Investment Topics April 13, 2025 113

Decoding the Investment Logic of DeepSeek

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Last week, a seismic shift occurred in the global technological landscape, triggered by the rise of the Chinese AI model DeepSeekThis development sent shockwaves through Western markets, particularly those tied to computational power, leading to staggering losses for tech giants like Nvidia, which saw a plummet of $600 billion in market capitalization overnightOther major players in the semiconductor industry, such as TSMC, AMD, and ASML, also faced significant declinesWhile the market experienced some recovery shortly after this downturn, it prompted a widespread reassessment of investment strategies in tech stocks and raised questions about the long-standing notion of 'American exceptionalism' within this context.

Goldman Sachs recently released a report indicating that the emergence of DeepSeek highlights a pivotal shift in the AI industry—from a focus on hardware infrastructure to an emphasis on software applications

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This transition not only challenges the dominance of 'American exceptionalism' but also opens new avenues for diversified growth within global markets, particularly benefitting Chinese tech stocks.

The report underscores a fundamental change in the investment logic surrounding AI: it is shifting from a hardware-centric approach to one that prioritizes softwareGoldman Sachs noted that the MSCI China Index is likely to exhibit robust performance in the short term due to its high exposure to AI softwareConsequently, investors are advised to overweight Chinese tech stocks, especially firms that demonstrate innovative capabilities and market advantages at the application level of AI technologyAlthough the A-share market has traditionally placed a heavier emphasis on hard technology, it has been making significant strides in establishing its foothold in AI software, thereby preparing to reap benefits from this evolving landscape.

The phenomenon of American stocks outperforming their global counterparts has often been termed 'American exceptionalism', which can be attributed to the nation's dominant position in global economics, technology, and innovation

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This exceptionalism has historically made American stock markets uniquely attractive to investors.

A key factor in this success is the immense investment made by American companies in research and development, as well as capital expenditureResearch from Goldman Sachs’ David JKostin's team reveals that U.Scompanies show a growth investment ratio significantly higher than other regions of the world, particularly in the field of AITheir substantial investments in AI infrastructure have allowed them to hold a dominating position in hardware and semiconductor markets.

However, the capabilities of DeepSeek's R1 model, which attained performance comparable to leading models like GPT-4 and Llama at a fraction of the cost—less than $6 million—have delivered a powerful blow to the narrative of 'American exceptionalism.'

Market analysis from Goldman Sachs observed a clear rotation in stock performance last week: AI hardware and semiconductor stocks faced significant valuation pressures, while stocks in software and services sectors thrived

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Their Phase 2 basket of stocks concentrated on AI infrastructure recorded a 3% decline compared to an equal-weighted S&P 500 index, whereas their Phase 3 basket—which includes companies capable of enhancing revenue through AI—experienced a 4% increaseThis shift in investment patterns indicates a broader acceptance of AI integrations beyond traditional hardware-focused firms, broadening the American stock market's horizons and allowing a wider array of companies to create new revenue streams or enhance productivity through artificial intelligence.

This trend signifies that global markets are expanding remarkablyAlthough AI infrastructure companies are primarily headquartered in the U.S., the potential user base is globally dispersed, indicating a shift towards inclusivity in AI application accessibility and benefits.

When examining the Asian stock markets’ exposure to AI developments, Goldman Sachs’ Timothy Moe’s team found that Chinese tech stocks have a distinct edge in the software component of AI technology

Their research assessed market familiarities regarding 'hard technology'—which includes hardware and semiconductors—and 'soft technology'—involving internet-related services and softwareThey found that in the realm of AI software, Chinese firms display significant exposure.

According to their analysis, soft technology constitutes an impressive 37% of overall earnings within the MSCI China Index, with a market capitalization share of 32%. Chinese stocks are more invested in the application side of AI, especially compared to the mainland A-share market, where the distribution between hard and soft technologies remains more balanced and cautiously weightedThe extensive engagement with AI applications by companies such as Tencent, Alibaba, and Baidu is evident, and their innovation in areas like natural language processing and computer vision positions them favorably against competitors with minimal exposure in CPU and semiconductor sectors.

Despite the A-share market’s stronger emphasis on hard technologies, there has been a concerted effort in recent years to expand its AI application landscape

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This development is creating added value for A-share investors.

Across other Asian markets, the exposure to soft technology remains relatively low, with South Korea and Japan displaying only 6% and 3% exposure in the MSCI indices, respectivelyIndian software companies lag significantly behind, as well.

Goldman Sachs' report emphasizes the underlying disparities in these markets, indicating that, as investors reassess the uncertain pricing of AI model training demands, the Korean index might face greater short-term pressures, while Chinese stocks could benefit from elevated application layer exposure.

From the evolving perspectives on hard and soft technology, it appears that investors have partially anticipated this shift but may not have fully accounted for the conservative valuations surrounding Chinese tech stocks in the software sector.

Maintaining their overweight rating on Chinese tech stocks, Goldman Sachs particularly favors sectors such as internet, media, and entertainment

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