DeepSeek disruption highlights need for resilient portfolios
By Paddy Flood (Portfolio Manager and Global Sector Specialist, Technology), Simon Webber (Head of Global Equities) and Johanna Kyrklund (Group Chief Investment Officer) at Schroders
While the impact of DeepSeek’s innovative approach to AI is yet to be fully understood, highly concentrated markets had become vulnerable to a pullback.
Stock markets suffered a sell-off on Monday 27 January as China’s DeepSeek claimed new advances in the field of artificial intelligence. DeepSeek says it has trained a generative AI chatbot at a fraction of the cost and time required by the market leaders.
The news raises important questions for investors about the implications for the technology sector, given that the AI theme has powered stock markets in recent years. The Nasdaq index fell 3% on Monday and shares of some AI-related companies were down much more.
Shocks such as this also reinforce the need for an active approach in building resilient portfolios.
Equities perspective from Paddy Flood and Simon Webber
What has DeepSeek done?
DeepSeek, a Chinese AI startup, has reportedly developed large language models (LLMs) comparable to market leaders, but at significantly lower training costs. If accurate, this could imply reduced demand for high-performance semiconductors required for the computational workloads associated with AI.
However, this conclusion hinges on whether DeepSeek’s cost data is truly comparable to the incumbent players and, more importantly, that other factors remain unchanged.
Increased efficiency in compute power does not necessarily translate into reduced demand for chips. Jevon’s Paradox—a well-established economic concept—suggests that improvements in resource efficiency often drive greater consumption of that resource. In this context, higher compute efficiency could spur further adoption and expansion of AI, potentially offsetting any direct reduction in chip demand.
Which companies could be the winners and losers?
If increased compute efficiency leads to reduced demand for chips/AI equipment, companies like Nvidia and other compute infrastructure providers could face headwinds. However, this outcome is far from certain, particularly given Jevon’s Paradox, as previously mentioned.
On the other hand, this development could prove favourable for software companies. Lower AI costs might make these technologies accessible to a broader base of customers who were previously deterred by high price points. For software providers embedding AI capabilities into their products, this could bolster adoption while preserving profitability.
Additionally, large hyperscale companies such as Microsoft, Meta, and Google could stand to benefit. Concerns have been growing around the potential returns on their substantial AI-related investments. If this situation results in reduced spending requirements for these companies, it could lower their capital expenditure needs and drive significant increases in free cashflow generation.
What next for the markets?
There are still a lot of uncertainties that need to be resolved, such as clarifying DeepSeek’s cost structure and whether cheaper infrastructure would really lead to less spending in the global AI race. This uncertainty does create risk, but the severity of these moves is likely to create opportunities for active investors, particularly in technology and industrials.
There will be a heightened focus on this topic in the days and weeks ahead. This will be especially relevant as several major tech companies are scheduled to report earnings this week and next, potentially providing additional clarity or signalling shifts in sentiment.
Johanna Kyrklund: Market shock highlights need for resilient portfolios
We’ve discussed before the dangers that highly concentrated equity markets can pose to investors. The level of index concentration now far surpasses that of the late 1990s. From a portfolio standpoint, having such high unintentional exposure to just a handful of companies does not feel prudent. Understanding the underlying stocks is crucial, and an active approach is needed to manage the risks.
The full implications of DeepSeek’s technology still need to be understood. But this example highlights that markets are vulnerable to a misstep by one of the large US megacaps, or by the emergence of new competition.
Major equity indices do not offer the diversification they did in the past. Investors wanting to build more resilient portfolios will need to take an active approach, looking across sectors and geographies, to build genuine diversification.
Further reading : The two key risks facing investors
Any reference to sectors/countries/stocks/securities are for illustrative purposes only and not a recommendation to buy or sell.
