Is DeepSeek A Bearish Game Changer
The Nasdaq and S&P 500 both plunged on Monday following the weekend announcement that DeepSeek, a Chinese AI startup, has introduced an advanced AI model capable of rivaling the performance of ChatGPT but at a fraction of the cost. This revelation directly challenges the foundation of the AI-fueled market rally, which has driven tech stocks to unprecedented heights over the last several years. The Nasdaq dropped 4% at the open, while the S&P 500, heavily influenced by AI-linked tech stocks, fell over 2% before recovering some ground.
What Is DeepSeek?
DeepSeek is a cutting-edge AI large language model (LLM) developed in China. Unlike its competitors, it matches the capabilities of models like ChatGPT while being developed for allegedly just $6 million—a fraction of the billions poured into similar systems by U.S. tech giants. The startup behind this breakthrough, a two-year-old company spun out of the Chinese quant hedge fund “High Flyer,” has allegedly exposed a fundamental flaw in the prevailing assumptions about AI development: high performance doesn’t require billions of dollars.
Why DeepSeek Sent Markets Down
If true, DeepSeek’s announcement directly undermines the two primary pillars of the bullish AI narrative that has driven tech and semiconductor stocks higher:
1. Demand for Advanced Chips Is Now at Risk
The AI boom has relied on the assumption that cutting-edge AI systems require advanced, high-cost semiconductor chips manufactured by companies like NVIDIA (NVDA), Broadcom (AVGO), and Taiwan Semiconductor Manufacturing Company (TSM). These chips have driven a massive upgrade cycle, propelling earnings growth for these stocks.
It was reported that DeepSeek shattered this assumption by leveraging legacy chips—older and far less expensive components—to deliver the same performance as models powered by advanced semiconductors. This move has effectively dismantled the foundation of the chip-driven AI growth story. As a result, NVDA shares fell 17% on Monday, while the semiconductor ETF (SOXX) dropped 8%.
The ripple effect is clear: If this is true, semiconductor earnings could shrink dramatically if companies can pivot to cheaper hardware for AI development.
2. Big Tech’s AI Investments Are Now Questionable
DeepSeek’s breakthrough exposes the inefficiency of the massive capital expenditures by major U.S. tech firms in their pursuit of AI dominance. Companies like Meta (META), Alphabet (GOOGL), and OpenAI have collectively invested tens of billions in AI infrastructure and development, operating under the belief that significant computational resources and advanced chips were prerequisites for cutting-edge AI. DeepSeek’s $6 million model invalidates this thesis, proving that high-performing AI systems can be developed at a fraction of the cost.
As of January 2025, here’s what the biggest tech companies are planning to spend on AI this year:
Meta: $65 billion
Microsoft: $80 billion
Amazon: $75 billion
Google: $24 billion
That’s a total of $244 billion on AI—just in 2025.
For perspective, the entire Apollo program, which put a man on the moon, cost $25.4 billion at the time. Adjusted for inflation, that’s about $200 billion today. That budget covered everything—spacecraft development, research, infrastructure, testing, and multiple missions, including the iconic Apollo 11 moon landing.
With this level of spending, 2025 will be the year the market expects to see real, tangible evidence that AI is driving growth. The big question now: Where are the companies actually using AI to improve efficiency and reduce costs?
This calls into question the ROI of these investments and directly undermines their earnings growth projections. With AI-related revenues accounting for a significant portion of the anticipated $25/share increase in S&P 500 earnings from 2024 to 2025, the valuation of the index is now stretched. Without this AI-driven growth, the S&P 500 trades at an unsustainable 25x forward earnings, highlighting the vulnerability of the broader market to this shock.
DeepSeek: A Permanent Shift or a Temporary Disruption?
DeepSeek represents the most significant blow to AI enthusiasm since the sector’s ascent began nearly two years ago. However, while the implications for tech and semiconductors could be severe, this development does not signal an end to the broader market rally—provided two conditions are met: 1) Economic growth remains robust, and 2) The Federal Reserve maintains its current trajectory of rate cuts. The Fed isn’t cutting rates anytime soon, but as long as they keep signaling future cuts, the market will take it as a green light for stocks.
That said, the downside risk for tech could be substantial. A 5-10% correction in the S&P 500, and potentially larger losses in the Nasdaq, are highly likely as the market adjusts to these new realities. DeepSeek might slow the momentum of AI-driven tech stocks and push a broader rotation into cyclical and value sectors.
Portfolio Positioning for the Post-DeepSeek Market
The introduction of DeepSeek underlines the importance of balanced exposure across sectors. Tech will remain an integral part of portfolios, but a shift toward value and cyclicals is now critical to managing risk while maintaining growth potential. Monday’s market reaction reinforced this thesis: while tech suffered, sectors such as financials, consumer staples, healthcare, and communications showed resilience. In fact, six of the 11 S&P 500 sectors posted gains.
A prudent allocation strategy includes:
Balanced exposure to tech and cyclicals (industrials, materials, and financials via ETFs like XLI, XLB, and XLF).
Increased weighting in value stocks (e.g., VTV) over VUG.
Preference for equal-weighted indices (RSP) over market-cap-weighted indices (SPY) to reduce concentration risk.
This diversified approach positions portfolios to capitalize on the broader market’s recovery while mitigating tech-specific risks.
The Broader Implications of DeepSeek
If this is all true, DeepSeek’s innovation accelerates the democratization of AI. By lowering the cost barrier, it enables smaller firms to enter the AI space and contribute to its development. This parallels the trajectory of the internet and cloud computing, which became transformative only after widespread adoption across industries.
As more companies gain access to AI development without requiring massive capital, the pace of innovation will accelerate. This increases the likelihood of AI delivering meaningful cost savings and productivity enhancements across sectors, making it a true economy-wide growth driver rather than a profit engine limited to tech and semiconductor firms.
Is DeepSeek’s Threat Overblown?
Skepticism surrounding DeepSeek is warranted but should not overshadow its disruptive potential. While some reports suggest DeepSeek may merely be a low-cost imitation of ChatGPT, the market reaction highlights the vulnerability of AI stocks to valuation shocks. Whether DeepSeek is a genuine game changer or not, it has set a precedent that will inspire further disruption in the AI space.
When analyzing data or announcements from China, skepticism is not just advisable—it’s essential. The country has a well-documented history of manipulating or obscuring critical data points to fit political or economic narratives. For instance, China's official GDP growth rates often remain remarkably stable, even during periods of global economic downturn, raising doubts about their accuracy. Similarly, the dramatic buildup of “ghost cities,” with millions of unoccupied apartments, contradicts official housing market statistics that paint a picture of robust demand. Another example is corporate reporting; Luckin Coffee, once hailed as a rival to Starbucks, was exposed for fabricating sales figures, leading to one of the largest financial scandals in recent history. Even in the technology sector, companies like Huawei have faced allegations of intellectual property theft while boasting "homegrown innovation." The case of DeepSeek itself fits this pattern of uncertainty, as claims about its performance and low development costs lack verifiable evidence. This context makes it prudent for investors to approach any Chinese data or announcement with thorough verification and a critical eye.
And remember - The one fact pertaining to all conditions is that they will change.
Feel free to use me as a sounding board.
Best regards,
-Kurt
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Kurt S. Altrichter, CRPS®
Fiduciary Advisor | President
Email: kurt@ivoryhill.com | ivoryhill.com
Balanced and well thought out.