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Market Commentary

Bubble Trouble

By February 4, 2025No Comments

 

“Speculation buys up, in a very real way, the intelligence of those involved.”

John Kenneth Galbraith, A Short History Of Financial Euphoria


On Monday last week, 27th January, euphoria over artificial intelligence, AI, turned to panic, and US tech companies lost around about $1trn in value.  What was the trigger?  What does it tell us about the potential of AI as a technology and as an investment? (Clue – they are not the same thing.)  And how did other investments respond i.e. should you be worried or excited?

 

The trigger for this rout was the launch of an AI product called R1 by Chinese company DeepSeek.  It was launched on Inauguration Day in the US (deliberate?), and in the days afterwards the implications of R1 began to build amongst those better informed technically.

 

It wasn’t until the Monday a week later that financial markets figured what was happening.  The assumptions behind the AI bull market, which had driven the S&P 500 to new bubble highs over a year or so, were crushed.

 

There were three planks behind the AI investment mania:

 

  • There will be massively successful products built on AI technology, the most well-known prior example being the iphone for Apple in the retail world.
  • Only the very largest companies, the likes of Apple and Google and Microsoft, can afford the tens of billions of investment required, which creates a huge barrier to entry. This in turn creates the potential for huge monopolistic profits for these companies, much as they already enjoy from other products and services.
  • Only Nvidia’s most advanced chips would be good enough to train the best AI systems.

 

Tens of billions have already been spent, but there is no obvious ‘killer app’ or product.  With the release of DeepSeek’s R1, the second and third assumptions are also doubtful.

 

DeepSeek has shown that there always was a cheaper and simpler alternative to the massive, expensive, and monopolistic AI infrastructure created in the US, and quite a few analysts, particularly in the US, are very angry:

 

“This isn’t about China.  It’s about how the American tech industry is incurious, lazy, entitled, directionless, and irresponsible… It’s been a con, a painfully obvious one… beneath the hype was an industry that provided modest at best outcomes rather than any kind of ‘next big thing”.

 

There is a lot more commentary like this.

 

Yet behind all of this emotion remains an extraordinary technology.

 

At its simplest artificial intelligence enables computers to perform tasks that we can perform, but faster or more consistently, or both.  It has the potential to revolutionise industries like healthcare, education, and climate change, by automating tasks and improving decision-making, or by equipping machines with the ability to perform tasks that mimic human intelligence.  At the least it should boost productivity across a range of industries in the decades ahead.  At best “it will power humanity through a transformation comparable to the Industrial Revolution”.

 

Before Stephen Hawking died he felt the possibilities for AI were much more extreme.  He said it will either be the best thing that’s ever happened to us, or it will be the worst thing, and “if we’re not careful, it very well may be the last thing.

 

Whatever the future holds, for better or worse, that potential is undiminished by recent events.  In fact R1 illustrates that they could come quicker.  Where the US giants wanted to hide what made AI tick, aided and abetted by their government, this merely inspired the likes of DeepSeek to innovate around the barriers.

 

Last year, when the US tried to block Chinese access to the most powerful chips on which AI apparently depended, and with Trump seemingly ready to do more of the same, we said:

 

“The parallel is Napoleon blockading British trade with Europe from 1806. 

This spurred Britain into action, the result being the 19th centuries domination by British industry”.

 

As Charles Gave put it:

 

“Never force your main competitor to become more competitive

because you are not competitive enough”

 

The US has also lost the moral high ground, if it ever had it.  The US products are hidden behind high walls – you do not know precisely how they work, and their monopolies are not about to share this knowledge with you.  In contrast, DeepSeek had previously promised to develop AI for the public good, and prevent “monopolisation” by a few companies.  If you want to download their product and use it to build your own, go ahead, no permission required.  When the company releases new models they also publish papers providing a wealth of detail on what is under the bonnet.

 

President Xi will be very happy with the PR potential of “open China, working for global good” vs “closed US, working for its own profit”.

 

If the potential benefits from AI are now brighter for the world, the investments opportunities are not.  This week was perhaps the end of the beginning for the AI investment cycle.  It is nothing new, whether you turn to canals and railways in the UK in the 18th and 19th centuries, or tech and telecoms in 1998-2000.  Greed trumps thoughtful analysis, and investors pile in.  But the improved productivity, profits, and products from new technology, typically take much longer to unfold than implied by the headlong rush of naïve investors into “the next big thing”.

 

That the AI bubble has been pricked by China should not be a surprise.  As we and others have highlighted regularly, China has a massive army of STEM graduates (science, technology, economics, maths), roughly 9 times as many as the US, and this army of smart young people is not complacent, and very entrepreneurial.  A study in 2023 found that China leads in 37 of the 44 advanced technologies which they measured (Source: Australian Strategic Policy Institute).  Why such a shock that, as the Economist headline put it last week, “Chinese AI has stunned the world”?

 

Although vast sums were lost in tech stocks over the last week, on Monday, when the shock hit hardest, more shares in the S&P 500 were up than down.  The damage was quite narrow.  It could take months for the real damage to emerge in the valuations of the major tech stocks, once they are re-priced on the basis of no new-big-thing on the horizon.  At best that dampens the outlook for the major US stock market index, the S&P 500, because its performance is heavily skewed to the share prices of the Magnificent 7 tech stocks.

 

Nonetheless, there were no crashes beyond this narrow, albeit very important, sector.  Encouragingly, the cheaper markets turned up, UK and Japanese smaller companies being two obvious example, along with positive signs out of the Chinese as their financial markets re-opened post celebrations for The Year Of The Snake.

 

If the latter rotation continues, that is very positive, though we cannot eliminate the potential for stupidity from Donald Trump, so remain on our guard.

 

 

 

 

 

 

 

 

 

 

 

Dennehy Wealth