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Some Deep-ish Thoughts About DeepSeek

Some Deep-ish Thoughts About DeepSeek

Posted January 27, 2025 at 1:00 pm

Steve Sosnick
Interactive Brokers

Today’s market reaction should serve as a reminder that even disruptors are susceptible to disruption.  The sudden, adverse market reaction to DeepSeek, a Chinese open-source artificial intelligence platform, indicates that some of the key assumptions that have been driving the AI trade, and hence major indices, are getting reassessed today.

The advent of ChatGPT opened the doors to a wave of investment in artificial intelligence.  AI itself is not a new theme, per se.  It’s been around for decades, but ChatGPT moved it from the realm of data scientists to something accessible by almost anyone.  Their model, along with others, relies on a significant investment in computing power.  This notion was reinforced just last week with the announcement of Project Stargate, which provided a further lift to key providers and investors like NVDA, ARM, and Microsoft (MSFT).

As with any gold rush, savvy investors realized that perhaps the best way to profit was not from mining the “gold” itself – especially with ChatGPT’s parent, OpenAI, being a private company – but via the providers of the “picks and shovels” used by the miners.  Nvidia (NVDA) immediately pivoted from being known as the preferred provider of chips for crypto mining to that of an AI-focused company.  This is something we noted after NVDA’s earnings call in February 2023, when we noted that the company referred to AI 70 times – 37 of them even before the first question was posed.  Kudos to Jensen Huang for recognizing the potential, and to early investors who rode that wave.

But DeepSeek is forcing us to rethink that notion.  If an upstart developer can create an open-source platform that requires far less hardware to be productive, then it has the potential to puncture the expected demand for the type of chips provided by NVDA, Broadcom (AVGO), AMD, and the like.  The first two stocks are down about -15% as I write this, which in turn are helping pull the Philadelphia Semiconductor Index (SOX) down by about -8.5% – its worst day since 2020.

Just last week, when Apple was about -4% lower, we noted that a decline in the largest company had a depressing effect upon market capitalization weighted indices.  Well, it’s that much worse when the new #1, along with #6 are each down by 15%.  Today’s -1.8% decline in the S&P 500 (SPX) and -3.2% drop in the Nasdaq 100 (NDX) are direct consequences of their concentration.  The ‘Mag 7” plus AVGO make up more than 1/3 of SPX and nearly ½ of NDX.  Moves of today’s magnitude in the largest have inordinate effects on these key measures.  Interestingly, advances on the NYSE roughly match those of declining stocks, while on Nasdaq, decliners only lead by about a 3:2 margin.  Top-heavy indices benefit mightily when the biggest components lead the charge higher but fall disproportionately when the opposite occurs.

I believe that part of the today’s sudden adverse market reaction was a direct result of a wave of complacency that overtook the equity market last week.  On Tuesday we wrote:

To my mind, the most striking element of the market reaction continues to be decline in the Cboe Volatility Index (VIX).  The current level of 15.21 – which would represent the lowest close since the day after Christmas– shows that traders are anticipating relatively placid markets over the coming month.  Remember, VIX does not explicitly measure fear, but instead is constructed to portray the market’s best estimate of SPX volatility over the next 30 days.  Bear in mind that this period includes the peak of earnings season, an FOMC meeting, and the potential for tariffs against Canada and Mexico to begin on February 1st.  Virtually no one expects a rate change from the Fed next week, but the statement and press conference might offer important clues about the timing of future potential cuts.

Keeping in mind that 10 of the past 20 days have featured SPX closes of more than +/- 1%, perhaps we have gotten a bit too complacent.  The skew chart … shows that SPX volatilities are down pretty much across the board since last week, but especially in at-money and near-upside options.  Could the market be telling us that [it thinks] the easy money has been made?

I also reiterated a similar theme in media appearances on Wednesday and Friday.  We’ve had no shortage of volatile days – up and down – but somehow investors had decided that the likelihood of volatility diminished, major events notwithstanding.  That an unexpected event brought the volatility sooner than expected should remind us that the best time to buy an umbrella is often when the sun is shining. 

Going forward, we will need to decide if today’s events are a blip, an inflection point, or a turning point for the AI trade.  My gut says “inflection point,” though it is clearly too early to draw real conclusions in the midst of a major sector’s repricing.  At its best, DeepSeek will represent a boon for artificial intelligence, making it cheaper for all and thus improving the odds and the timeframe that its potential productivity boosts will be reflected in a wide variety of companies’ bottom lines.  Maybe not the one’s that we’d all expected, however.

My colleague Andrew Wilkinson put it succinctly in a message this morning with the phrase “where’s the moat?”  A good portion of the valuation premium that has been placed upon our largest tech stocks, our largest stocks overall, was based upon their entrenched competitive advantages.  That entrenchment is being reassessed right now, bringing some unwelcome moves for some stocks that seemed unassailable just last week.  I think back to the internet bubble, when many of us utilized computers provided by Sun Microsystems or Compaq, when Cisco (CSCO) was priced to rewire the whole world, and Yahoo was the search engine of choice.  The promise of the internet was realized, but remember that some of the companies that best utilize that promise – Alphabet (GOOG, GOOGL) and Meta Platforms (META) – only arose years later.

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18 thoughts on “Some Deep-ish Thoughts About DeepSeek”

  • Anonymous

    I have been shorting the markets since Trump inauguration. It was just a beautiful storm: high valuations, AI hype, Trump sabotaging the US in any way possible, Elon supporting national socialists… but I didn’t expect DeepSeek. Sweet nice trigger. Still bearish. The floor is coming.

  • Anonymous

    so basically you got lucky. still not even close to where we started on Nov 6

  • Anonymous

    I got lucky here too. Been heavily shorting the tech sectors and semi’s and today finally paid off. The “Non-introduction” of tariffs on day one is what got me and other short sellers. Well that and also the high Valuations compounded by an increasing 10 year has the market tee’d up for a 10% correction. So really today’s luck of the draw was sure to come. One way or another. But I feel certain more pain is to come and eventually buying opportunities once we see a 10% correction in the overall s&p index.

    • Anonymous

      Agree. Most people don’t realize that tariffs will hurt American economy twice. First, they will pay more for the imports. Second, the countries will impose tariffs on American exports. Besides, there is this weirdness going on. I don’t think many jews, black people, moderate people, Europeans etc will buy Teslas while Elon makes nazi salutes. Just weird! It seems the world is watching with apprehension, but eventually it will move on, embrace more predictable China and occupy the vacuum the US is leaving behind. Great time to go short

  • Anonymous

    If our government is worried about TikTok stealing our personal information, do you really think we will be using Chinese chips to run our AI?? Would you even trust Chinese AI?? Today’s selloff was much overdue, but the reasoning behind the selloff was ridiculous. This was a good day to add to my positions (as well as to open a few new ones). Cheers!

    • Anonymous

      Agree with you 100%!!

  • Anonymous

    Somebody needs to study what a NAZI salute looks like. One clue – you don’t start with your hand over your heart. BTW – have you considered moving to China?

    • Probably_a_chinese_SPY

      Yeah, Elon is a very smart guy. I’m confident he had no idea what he was doing, like all those times he engaged with far-right ideologues and self-identifying Nazis on his own social-media platform. He was “welcoming both sides” of course. Remember, he is very smart. So, if he did get called a Nazi, he would never associate with Germany’s far-right political party before and then all most immediately after such salutations. It’s really not that hard. At least blame whatever gave him the gurn he had going on beforehand. Anyways, I enjoyed the article a lot, and had the fortune to be long volatility (VIX calls) over the weekend but it was truly happenstance; for the meantime, I’m short asinine forum comments, as you can’t go wrong with that one.

  • HundredLotTrader

    I was negative delta QQQ and NVDA, I realized portfolio percentage points today closing short calls and long puts and then reversed selling puts and rolling protective hedges on NVDA out to May. I’m risklessly positive delta in net profitable positions awaiting earnings. I didn’t know anything about DeepSeek but saw the move written all over the charts. Do I believe this suddenly ends everything? No, because funny enough I actually posted a video on YouTube in mid December outlining this price point on NVDA and how the market was targeting it. I said it was going to look really scary and everyone was going to think it was the end of the world and I’d be sitting there soaking up NVDA, which I did (125 synthetic futures at credit with paid for hedges rolled to May). It did however take a lot longer to get here than I’d anticipated. My Tinfoil hat take says the narrative abruptly shifts in a few weeks time now that NYTimes is reporting how all the AI stuff was overblown etc etc. The market has an unbelievably short memory.

  • Spock

    Has DeepSeek been thoroughly benchmarked by an unbiased independent organization not affiliated with China or allegiant to any particular government? If not, I don’t trust the hype about it if it’s mostly coming out of China or anyone anywhere with any strings attached that lead to China. AI requires GPU processing horsepower, no way around it. No magical software algorithms or coding can substitute for raw GPU processing capacity. Perhaps they are using a sort of distributed network of GPU processing capacity…. something like what is behind the crypto token named RENDER. But I remain skeptical of the claims that have been made abiut DeepSeek. I have no dogs in the fight, no positions in any of the MAG7 or other western AI firms, I’m just a futures trader, I go whichever direction the mkt shows me. Just some observations.

  • Klaus

    Possible typo. You mentioned OpenSeek twice above, but I think you meant DeepSeek.

    • Interactive Brokers

      Thank you for passing this along. The changes mentioned are now reflected in the article. We appreciate your feedback!

  • Retired Semi VP

    Besides some skepticism on DeepSeek claims, I also wonder if their efficiency applies to inference versus just training AI efficiency, the latter which most articles seem to address. More recent releases of AI models that get closer to general intelligence use significant compute to answers queries. Thus, wouldn’t surprise me to see some of the negativity wrt infrastructure providers reverse as more thorough analysis is reported.

  • Chris Landau

    Has anybody here tried Deepseek? I tried it with reference to solar science and publishing in China. I got intelligent step by step answers to my questions. I paid nothing. I did not get hammered by adverts as Google does. DuckDuckGo helps there too. I loved Google. Now I think they invade my privacy with their adverts. Please keep this platform civil so we can all learn from each other on how to make money. That is the point is it not? The political stuff is a backdrop that does have an influence on markets but should not polarize us away from intelligent discussion.Let us keep learning. Use this platform as a civil university lecture hall. Propose new ideas without having destructive criticisms, so we can all win. Nothing lasts forever. Hold onto your dreams. Life and markets are simply change. Thank you

    • Darrezz Karringten

      That’s a common sense reply. Thanks for being level-headed in the midst of uncertainty.

  • barramundi

    no thanks to giving training data to adversary state

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