The market, especially the Nasdaq and AI stocks are selling off this morning on concerns that a Chinese company’s AI model has surged to the top spot in Apple’s App store. This Chinese company called DeepSeek introduced its new AI model, called R1, on Jan 20 which competes with Microsoft-backed Open AI’s ChatGPT and others. DeepSeek’s R1 model apparently used first generation Nvidia chips (H100’s) with open source programming and cost just $5.6 million to “train” in contrast to the hundreds of millions spent on other models.
DeepSeek’s R1 model (we have downloaded it and it works very well vs. ChatGPT) challenges long-held assumptions that AI demands huge investments for firm’s to take advantage of it, which is behind the 10-15% declines this morning in many AI-related stocks such as Nvidia and Broadcom.
However, several analysts and industry experts point out that China’s access to next generation chips from Nvidia will be restricted. Microsoft’s CEO also posted this morning that lowering the cost of AI will increase demand for its wide ranges of usage as has happened with other major technology evolutions. This interview from AI expert and billionaire Alexandr Wang from Davos, Switzerland last week is worth a listen:
He points out the recent $500 billion US-led “Stargate” AI investment initiative with Oracle, Softbank and others plus a $600 billion investment initiative from Saudi Arabia last week showcases the AI arms race that will play out over the next 2-5 years which relies heavily on US tech companies.
We had been concerned about stretched valuations among several large cap tech and AI stocks which now make up about 32% of the S&P 500’s market capitalization. VGA implemented a hedge position in early January to attempt to mitigate the revaluation risk of these so-called Mag7 stocks to the S&P 500 and are currently underweight most of these companies in our strategies.
Note below, that while the market-cap weighted S&P 500 and Nasdaq are stretched in terms of their historic price-earnings multiples (historically 16x and 25x respectively), the average or equal-weighted S&P 500 is not expensive nor are other styles like US Mid-cap. This suggests a 5-10% pullback in the market will make many stocks outside of the Mag7 very reasonably valued.
Source: Bloomberg
Net-net: the DeepSeek news will cause increased volatility and some re-valuation in the short run but the AI theme will likely continue to play out for the next several years before a more lasting valuation bubble bursts. This chart from Bespoke compares the current AI bull market run since ChatGPT was introduced in November 2022 to the dotcom run from 1995-2000. The two are tracking closely and the comparison suggests we are less than half-way through the AI bull market. As always, we will adjust our strategy exposures and positioning should the backdrop deteriorate but, for now, this looks like a correction within an ongoing bull market to us.
Source: Bespoke