The DeepSeek frenzy has cooled since its launch last week. But the threat to the US’s AI industry has not gone away

• DeepSeek’s emergence highlights increasing market nervousness about an AI bubble in the US
• Despite US restrictions, China is closing the AI technology gap faster than expected
• The US - China tech war looks set to deteriorate, although there remains room for bargaining and negotiation

It appears that the dust has settled on the DeepSeek saga, at least for now. Positioned as a low-cost alternative to ChatGPT, the launch of DeepSeek’s new AI model last week rocked the US tech and energy sector and caused a huge US$2 trillion selldown.

But the affected stocks have since recovered. Investors seem reassured that DeepSeek’s model poses little or no threat to the AI industry’s trajectory, and the US’s current supremacy in this space appears intact. Going forward, the only lesson learnt seems to be that chip sales to China needs to be further restricted.

However, we would argue that the strong market reaction to DeepSeek belies three emerging trends that investors should not ignore:

1. There is increasing nervousness about an AI bubble

The Magnificent Seven’s reign has now lasted close to a decade. Since February 2016, these stocks have risen by 450 percent, nearly double that of the S&P500. There was no let up in 2024, with Nvidia and Meta returning 171 and 65 percent respectively.

There are naturally comparisons with the dotcom bubble of the 1990s. However, we would argue that the current market environment remains distinctly different. It is worth recalling that one of the most important catalysts for the downturn came from weak earnings. In 1999, the big dotcom companies of the day, including Microsoft and Cisco, reported consecutively lower earnings and earnings misses. Even worse, there were fears that earnings were being fraudulently inflated, amid the Enron and WorldCom scandals.

At the time of writing, four out of the Magnificent Seven companies that have announced their 4Q 2024 results – Microsoft, Meta, Apple, and Amazon – continue to beat their earnings forecasts. However, we would note that at such lofty valuations, it doesn’t take a lot for the Mag 7 stocks to wobble. Tesla and Alphabet missed on earnings expectations, and both stocks are down 6 – 8 percent YTD. Going forward, we would expect the US equity market to become more volatile, while continuing to reach new heights.

2. DeepSeek is not China’s only contender in the AI race

It would be a mistake to assume that US AI companies have seen off the DeepSeek challenge, and can rest easy for now. Just days after DeepSeek’s launch of its V-3 on January 10, and R-1 model on January 20, Alibaba released its Qwen 2.5 AI model, and ByteDance released an update to its flagship AI model. Both ByteDance and Alibaba claim that their models surpass OpenAI on a range of performance metrics, while being cheaper to produce, and without the use high end chips.

The US’s attempts to limit China’s access to advanced hardware may also not be having the desired effect. Late last year, Huawei Technologies released its Mate 60 Pro smartphone powered by a proprietary advanced chip manufactured by China chipmaker SMIC. It had previously been assumed that banning the export of necessary technology would hobble China’s chip manufacturing industry, and cause it to fall behind the US by 3 – 5 years.

However, given the availability of strong state support, a large domestic market, and a highly educated population, such lags look likely to get ever shorter. In addition, any existing differential may become less important over time. While DeepSeek may not be the gamechanger that some had feared, its achievements suggest that Chinese AI companies are able to do more with less, and thereby leapfrog the US’s hardware advancements.


3. Trade tariffs and export bans are not a one-way street

The US’s response to the competition from Chinese AI companies is likely to be a further deepening of China-focused trade tariffs and export bans, especially of advanced technologies. Of course, trade tariffs appear to be the weapon of choice for President Trump, and countries around the world are currently engaged in what the Economist is calling the “art of retaliation”.

For example, Canada and Mexico threatened retaliatory tariffs on a range of US imports, which subsequently caused stock markets globally to destabilise, and President Trump to pull back from the brink. However, the 10 percent levy on all goods exported from China to the US proceeded as scheduled, despite a White House statement that President Trump and President Xi were due to speak soon.

In retaliation, China announced that it will be imposing 10 - 15 percent tariffs on US coal, LNG, crude oil, farm equipment and some autos. It will also extend the export controls on critical and rare earth minerals to the US. A ban on the export of gallium, germanium and antimony, imposed in December 2024, will now also include other minerals that have the potential to significantly disrupt the US’s semiconductor, manufacturing and AI industries.

However, as noted previously, President Trump appears to be using tariffs more as a bargaining chip than a strict policy. As with Trump’s first term, we would expect these measures and counter-measures to evolve over time.

What should investors do?

If there is one thing that DeepSeek has taught us, it is that even the largest tech companies in the world are vulnerable to disruption. In fact, we think that the fundamentals supporting current global market behaviour, whereby performance is driven by just a few megacap tech stocks, could be challenged with further AI innovations (e.g. new chips and new large language models). While we do not think that these stocks will crash, the higher micro-level risks surrounding these AI-driven stocks suggests that the time seems ripe for a rotation into the smaller-cap, less expensive stocks, and for an equal-weight index to outperform a cap-weighted index.

Investors are advised to:

• Take a more defensive approach to US equity markets
• Look for diversification opportunities in Asian equities and credits. Asian technology stocks could benefit in the medium-term on the back of this development
• Hedge against equity downside risks by investing in fixed income and gold