings prospects and valuations for different companies across the AI supply chain as a result of DeepSeek's innovation.

Even though DeepSeek has led to a significant sell-off in U.Stech stocks, this move reflects not so much a renunciation of the AI technology revolution, but more a recalibration of the various elements that contribute to AI’s growth trajectoryThe critical role of computing power in AI competition has become more ambiguous, and the barriers to entry for advanced models may be less daunting than previously thought.

At present, many market participants are still deliberating the underlying principles governing AI evolution and have yet to arrive at definitive conclusions

This uncertainty casts a long shadow over stocks related to foundational AI models, AI hardware, and pertinent energy sectorsHowever, interest is expected to shift towards application-focused firms, as true innovation in AI will only come to fruition when it effectively integrates with consumer behaviors and needs, ultimately leading to enduring performance results.

This week also marks a significant occasion for the Bank of England, as it holds its first rate decision meeting of the yearThe general anticipation is a reduction in the interest rate from 4.75% to 4.5%, along with an update on economic growth and inflation forecasts.

From previously issued data, the preliminary January PMI reading for the UK painted a mixed pictureThe composite PMI rose slightly from December’s 50.4 to 50.9—just enough to skirt above the threshold that denotes growth contractionHowever, an alarming trend was evident in the labor market, as layoffs in January surged to the highest pace since 2009, aside from the pandemic

Chris Williamson, chief business economist at S&P Global Market Intelligence, indicated that the rising pressures of inflation posed a complex challenge for the Bank of England, hinting at a potential environment of stagflation.

The impending rate cut appears all but assured, but the specter of stagflation has added layers of complexity to the Bank's forward path this yearWhile markets foresee three cuts by 2025, with rates stabilizing around 4% by year-end, Goldman Sachs suggests a more aggressive approach, potentially involving as many as six cuts before next spring due to sluggish economic growth and a cooling labor market.

Economist Thomas Pugh from RSM accounting firm concurs that significant weakness in economic growth may prompt the Monetary Policy Committee to revise down its forecasts for the yearHowever, re-emerging inflation pressures complicate mattersHe predicts a total of four cuts this year, bringing rates down to 3.75%.

Heading into the Bank of England meeting, market sentiment has already started pricing in anticipated rate cuts

Consequently, the Great British Pound has begun to trend bearish against the dollar, and the UK debt market could receive some respite from a more dovish stance on rate adjustments.

ING's recent research indicated that the GBP/USD could dip to 1.20 in the second quarter, while the EUR/GBP approaches 0.85. In the short term, UK bonds could benefit from the Bank's accommodating posture, with the yield on 2-year bonds likely to decline sharply, whereas the 10-year duration might remain pressured by elevated U.STreasury yields.

As the week progresses, the Eurozone is set to release key data points including final January PMI, preliminary January harmonized CPI, retail trade figures, producer prices, as well as industrial orders and production data from GermanyECB Chief Economist Philip Lane is scheduled to speak at the Peterson Institute on Wednesday, which may provide further insights regarding the Eurozone's economic recovery and offer clues about the ECB’s direction as it heads towards its anticipated rate cut in March.