"AI's Pinduoduo" DeepSeek impacts global stock markets, but analysts say the sharp decline presents opportunities

On Monday, Nasdaq index futures plummeted, and Japanese tech stocks fell, as the popularity of China's low-cost artificial intelligence model DeepSeek shook investors' confidence in the profitability of AI among U.S. tech giants and the industry's huge demand for high-tech chips.

The surge in popularity of the AI model from the startup DeepSeek is attributed to its scores in several major tests being close to those of OpenAI's official version o1, with some tests even surpassing o1. Crucially, the query cost for this model is only $0.14 per million tokens, compared to OpenAI's cost of $7.50, making it 98% cheaper, and it allows for open-source use. Moreover, it is reportedly using lower-cost chips and less data, seemingly challenging the prevailing bets in financial markets that AI will drive demand across the supply chain from chip manufacturers to data centers.

Researchers at DeepSeek wrote in a paper last month that the recently launched DeepSeek-V3 model was trained using Nvidia's H800 chip, costing less than $6 million. The H800 chip is a "stripped-down version" of Nvidia's top-tier AI chip. Due to its extremely low training costs, DeepSeek-V3 has been dubbed the "Pinduoduo of the AI world."

Nirgunan Tiruchelvam, head of consumer and internet at Singapore-based Aletheia Capital, stated that DeepSeek's product "poses serious issues for the argument that it is the most suitable way to approach the massive capital expenditures and operating costs generated by Silicon Valley's AI trend."

The market knows little about the Chinese AI startup DeepSeek, but on the morning of January 27, the DeepSeek app topped the free app download charts in the Apple App Store in both China and the U.S., surpassing ChatGPT in the U.S. download rankings. After DeepSeek's surge in popularity, it experienced two outages.

DeepSeek's impact on the global market led by AI tech stocks

There is an increasing number of claims regarding the cost-effectiveness of DeepSeek's latest AI model using less advanced chips, raising doubts about the validity of high valuations for companies like Nvidia. DeepSeek's low costs have led to questions about the massive resource investments in AI.

Ling Vey-Sern, managing director at Union Bancaire Privee, stated: "DeepSeek demonstrates that it is possible to develop powerful AI models at lower costs. This could disrupt the investment case for the entire AI supply chain, which has been driven by the high expenditures of a few mega-scale companies."

Chinese AI-related stocks reacted positively, with the stock price of Merit Interactive Co., listed in mainland China, hitting the daily limit. Merit is one of the companies most closely associated with DeepSeek, having previously stated in a filing that it had incorporated the model of this local AI company into its marketing. In Hong Kong, the Hang Seng Tech Index rose 2% ahead of the upcoming Spring Festival holiday this week As investors reconsider assumptions about computing power and energy, AI trading elsewhere has plummeted.

In the U.S. stock market, as of the time of writing, Nasdaq 100 index futures fell 2.6%, and S&P 500 index futures dropped 1.4%. This model has raised valuation concerns in the chip industry, leading to a sharp decline in chip stocks. Nvidia (NVDA.US) fell 12% in pre-market trading; Nvidia's chips are seen as key to AI technology, leading the global AI stock boom. Since the beginning of 2024, Nvidia, a representative in the AI field, has seen its stock price rise by 196%, surpassing the Nasdaq index's 35% increase. Broadcom (AVGO.US) dropped over 12%, Super Micro Computer (SMCI.US) fell over 10%, TSMC (TSM.US) declined nearly 10%, Micron Technology (MU.US) fell nearly 9%, Arm Holdings (ARM.US) dropped over 10%, and AMD (AMD.US) fell over 5%.

Aside from chips, data centers and related companies were also impacted on Monday. Tesla (TSLA.US), Amazon (AMZN.US), and Meta (META.US) saw their stock prices drop around 5% in pre-market trading.

Wong Kok Hoong, head of stock sales trading at Malayan Banking, stated: “This is a case of crowded trading, and now DeepSeek has given investors and traders a reason to close their positions.”

The tech-heavy South Korean stock market closed lower. European tech stocks also faced pressure after opening, particularly Dutch computer chip equipment manufacturer ASML (ASML.US), whose clients include TSMC (TSM.US), Intel (INTC.US), and Samsung. Siemens Energy, one of the few winners in the European AI sector, saw its stock price drop by 22%.

As Nasdaq futures fell, major U.S. tech companies like Apple (AAPL.US) and Microsoft (MSFT.US) are set to announce their earnings this week, with expectations of slowing profit growth and still high valuations, raising concerns about a massive rebound driven by AI in the industry. The expected price-to-earnings ratio for the Nasdaq 100 index is 27 times, while its three-year average P/E ratio is 24 times. Nvidia's P/E ratio is 33 times, slightly below its three-year average.

What do analysts think?

The "low-cost computing power wave" led by DeepSeek has caused investors to start questioning the reasonableness of spending by major U.S. AI companies. If these tech giants' massive investments in AI still fail to generate satisfactory revenue and profits, as well as performance data that exceeds market expectations, a "tech stock sell-off wave" larger than last summer's may occur.

The release of DeepSeek has raised new doubts about the earnings reports of tech giants and challenged the view that China's AI technology has lagged behind the U.S. for years. Washington's trade restrictions have prevented China from obtaining the most advanced chips, but DeepSeek's model is built using easily accessible open-source technology Nick Ferres, Chief Investment Officer of Vantage Point Asset Management in Singapore, stated: “The market is questioning the capital expenditures of large tech companies.” He pointed out that positions have become crowded.

Charu Chanana, Chief Investment Strategist at Saxo Bank, said: “Although current leaders like Nvidia have established a foothold, this reminds us that the dominance of artificial intelligence should not be taken for granted. The emergence of DeepSeek in China indicates that competition is intensifying, and while it may not pose a significant threat now, future competitors will develop faster and challenge existing companies more quickly. This week’s earnings reports will be a huge test.”

In terms of stock price movements relative to expected sales, the valuations of American tech giants appear more unstable. According to Bloomberg Intelligence, the IT sector of the S&P 500 is trading at nearly 8 times the expected sales for the next 12 months, close to the highest level in at least a decade.

Nevertheless, the Chief Investment Officer for the Americas at UBS Global Wealth Management believes these valuations are worth investors continuing to buy, as AI investments are expected to generate larger overall revenues in the next year or so.

Masahiro Ichikawa, Chief Market Strategist at Sumitomo Mitsui DS Asset Management, stated: “The market is concerned that the view of cutting-edge American technologies like Nvidia and ChatGPT being the most advanced globally may begin to change. But I think this may be a bit premature.”

Société Générale suggests taking advantage of ongoing volatility to invest in new long-term themes that prioritize a long-term “America First” strategy, such as purchasing equal-weight stocks in the S&P 500, where the weightings of industrials, utilities, and financials are much higher compared to the tech sector.

Société Générale analyst Manish Kabra noted that Nvidia and its four major clients—Microsoft, Google under Alphabet, Amazon, and Meta—have contributed about 700 points to the S&P 500's rise over the past two years. In other words, the S&P 500 would be down 12% today if these five giants were excluded. Nvidia alone contributed 4% to the performance of the S&P 500. The analyst also mentioned that this is the ‘America First’ premium we find in the S&P 500.

Kabra pointed out that the tech-heavy Nasdaq 100 futures experienced a 3% panic sell-off, primarily because it is believed that the DeepSeek AI model launched in China indicates that the development costs of AI products can be significantly lower than those of American mega-corporations. The analyst added that there are several questions regarding the “real costs” of the DeepSeek AI launch, their capabilities, and the broad acceptability of their products Kabra added that large-scale enterprises may have the responsibility to prove that their capital expenditure forecasts are reasonable, but on a top-down basis, he believes that if more companies create efficient ways to use artificial intelligence, large-scale enterprises should also benefit from it. Analysts stated that if cost-effective methods can be created, it would be a positive outcome.

Additionally, Kabra cited the views of Bernstein analyst Stacy Rasgon and her team, stating that DeepSeek did not "build OpenAI with $5 million," and while DeepSeek's model looks great, they do not consider themselves a miracle; the weekend panic triggered by this seems to be exaggerated. The analyst pointed out that the strong dollar and slowing profit growth are the main reasons they advise against over-allocating to tech stocks and the Nasdaq 100 index. In other words, Société Générale recommends buying defensive tech stocks amid the current panic.

The Chief Investment Officer of Man Numeric stated, "Valuations may continue to expand due to bullish market sentiment, but people may feel disappointed about the monetization prospects of artificial intelligence, leading to a new round of selling and liquidation." However, he also emphasized that large tech giants "are still excellent companies that can generate substantial cash flow," and with strong cash flow and stock buyback scales, they will remain a "safe haven" amid panic selling.