24 Jan 2025
7 min read

Who’s Afraid of DeepSeek?

Deep Seek

Since the AI boom got rolling in US stocks, there have been a few generally accepted truths about how the technology would play out.

Firstly, you needed large volumes of computational power to train models classed as state-of-the-art. Second, you needed large financial resources to pay for that computational power. Third, it was the US that was setting the pace, with other countries unable to keep up with Silicon Valley’s deep pockets and engineering talent. 

All three assumptions are now in doubt after Chinese AI company DeepSeek1 launched its R1 model (the latest in a class of ‘reasoning’ models to handle more complex tasks). The R1 model is not only comparable in terms of performance to Open AI’s o1 model (scoring similarly in coding and math tests), it is also vastly cheaper, charging $0.14 per million tokens (pieces of sentences) compared to OpenAI’s $7.50. 

The model also writes out its thought process (so-called Chain-of-Thought) in ways users find helpful. DeepSeek’s relatively small team of researchers, based in China’s tech heartland of Hangzhou, have also published the model’s source code to all, thrilling researchers. To top it all, DeepSeek reports that costs were minor compared to most AI models to train, at just under $6 million.

Figure 1: Input / output pricing for o1-Class inference models

Figure 1

Source: https://api-docs.deepseek.com/quick_start/. Pricing data as of January 28, 2025. Note: Cache hit/miss refers to whether the system can quickly retrieve a previously processed result for a similar input, rather than having to process the input from scratch again.

Seeing market vertigo?

DeepSeek’s advances have US equities feeling vertigo after rising so high in the past four years. In particular, DeepSeek’s claim that they produced their model without using an expanded amount of high-end GPUs (graphics processing units) of the kind Nvidia1 produces has chipmaking stocks (such Nvidia and Taiwan Semiconductor Manufacturing Company1) swooning. Large-cap equities had been pricing in a substantial build-out of these cutting-edge chips as the AI boom steadily spread.

Does DeepSeek threaten those assumptions, and in so doing, threaten the US AI complex? While it’s too early to say, it wouldn’t be the first time. The dot.com bubble saw tech hegemons like Oracle1 and Cisco1 soar in value, until it was clear their monopoly on high-end servers was too expensive for the typical user, only then to crash in a market rout. Could Nvidia await the same fate?

What’s in DeepSeek’s secret sauce?

In light of DeepSeek’s remarkable engineering feat, researchers have been poring over the firm’s technical report to explain how it achieved such incredible results at low cost. As with any breakthrough, there is skepticism of its reliability. This skepticism takes three main forms.

Firstly, on cost. DeepSeek’s reported minimal model cost of just $5.5 millon likely refers to training only, not the cost of expenditure on computation, staffing or running the model, all of which will be substantial (albeit perhaps covered by local government). 

Secondly, on chips. Detailed research finds that despite Biden-era controls on China’s access to AI chips, many thousands of GPUs will have entered China anyway, casting doubt on claims DeepSeek had no additional chip capacity. 

Lastly, on design. DeepSeek’s prior models (like its V3 model) have referenced OpenAI explicitly when asked some queries, leading people to think the firm’s R1 model is piggy backing on OpenAI’s technology, rather than developing new reasoning capabilities.

While the numerous efforts to raise efficiency throughout DeepSeek’s process have undoubtedly wrung substantial efficiencies out of the model, it’s unclear how much of their success is attributed to these unmentioned factors.

The Trump factor 

DeepSeek’s R1 launch was timed to match with Trump’s re-inauguration as US president. With US-China relations in the spotlight, Cold War comparisons were quick to come by. Mark Andreessen, Silicon Valley luminary, described DeepSeek’s R1 model as a “Sputnik moment” for AI. 

Those familiar with the Cold War Space race will know that Sputnik’s launch was a foundational moment for NASA and the US government’s quest to put a man on the moon. But it also led to fears (proven baseless) that there was a “missile gap” between the US and USSR.

Today, given geopolitical tensions, it’s possible national security aims could supersede economic ones. We think Trump’s new administration might find any Chinese tech advantage challenging – and so devote government resources at winning the AI race. That could present potential upside for many US-based AI firms, in our view.

Portfolio implications

Suspicions aside, we believe that DeepSeek’s groundbreaking method to raise performance could augur well for AI adoption. A cheaper product could encourage more users to harness the technology for profitable use; although Cisco’s servers built in the dot.com era proved loss-making for some time, they are part of why you are reading this on the webpage you are now. 

There could be clear benefits to the entire corporate sector should a productivity-enhancing technology become available at a significantly lower price. The MSCI EAFE and even the S&P equally-weighted index were up slightly on Monday as the market digested this potentially game-changing news.

Nevertheless, for the AI-supercharged US equity index, heightened valuations and a sudden injection of uncertainty might be problematic. While we don’t have a tactical view on US equities today our process has always emphasized diversification2, leading us to hold a smaller amount of US mega caps than a pure market-capitalization-based approach. Regardless of what comes next, this episode is a useful reminder of the potential benefits of spreading our bets.

1. For illustrative purposes only. Reference to a particular security is on a historic basis and does not mean that the security is currently held or will be held within an LGIM America portfolio. The above information does not constitute a recommendation to buy or sell any security.
2. It should be noted that diversification is no guarantee against a loss in a declining market.

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