DeepSeek May Be Bad News for Nvidia, but it Helps the Inflation Cycle
A cheaper, more efficient AI competitor has arrived from China but this is all part of a natural market cycle.
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Less than 72 hours ago, people could not help falling over themselves to fund new AI projects, raise more money and expand the AI race for faster computations, hoping to be the first to reach the point of economic singularity.
Over the weekend, though, DeepSeek — which is a Chinese competitor to ChatGPT — announced that it developed AI at a fraction of the cost that was faster and on the top of the list of apps downloaded from Apple.
OpenAI employs about 4,500 people compared to DeepSeek's 200, so the efficiency is miles above and beyond if the cost of development is confirmed. Coming into Monday morning, Nasdaq opened down 5% at one point and S&P 500 down 3%. It hardly comes as a surprise, given that more than 35% of the index is made up of the large-cap technology stocks exposed to the AI theme. Over the last year, they have invested about $60 billion to $80 billion in capex, so China’s deflationary push is a huge shocker. But is it a game changer?
It is all part of a normal cycle. When one company has a leading advantage, but as time goes on, other companies follow suit and eventually pricing and margins fall as it becomes mainstream. Monopolies do not last forever and the large-cap tech firms have led in this space — and there will be others — but to call this the end of the U.S. AI race is a long shot.
This is all part of a healthy cycle when pricing falls and it's a deflationary impulse that benefits the consumer. We saw the same in the auto and EV manufacturing cycles, where China came out and crushed the market with cheaper and more efficient electric cars. The more concerning thing is that DeepSeek is using much cheaper chips than Nvidia’s NVDA higher-cost ones to get a stronger AI, and that is hurting a stock that has priced about 50% profit margins over the next few years. The stock has been plateauing as analysts debate whether it is ex-growth. Time shall tell.
This should be welcome news for the global inflation cycle, as many have been worried since the end of last year whether inflation would spiral out of control.
The beauty of every productivity cycle is that much higher growth and hopefully lower prices leads to massive economies of scale, leading to higher productivity. This is where the U.S. aims to be, eventually. The only question is: Does it get there before it collapses over its own debt?
For now , we are in the midst of the Q4 reporting season. The index is reporting higher earnings for the fourth quarter with the blended earnings growth rate at 12.7%. If this is the actual growth rate for the quarter, it will mark the highest year-over-year earnings growth rate reported since Q4 2021 (31.4%) and the sixth consecutive quarter of year-over-year earnings growth for the index. This is extremely supportive for now.
As we wait for the Fed FOMC this week, investors are all too cautious, wondering if it will be yet another hawkish message. Since December 18, the data has come in a tad bit dovish, so there is no reason to be more hawkish than need be. The futures market is almost pricing in zero rate cuts for this year now. For now, the tariffs are not as punitive as first thought they would be as Chinese tariffs are claimed to be around 10% starting from February 1, as opposed to the 60% number first touted.
Positioning had moved from extreme bearishness to extreme bullishness over the last few weeks. To call the end of the cycle would be premature, but some companies will benefit at this stage of the cycle with lower costs compared to others priced for perfection. So far, this year has proven to be a trader’s market, which is a big change from the passive buy/hold theme over the last two years. Will it continue?
At the time of publication, Bengali had no positions in any securities mentioned.
