S&P 500 Bounces After Massive Gap-Down on DeepSeek AI Fears

S&P 500 Talking Points:

• What a difference a week can make, as the euphoria from the inauguration early last week has given way to fear to start this week. And before that, we had strength on stocks coming back following the fill of the election gap in the S&P 500.
• Last Wednesday saw a massive gap in SPX after news of the Stargate investment with potentially $500 billion drawn into investment in AI. But, over the weekend a Chinese LLM named DeepSeek took the internet by storm, with an allegedly small investment of $5 million to train the model.
• This triggered fears that the AI rally in the U.S. has become overblown and it also raised competitive concerns. I spoke to this in the 2025 Forecast for Equities and you’re welcome to access that from the link below:

Equities AD

Last week was a frenetic rally in U.S. equities, and that was an extension of the move that had started the week before. If we draw back to early-January stocks had struggled, at least in a relative sense, as U.S. Treasury yields were bumping higher and the 10-year was moving for a test above 4.8%. That’s a line in the sand that’s seen equities struggle over the past couple years and earlier in 2025, it was no different.

But, as yields softened, with the help of a poor PPI print and a below-expected Core CPI print, equity rallies came back to life. And then last Monday even though U.S. markets were closed in observance of Martin Luther King Day, the inauguration of Donald Trump brought along more hopes for continued gains in U.S. equities, and markets gapped-higher the following Tuesday and continued to gap-higher through last week.

On Wednesday morning there was a sizable gap-up on news of the Stargate investment initiative, which was announced at the White House amongst a group of tech heavyweights. Masayoshi Son of Softbank made the announcement himself and he noted a whopping $500 billion investment from a wide range of companies in the AI space in the U.S.; and suddenly, those higher rates weren’t as fearsome as they were just a couple of weeks earlier and stocks took a strong rally from Wednesday and through Thursday.

But then – another risk appeared over the weekend with the DeepSeek AI announcement out of China. It’s a free, open-source product that allegedly was developed for a mere $5 million which would make the capital expenditures on graphic processing units in the United States, the bulk of NVDA’s business, look like wasted capital.

There’s probably a lot more to the story and I’ll dig into this below, but first I wanted to look at some updated charts from this weekend’s forecasts. As I had pointed out then, bulls had appeared to get ahead of themselves and this week was already going to be big, with Wednesday’s FOMC rate decision and Friday’s Core PCE data. But there’s also a slew of corporate earnings, such as Tesla, Meta and Microsoft on Wednesday and Apple, Intel and Visa on Thursday.

The Nasdaq 100 finished last week with price sitting right on top of the gap produced by the Stargate announcement, but that has since been gapped through with the morning’s low at 21,000 for the cash index.

In SPX, the cash index gapped-down after last week grasped onto 6,100 into the close. But that gap-down has been heavily bid so far and price has already pushed through and finished off the inauguration gap from last week. The next gap overhead is the gap from the stargate announcement last Wednesday, running from 6049-6074.

S&P 500 (SPX) Daily Price Chart

VIX Spike

Going along with this move in equities has been a spike in the VIX index, as it pushed above 20 for only the second time this year. The first instance was two weeks ago, also on a Monday, as weekend fears pushed by higher rates finally filled the election gap in the S&P 500.

As I had said in the 2025 Forecast for equities, I liked continued strength themes in stocks. But – I did not like chasing prices higher and, instead, looking for pullbacks to lead into bullish trend continuation scenarios.

The election gap was the first zone in SPX that I wanted to see support show up at and that happened in the first couple weeks of the year. And then prices jumped up to fresh all-time-highs a week-and-a-half later, which posed a similar problem as before where traders would essentially be forced to chase the move-higher.

The pullback to start this week certainly has some drive from the DeepSeek announcement but given the economic calendar it’s of little surprise that we’re seeing a bit of de-risking. But there’s a few notable items to consider on top of the AI items.

VIX Daily Chart: Back Below 20 After 2^nd Spike Over that Level This Year

SPX: A Cornucopia of Risks

So while the DeepSeek headline is an obvious bearish driver for U.S. equities, especially given how important the AI boom has been to surging equity values over the past two years, it’s also not the only major risk on the horizon. And given how built-in that rally had become last week, it makes sense that we’re seeing some de-leveraging ahead of a wide slate of pertinent items.

The FOMC rate decision on Wednesday is of interest as it was the last Fed meeting that heard a less-dovish outlay for the year ahead. That triggered the last notable pullback in equities and that’s one of the factors that pushed both higher rates and struggling equity prices around the yearly open.

After that Fed meeting on Wednesday, we hear from some corporate heavyweights with Tesla, Meta and Microsoft all reporting earnings.

On Thursday, we get Japanese CPI data after the U.S. markets close for the day and this similarly can be big, as the Bank of Japan hiked rates last week and fears of another round of carry unwind could similarly act as a de-leveraging event across U.S and, in-turn, global equities.

We also get corporate earnings from Apple on Thursday, and that leads into a massive driver with Core PCE on Friday morning, which is often called the ‘Fed’s preferred inflation gauge.’

Inflation has been stubbornly high even as the Fed cut rates and this is what’s helped to price out quite a few expected cuts for 2025, so the emphasis on inflation very much remains a high point for the market. There’s still an expectation that we’ll get at least one rate cut from the Fed this year but if that Core PCE driver comes out hot, we could see that come into question and that could further lead to motivation for a larger pullback in equities. But – it could also be the rationale to get bulls back in the driver’s seat to fill that gap produced from the weekly open.

Below, I’m looking at S&P 500 equity futures via ES, and the 5950 area of support has so far held the lows for the day. I’ll get shorter-term on the next chart in effort of devising some levels to work with short-term strategy.

S&P 500 Futures (ES) Daily Price Chart

S&P 500 Futures Shorter-Term

From the two-hour chart below we can see an already pretty sizable bounce, as the 38.2% retracement of the pullback from last week’s high to this week’s low is coming in as short-term support.

The 6k level is of importance, as this is a psychological level that’s confluent with the 23.6% retracement of that same move; and, ideally, this is the support that bulls will hold in order to retain control of shorter-term trends.

The 6050-6055 area is key resistance overhead and we’ve already seen bull shy away from a test there this morning, and this is followed by 6078-6080 and that’s followed by the weekly open gap, running from 6105 up to 6132.

And regarding DeepSeek fears: This is a highly speculative story thus far and there’s wide-ranging accusations that the alleged $5 million investment to create the LLM is an overblown statement. The only way to get clarity on that is to wait, but for the amount of selling that we saw to start this week, along with VIX spiking over the 20-handle, it would seem to be a bit overblow at this point. Of course, a larger pullback can show in stocks but at this stage I’d attribute that more to de-leveraging based on fear of the economic docket ahead, or perhaps even a return of Yen carry unwind.

S&P 500 Futures Two-Hour Chart

--- written by James Stanley, Senior Strategist