AI-fueled stock rally dealt $1 trillion blow by Chinese upstart

For the better part of two years, artificial intelligence technologies have been a nonstop gift for US equities investors. The Nasdaq 100 Index rose 92% from the start of 2023, adding more than $14 trillion in value and minting billions for a handful of tech executives and founders.

Just last week, the S&P 500 Index powered to another record thanks in large part to more AI hype, this time from the Oval Office in the form of $500 billion in planned investments. President Donald Trump declared the US the global AI leader — a statement few would've contested long before he even uttered it. Nvidia Corp. had the best chips. Meta Platforms Inc., OpenAI and other US tech giants had significant leads in developing the bots that would drive it.

Then came DeepSeek, a Chinese startup whose AI platform appears to look as good as anything on the market at a fraction of the price and a sliver of the energy consumption. 

The Nasdaq 100 fell 3% Monday, the most in six weeks, leaving it virtually flat for the year and worth almost $1 trillion less than on Friday. Nvidia had its worst day since March 2020 when the pandemic hit, losing almost $600 billion in market value in the biggest wipe-out in history. Energy firms expected to profit from unprecedented AI demand sank, led by a 21% beatdown for Constellation Energy Corp.  

Suddenly, a rally predicated largely on US AI dominance turned into a question of whether the hundreds of billions in AI investments would ever lead to profits large enough to justify the rich valuations afforded to Megacap stocks. The group makes up 30% of the S&P 500's by weighting, more than at any time in history. 

"Today's moves show just how precarious this market set up is," Max Gokhman, senior vice president at Franklin Templeton Investment Solutions. "When valuations stretch to the sky it's easier for small trembles to make the entire market rumble."

DeepSeek's latest AI model rose to the top of the Apple's appstore charts over the weekend, presenting a visible challenge to costlier models like OpenAI and raising questions over the hundreds of billions in planned spending on the technology by the likes of Meta, Microsoft Corp. and Alphabet Inc. Nvidia, whose shares soared ninefold in the past two years, tumbled 17%.

"DeepSeek shows that it is possible to develop powerful AI models that cost less," said Vey-Sern Ling, managing director at Union Bancaire Privee. "It can potentially derail the investment case for the entire AI supply chain, which is driven by high spending from a small handful of hyperscalers."

Nvidia, for its part, downplayed the threat from DeepSeek, calling that an "excellent AI advancement" that complies with US technology export controls. While most of Nvidia's best products can't be sold to Chinese companies, its statement points out that inference, the work of running AI models, nonetheless needs a lot of its products. 

"Inference requires significant numbers of Nvidia GPUs and high-performance networking," the company said.

The rout in Nasdaq companies comes at the start of a big week for earnings from major tech companies including Apple and Microsoft, with investors already prepared to scrutinize massive capital outlays against returns that have so far been paltry in comparison.

To be sure, the selloff in US markets was relatively orderly despite the bludgeoning for megacap tech. The S&P 500 pared its losses to less than 1.5%, with more than 350 of its members advancing — highlighting that the damage was mostly contained to sectors exposed to AI. The Dow Jones Industrial Average rose 0.7%, with only seven of its members finishing in the red.

Analysts said some companies such as Salesforce Inc., banks and major retailers — companies expected to use AI bots rather than develop them — stand to benefit from DeepSeek's open source approach if they can deploy AI for a fraction of what it otherwise would have cost.

At the same time, there's more to the market than tech and AI. The Federal Reserve will start its two-day policy meeting Tuesday, with officials expected to keep rates steady as the battle against inflation continues. And Trump's deregulation push and plan to extend deep tax cuts have the potential to spur growth, albeit with the risk of being inflationary.

Regardless, the shockwave from DeepSeek's latest iteration, which was released last week, has caused a rethinking of how to value anything related to AI. It is widely seen as competitive with OpenAI and Meta's latest offerings. Lauded by investor Marc Andreessen as "one of the most amazing and impressive breakthroughs," DeepSeek's app shows its work and reasoning as it addresses a user's written query or prompt. 

"We don't know whether this is the 'Sputnik Moment' for stocks, but this is certainly a wake up call that we are not the only game in town," Paul Nolte, market strategist and senior wealth manager at Murphy & Sylvest Wealth Management, said. "That requires a lot of investors to look at the AI companies in a different way: To put these very high valuations in the stocks thinking they have cornered the market is a huge mistake and that is being re-rated."

The Nasdaq 100 is trading at around 27 times estimated forward earnings, compared with its three-year average of 24 times. Nvidia is at 33 times, though that's slightly down from its three-year average.

The DeepSeek release raises new doubts, challenging the notion that China's AI technology is years behind US counterparts. Washington's trade restrictions had kept the most cutting-edge chips out of China's hands, but DeepSeek's model was built using open source technology that is easy to access.

"While current leaders like Nvidia have a strong foothold, it is a reminder that AI dominance cannot be taken for granted," said Charu Chanana, chief investment strategist at Saxo Markets. "The emergence of China's DeepSeek indicates that competition is intensifying, and although it may not pose a significant threat now, future competitors will evolve faster and challenge the established companies more quickly. Earnings this week will be a huge test."