DeepSeek DeepSinks Bullish Exuberance

On Monday, markets were rocked by news that a Chinese Artificial Intelligence model, DeepSeek, performed better than expected at a lower development cost. As we noted in our Daily Market Commentary yesterday:

“The 3% panic sell-off on the Tech-heavy Nasdaq-100 futures is focused on the view that China’s DeepSeek AI model rollouts show AI products can be created at a much cheaper cost than what the US hyperscalers are working on.

There are many questions about the ‘true cost’ of DeepSeek AI rollouts, their capabilities, and the wide acceptability of their products. Arguably, the onus may be on the hyperscalers to justify their capex projections. Still, on a top-down basis, we see that if more companies create productive ways of using AI, hyperscalers should also benefit from this. If cost-efficient ways can be created, this has to be a net positive.” – Societe Generale

There are two important points that investors should consider:

First, everyone is suddenly an expert on DeepSeek and AI in general. Yes, there are certainly potential consequences to an AI that can potentially run more efficiently than other large-language models (LLMs). There are also many benefits that will come from increased competition. The latter was a point we discussed on Monday’s Real Investment Show: DeepSeek just started the “CyberSpace Race.”

Secondly, I will admit I am not an expert on “A.I.” and DeepSeek. Therefore, I can only tell you what we know so far.

DeepSeek – What We Know So Far

China’s DeepSeek AI model rocked current thinking due to its innovative approach and potential advantages over existing large language models (LLMs) developed in the U.S. Several key distinctions make DeepSeek unique, particularly its cost-efficiency, resource utilization, open-source nature, and performance. These characteristics present opportunities and challenges for the broader AI industry, especially for companies supplying technology to AI developers.

One of the most striking differences is DeepSeek’s cost-effective development. Unlike U.S. models like OpenAI’s GPT-4, which require substantial financial resources—often hundreds of millions of dollars—DeepSeek’s R1 model was developed in just two months with an investment of under $6 million. This lean approach demonstrates that high performance can be achieved without the massive budgets typically associated with cutting-edge AI. DeepSeek’s innovative training methods allow it to operate effectively with less advanced hardware, unlike U.S. models that often depend on high-performance computing resources. This resource optimization reduces barriers to entry and makes advanced AI capabilities more accessible.

DeepSeek’s open-source nature also sets it apart. By releasing its code openly, the model fosters collaboration and global contributions, enabling developers worldwide to adapt and improve upon it. On the other hand, U.S. LLMs are often proprietary, restricting access to their underlying code and limiting external innovation. Despite these differences in approach, DeepSeek delivers comparable performance to U.S. models in areas like problem-solving, programming, and natural language inference, challenging the notion that high costs and proprietary systems are prerequisites for success in AI development.

The rise of DeepSeek presents significant implications for companies supplying AI developers with technology. The risk is that its efficiency and cost-effectiveness could reduce the demand for high-performance computing hardware, impacting suppliers specializing in this area. Furthermore, its success as an open-source model may shift the industry toward open-source AI development, reducing the proprietary software and support services market. This shift could also pressure existing AI developers to lower their operational costs, leading to a demand for more affordable hardware and software solutions. Suppliers may need to innovate and focus on products that support efficient AI training and deployment to remain competitive.

However, for all the potential negatives, introducing competition could also be an enormous benefit.

Is DeepSeek The Sputnik Moment Of Our Generation

The emergence of China’s DeepSeek AI model and its potential challenge to U.S. dominance in artificial intelligence (AI) development draw strong parallels to the “Space Race” of the 1950s and 60s. Much like the Soviet Union’s launch of Sputnik in 1957 sparked a wave of competitive innovation and economic transformation, DeepSeek could serve as a modern-day “Sputnik moment” for the global AI industry. This dynamic could ignite a new era of technological progress and economic growth while presenting significant opportunities for technology companies.

Parallels to the Space Race

The Space Race was defined by intense competition between the U.S. and the Soviet Union to achieve technological superiority in space exploration. When the Soviets launched Sputnik, the first artificial satellite, it shocked the world and spurred the U.S. to accelerate its science, technology, and education investments. This competitive drive led to landmark achievements, including the Apollo moon landing, and fueled economic growth by creating new industries, advancing technologies, and fostering innovation.

Similarly, DeepSeek’s rise represents a competitive challenge to the U.S. in AI. DeepSeek’s cost-effective development and open-source model highlight alternative approaches to AI that challenge the resource-intensive methods commonly used by U.S. companies. The competitive pressure posed by DeepSeek could push U.S. companies to innovate even faster, refining their technologies, optimizing costs, and exploring new applications for AI.

The Space Race demonstrated that competition drives innovation, fueling economic growth. The technologies developed during the Space Race, such as satellite communications, advanced materials, and computer systems, had far-reaching economic impacts. Similarly, the AI competition sparked by DeepSeek could lead to breakthroughs in computing power, software algorithms, and machine learning applications. These advancements would not only enhance AI’s capabilities but also create new markets, drive productivity, and foster economic expansion.

The Bullish Case Of Competition

As such, if DeepSeek serves as the “Sputnik moment” for AI, it could reinvigorate the global push for technological leadership. For U.S. companies like Nvidia, Google, and Microsoft, this could be a positive catalyst in several ways:

Accelerated Innovation: Just as the U.S. ramped up its investment in space technologies after Sputnik, companies like Google and Microsoft may significantly increase their R&D spending to maintain their competitive edge in AI. This could lead to the development of more advanced models, better algorithms, and new use cases for AI across industries.
Demand for High-Performance Hardware: Companies like Nvidia, a leader in GPUs and AI hardware, stand to benefit from the heightened competition. Advanced AI models require powerful computing infrastructure, and Nvidia’s products are essential for training and deploying these models. If the competition intensifies, demand for Nvidia’s hardware could rise significantly.
Expansion of AI Applications: The competitive push could accelerate the adoption of AI in various sectors, from healthcare and finance to autonomous vehicles and education. This would benefit companies like Google and Microsoft, which provide cloud platforms and AI tools to support these applications.
Increased Government and Private Sector Funding: As seen during the Space Race, heightened competition often spurs increased investment from both governments and the private sector. Governments may allocate more funding for AI research and development, while private companies may double down on their AI initiatives to maintain relevance in a rapidly evolving market.
Broader Economic Benefits: A surge in AI innovation could lead to productivity gains across industries, boosting economic growth. The ripple effects of AI advancements could create jobs, transform industries, and enhance the quality of life, much like the technological spin-offs from the Space Race.

What We Think Right Now

Yes, the rise of DeepSeek poses competitive challenges. However, it also creates opportunities for U.S. companies to innovate and expand their markets. However, this competition will require significant investments, and companies must navigate potential risks, such as overvaluation and increased regulatory scrutiny. For investors, this environment underscores the importance of focusing on companies with strong fundamentals, competitive advantages, and a proven track record in AI development. Such was a point made by Chamath Palihapitiya yesterday:

“Startups need to realize that they are “default dead” companies. This means they must, by definition, grasp victory from the jaws of defeat. Meanwhile, VCs are asleep at the switch – massively overfunding marginal ideas. We must improve at taking huge shots on goal and allocating capital to the best of these ideas. I worry that in this current melee, we’ve overspent billions on dumb features which these next-gen models will roll over in the next 12months or earlier. Lots of capital losses are coming.”

The parallels between the Space Race and the current AI competition sparked by DeepSeek are striking. Just as Sputnik catalyzed an era of unprecedented innovation and economic growth, DeepSeek could serve as a similar wake-up call for the global AI industry. This competition presents an opportunity for technology-related investments and companies to accelerate innovation, expand markets, and drive long-term growth. While the road ahead is competitive, the potential rewards for staying ahead in the AI race are immense. The A.I. “Cyber Space Race” is only just beginning, and there are still many opportunities that we will want to participate in.

So, why did the market react so negatively to the news if that is the case?

The Selloff Just Needed A Catalyst

A great note from Societe Generale sums up our current view on the magnitude of the current selloff.

“Market panics are common, and currently, it is understandable with American exceptionalism in full force. The Mag-5s (NVDA + its top 4 customers, i.e. Microsoft, Google, Amazon, Meta) have contributed approximately 700 points to the S&P 500 over the last 2 years. In other words, the S&P 500 excluding the Mag-5s would be 12% lower today. Nvidia alone has contributed 4% to the performance of the S&P 500. This is what we find to be the ‘American exceptionalism’ premium on the S&P 500.”

Moreover, Bernstein analysts Stacy Rasgon and team have published their take on this, concluding that:

DeepSeek DID NOT “build OpenAI for $5M”
The models look fantastic, but we don’t think they are miracles, and
The resulting Twitterverse panic over the weekend seems overblown

Okay, so why the panic selling?

As we previously warned, when “everyone is on the same side of the boat,” an unexpected, exogenous event causes sharp reversals.

Over the last two weeks, sentiment reversed from negative to extremely bullish following the inauguration. In this week’s #BullBearReport, we stated that “the technical gauge reversed sharply for short-term oversold back to more bullish levels. While not at more severe “overbought” warning levels, current levels suggest that near-term upside could be somewhat limited.“

Furthermore, the investor “Fear/Greed” gauge moved from neutral territory back into extreme greed. This indicator is based on how professional and retail investors position themselves based on equity allocations, including options, bullish and bearish sentiment, and concerns about risk.

We see the same surge in investor sentiment by the standard deviation of “net bullish sentiment.” After reversing rather sharply from the December highs, investing sentiment reversed sharply last week following the inauguration. While not back to more extreme levels, the swiftness of the reversal has been remarkable.

Up until now, the A.I. field has been dominated solely by U.S. companies. That dominance led to a rise in markets driven by a handful of mega-capitalization companies. Suddenly, everything has changed, or at least it seems that way. With everyone short-term bullish on the market, the risk of a reversal was elevated. Such is particularly true when an unexpected event, like DeepSeek, causes the market to question current earnings growth assumptions.

This is why, as investors, we must remain vigilant about the risks we take within our portfolios.

Technically speaking, the selloff on Monday, while unexpected, only reversed some of the recent gains. The market remains on a buy signal and defended support at the 50 and 20-DMA. Could there be more selling pressure in the days ahead? Possibly. However, much of yesterday’s selling seemed to be a “shoot first, ask questions later” type of action.

The current bull market is likely not over. Furthermore, the panic will subside as markets come to grips with DeepSeek and its real implications. However, our recent discussions have made our aversion to risk more apparent. DeepSeek only adds to why we are becoming more cautious on outlooks as we head into 2025. The risks seem obvious between high valuations, a slowing economy, and elevated earnings expectations.

Does this mean we expect the market to crash? No. Not yet, anyway.

But it is incredibly difficult to know with certainty, so we suggest that investors “curb their enthusiasm.”

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