The emergence of Deepseek, a Chinese Large Language Model which can compete with its Western counterparts at much lower costs and using less high-end tech catalysed a correction for the technology sector and especially Nvidia. US large caps were down nearly 1.5% on Monday and Nvidia had lost nearly 20% of its value from its recent highs.
We have often said that valuations were high and that the market was susceptible to a correction (although the timings are always unsure). Additionally, geoeconomic uncertainty is rising. So even a less significant event would be enough to catalyse a correction.
We believe that the underlying narrative that drove equity performance in the past two years, that AI will profoundly change the world, is still very much relevant. The only thing that changed is that some of the froth is being removed from valuations and earnings expectations.
We will monitor for developments but no element of this correction worries us at a systemic level thus far.
What happened?
In the past few days, a Chinese Large Language Model (LLM (what most people call AI) called Deepseek made its debut, upsetting global financial markets. While not groundbreaking in terms of performance, Deepseek purports to achieve similar results with competitors for a fraction of the cost of training and using less powerful microchips. The news upset financial markets, which for the last two years had changed their bullish narrative from “helpful central banks” to the “AI Revolution”. Led by the so-called Magnificent Seven (Nvidia, Apple, Google, Meta, Tesla, Amazon and Microsoft) equity markets managed to weather higher interest rates, economic uncertainty and the contraction of global liquidity thanks to hopes that they could lead the world in the next era. Nvidia especially, a microchip company listed since the late 1990s, became the world’s largest listed firm in only two years, after Chat GPT began to answer questions in a language humans could understand. Nvidia, the purveyor of the world’s cutting-edge microchips, came to be thought of as the company best positioned to benefit from the fourth industrial revolution. The idea that Deepseek could deliver cutting-edge technology without having to use Nvidia’s most cutting-edge chips, sent the world’s most expensive company plummeting nearly 20%.
What do we make of it?
There are a number of headwinds that justify the correction. First, the US equity market had been trading at very frothy valuations for some time, near 10% all-time highs in terms of the Price/Earnings ratio. Nvidia, specifically, was required by most investors to double earnings every year for valuations to even approach the norm. We have often said that valuations were high and that the market was susceptible to a correction (although the timings are always unsure). Second, the global economy is awash with worries over trade wars and the conduct of US policy going forward. Economic uncertainty is very high. So it would not take much for investors to take profit off the table.
Having said that, we would maintain a sanguine approach. US tech stocks and Nvidia were very expensive – and still are. The Fourth Industrial Revolution is still very much intact. China didn’t find a way to outpace US AI companies, only to be more efficient when it finally caught up. So this is not a “Sputnik” moment where tech leadership changed hands.
Thus The underlying narrative that drove equity performance in the past two years, that AI will profoundly change the world, is still very much relevant. The importance of Nvidia per se is not undermined, but the latest development does allow its competitors, AMD and Intel, back in the game. The only thing that changed is that some of the froth is being removed from valuations and earnings expectations.
Will the correction persist?
It’s very difficult to say how long the correction will persist. The stock market would need to fall nearly 10%-20% from its highs for valuations to normalise. On the day of the Nvidia correction, other major tech companies weren’t significantly affected.
The rest of the market ex-Big Tech was down just half a percentage point. Overall, markets remain liquid, most non-tech and non-US stocks trade in more agreeable valuations and potentially higher inflation is more conducive for equities than bonds.
We will monitor developments, of course, a 20% correction for one of the world’s biggest companies is not trivial. But no element of this correction worries us at a systemic level thus far.