AI disruptor tests ties that bind US darlings, Magnificent Seven

Fund managers have reacted to the challenge inflicted on the Magnificent Seven after an artificial intelligence (AI) chatbot powered by Chinese start-up, DeepSeek, burst onto the scene this week.

Investment specialists have warned investors to broaden their horizons beyond and US big tech as fears of an impending ‘dismantling’ of market power among the Magnificent Seven crystallise, given the crumbling of Nvidia’s value yesterday morning.

“It’s a timely reminder of the volatility of Nvidia stock. The company is up an eyewatering 90% over the past year. In fact, the top 10 single day stock falls (in terms of market value destruction) are all Mag-7 stocks – 8 of which are Nvidia alone. Across the market, there was collateral damage across the semi conductor supply chain (TSMC, ASML) and even energy sector (Siemens) – as markets digested the news,” Betashares Senior Investment Strategist, Cameron Gleeson, said.

“The US market has become reliant on big tech to drive returns in the last few years. It’s perhaps a little early to call an end to the AI market narrative, but investors should be mindful that the US market is far broader than just big tech. For example, the S&P500 on an equal weight basis was flat, despite the mega sell off in Nvidia. As part of this changing of the guard, US financials are having a very strong Q4 2024 earnings season, with expected 28% earnings growth. At the end of the day, diversification remains an important bulwark for investor portfolios.

“It’s also worth thinking through the longer-term market implications. The development of more efficient AI training, is at face value, a net negative for the hardware (semi conductor industry) and longer term could be a very strong net positive for software (for example Meta and Salesforce were up overnight). End-user AI application development becomes cheaper and therefore has wider applications, so anyone who owns the customer by providing AI embedded solutions wins.”

Richard Clode, Portfolio Manager at Janus Henderson Investors, also suggested several concerns lie around the impact DeepSeek would have as a Chinese entrant on the US-strong AI market and its current struggles in scaling and sustainability of earnings.

“We continue to expect ongoing strong spending on AI capex as seen recently from announcements by Meta and the Stargate AI project. But we also think we need to be more selective in those AI capex beneficiaries, as well as think about the next phases of AI investment opportunity as this new tech wave develops,” Clode said.

“We characterise infrastructure as the first phase of a new wave followed by platforms and then the software, applications and services. We are approaching that pivot to the platform phase led by the cloud but still see longer-term investment opportunities in AI infrastructure as well.

“The market has rapidly shifted from concerns on AI capex being too high, to now worrying that AI capex is going to collapse. Both cannot happen simultaneously, and the truth likely lies in between. Ultimately, we think these developments are positive for the long-term health and development of AI.

“We continue to identify selective AI infrastructure beneficiaries and build our exposure to platforms that will benefit from more efficient AI compute, training models and inferencing.”

Clode also indicated several possible ‘next moves’ for DeepSeek and the AI market, given its innovation of large language models (LLMs) and its use of an open source model.

“Any new technology wave requires innovation to drive down the cost curve over time to enable mass adoption. We are witnessing multiple avenues of AI innovation to address scaling issues with training LLMs as well as more efficient inferencing. DeepSeek appears to bring some genuine innovation to the architecture of general purpose and reasoning models. Innovation and the driving down of costs are key to unlocking AI and enabling mass adoption longer term.

“DeepSeek’s model leverages a technique called distillation, which is being pursued more broadly in the AI industry. Distillation refers to equipping smaller models with the abilities of larger ones, by transferring the learnings of the larger, teacher model into the smaller, student one. However, it is important to note DeepSeek’s distillation techniques are reliant on the work of others. Exactly how reliant is a key question the market is grappling with currently.

“As AI luminary Yann LeCun has noted, this is a victory for the open source model of driving community innovation with DeepSeek leveraging Meta’s Llama and Alibaba’s Qwen open source models. Again this is positive for the longer-term development of AI, driving and proliferating innovation. However, due to the current state of geopolitics one would probably expect greater US government scrutiny on other countries accessing state of the art AI LLMs from the US.

“It has long been our belief that monetising LLMs in the longer term will be challenging given the volume of competition, including from open source developers and competitors looking to monetise in alternative ways. The DeepSeek announcement only brings greater scrutiny to the return on investment (ROI) of the huge capex general purpose foundational model developers are spending.”