Deep(Seek) Impact: US tech stocks tumble as Chinese disruptor emerges

It could be nothing, it could be everything. China's DeepSeek is sending ripples through the markets as investors wake-up to the potentially disruptive impact of the lower cost artificial intelligence alternative. There is still a lot of information to verify, unpack, and discount into asset prices. However, so far, the story is roughly this. DeepSeek is a Chinese AI firm, backed ostensibly by a moderately sized Chinese hedge fund, High Flyer. The company recently released its R-1 product and it is this that is causing this upheaval in stock markets to start the week. In short, the product achieves output and outcomes comparable or better than its US competitors, chiefly OpenAI's o1 model. Crucially, it has done so with fewer and older GPUs - Nvidia's H800 chip - at a cost of roughly $US6 million and reportedly in the space of 2 months. When compared to US tech firms like OpenAI and Meta, which have spent billions over the course of years, the difference is stark. Essentially, the news has raised concern that there's been massive levels of overinvestment in AI, the return on which now may be significantly eroded because of a much cheaper competitor. Compounding this is that DeepSeek has made its model open source, making it vastly more accessible and appealing, further eroding US tech's expected ROI.

The markets discount downside risks from DeepSeek but there could be positives

There are several first order implications of all this, assuming that all the information so far received is true. First, as mentioned, it suggests excessive AI capex in the US and either extreme waste or overcapacity. Second, it may imply lower demand for Nvidia's chips because hyperscalers will be able to do more with less, and can do so with Nvidia's lower margin products. Third, it shifts the balance in the technology arms race between the US and China, possibly provoking greater hawkishness from a Trump administration hell bent on "winning" the battle for tech supremacy. Fourth, it may mean weaker US economic activity if it leads to lower investment in artificial intelligence. There are other consequences and possible second order impacts in addition to these. However, these are the most pertinent, at least as it applies to the narrative today.

Despite the focus on the negative aspects of the news so far, there could be positive consequences from the DeepSeek development. The breakthrough is a huge step forward in achieving greater scale, efficiency and therefore productivity in the AI space, benefiting consumers and general economic output. The news might also prove to be good for Nvidia too due to cheaper AGI allowing for even broader chip demand. The positive impacts depend on the nature of AI demand. Specifically, whether the market comes to believe that cheaper models would invite an increase in demand, or that the capacity so far created by the US investment boom means supply significantly outstrips demand.

Tech stocks drop as investors “shoot first, ask questions later”

As far as the markets are concerned, I think there is a shoot first and ask questions later quality to the sell-off. There's a lot of information to parse and discount, with some commentators doubting the veracity of the figures DeepSeek have published. What can be said is that prior to this news we had a strong but richly valued and overstretched stock market. As a result, it was prone to shocks. There's a quote attributed to Mark Twain that is often thrown around in the markets which is “It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so." No one should be making grand prognostications based on 12 hours of price action but major corrections in the market often happen when something assumed to be absolutely certain proves to be anything but. For now, it can confidently be said that today has sparked a re-think of the "AI trade" and risks of a US-China trade war.

(Past performance is not a reliable indicator of future results)