Quick Bites | China’s DeepSeek adds to valuation jitters

Quick Bite: China’s DeepSeek adds to valuation jitters

Author: Paul Zwi

 We should not be so surprised that obscure Chinese company DeepSeek was able to replicate some of the artificial intelligence (AI) achievements of the mega-cap US technology titans – after all, China has led in the development of 5G, high-speed rail, solar panels, electric vehicles (EVs), batteries, drones, and robots. It still came as a shock, however, that perhaps the hundreds of billions spent by the giants of US tech might be capital that will never see the promised returns investors hoped for.

DeepSeek has questioned the AI narrative and asks whether the deflation of the AI story will remain a short-term market phenomenon, or impact broader market confidence. While I don’t pretend to know the answer to that question, the least a prudent analyst can do is frequently re-examine valuation metrics to try not to fall into any “it’s different this time” traps.

 

Of course, market narratives come and go – they don’t last forever. If the AI bull market stalls, what will take over? There are other strong themes, not least of which are Trump’s deregulation, cheap US energy, the strong US dollar (USD), potential Chinese stimulus, expectations of a merger and acquisition (M&A) boom, and central banks cutting rates. Most of these themes center on the US, and we’ve written frequently about “US exceptionalism”.

Let’s turn again to the mighty greenback. Arguably, the USD’s recent moves have been linked to Trump’s stance on tariffs. But given the news on DeepSeek, it may not be all that surprising to see a flattening-out in the USD. If China can develop a more efficient AI at a very low cost, it calls into question the need for very high-end computer chips (thus the fall in Nvidia), one key US comparative advantage. Whatever the reason, over the past year, the US dollar and US growth stocks’ relative performance have been correlated. So it’s possible that if the Nasdaq now starts to underperform on the back of the DeepSeek news, then the USD might follow.

 

Source: Gavekal Research

I noted above that a prudent analyst should pay attention to basic valuation metrics, and not get too caught up in the prevailing market narrative. The chart below shows the average historical percentile ranking across 8 different valuation metrics, including the most followed indicators such as trailing price to earnings (PE), forward PE, Price-to-Book, enterprise value over earnings before interest, taxes, depreciation, and amortization (EV/EBITDA), market cap to GDP, and others.

Pretty much, the signals are clear: the US stock market has reached new heights of valuation extremes. One can make the point that valuations seldom cause markets to turn, but I don’t buy that argument. As I’ve said before, “trees don’t grow to the sky”. The value you buy today (or lack thereof) will determine the long-term performance you get to enjoy in 5 or 10 years.

 

Source: edgeandodds.com