The emergence of China’s DeepSeek AI chatbot has triggered a significant market recalibration, causing initial panic among AI hardware stocks while creating unexpected opportunities in the software and application sectors. On Monday, Nvidia plummeted 17% alongside other AI chipmakers, nuclear, and utility stocks as investors grappled with the implications of a supposedly cheaper AI model that challenges the prevailing narrative about massive infrastructure investments.
DeepSeek’s cost-efficient approach has fundamentally altered the AI investment landscape. The tool reportedly costs a fraction of what US AI hyperscalers have spent, raising questions about whether massive capital expenditures on technology and energy infrastructure are truly necessary. However, Bank of America identified a silver lining: lower-cost AI capabilities could accelerate adoption across the software sector, with AI models becoming more accessible and affordable for revenue-generating applications.
Major financial institutions are now predicting a phase shift in AI investing—from hardware beneficiaries like chipmakers toward applications and services. Bank of America highlighted large-cap software beneficiaries including Salesforce, Adobe, ServiceNow, and Intuit as positioned to capitalize on this transition. JPMorgan echoed this sentiment, noting that historically, lower technology costs have democratized opportunities for innovators, with software eventually eclipsing hardware in terms of margins and sustainable growth.
The iShares Expanded Tech-Software Sector ETF has gained 4% since Monday’s opening bell, demonstrating investor confidence in the application layer. Gabelli Funds portfolio manager John Belton cited the implied drop in computing costs as potentially beneficial for financial, internet, and healthcare stocks. Some investors, like Laffer Tengler Investments CEO Nancy Tengler, have already shifted portfolios toward the application side of AI.
The DeepSeek episode may also catalyze a broader market rotation. Despite nearly $1 trillion in market cap being erased from US equities on Monday, 70% of S&P 500 stocks actually gained during the session. JPMorgan views this rotation and higher dispersion as healthy, given that equity crowding in the “Magnificent Seven” tech stocks had become increasingly stretched. Goldman Sachs noted the market is likely entering a longer broadening period, with a rising balance between value and growth investing not seen in years.
Key Quotes
The lower cost of technology historically democratized opportunities for innovators and entrepreneurs with hardware eventually becoming a commodity compared to higher-margin Services with more sustainable growth (e.g., Software eclipsed Desktops and Chipmakers, Internet Service Providers surpassed Telecom Equipment and Services)
JPMorgan analysts explained the historical pattern of technology evolution in a Tuesday note, drawing parallels to previous tech cycles where cost reductions led to software dominance over hardware. This perspective suggests the DeepSeek disruption follows a predictable pattern of industry maturation.
While the sell-off erased almost ~$1 trillion of market-cap from US equities, we view the rotation and higher dispersion as healthy given equity crowding was becoming increasingly stretched and unsustainable
JPMorgan’s assessment highlights the paradoxical benefit of the DeepSeek-triggered selloff. Despite massive losses, the bank views the market rotation positively, addressing concerns about over-concentration in mega-cap tech stocks that had become a systemic risk.
We’re in a little bit of a stretched phase
Chris Zaccarelli, chief investment officer at Northlight Asset Management, described the market imbalance where Magnificent Seven stocks’ percentage weight in the S&P 500 on a market cap basis almost doubles their weight on a profits basis, underscoring the need for market rebalancing.
Our Take
The DeepSeek disruption reveals a fundamental truth about technology markets: innovation often comes from unexpected sources and challenges established assumptions. While US tech giants have pursued a capital-intensive AI strategy, DeepSeek’s cost-efficient approach suggests multiple pathways to AI capability exist. This doesn’t diminish the importance of US AI leadership but rather signals market maturation.
The rapid pivot from hardware panic to software optimism demonstrates investor sophistication in understanding AI’s value chain. Lower infrastructure costs don’t eliminate AI’s potential—they amplify it by making the technology more accessible. The real winners will be companies that can effectively deploy AI to solve real business problems, not just those building the underlying infrastructure.
This episode also serves as a healthy market correction mechanism, forcing a long-overdue reassessment of valuations and concentration risk. The broadening rally benefits market stability and creates opportunities across sectors that have been overshadowed by the Magnificent Seven’s dominance.
Why This Matters
This development represents a critical inflection point in AI investment strategy and market dynamics. The DeepSeek disruption challenges the assumption that AI dominance requires unlimited capital expenditure, potentially democratizing AI technology and accelerating adoption across industries. For businesses, this means AI capabilities may become more accessible and affordable, lowering barriers to entry and enabling smaller companies to compete with tech giants.
The shift from hardware to software investment signals the maturation of the AI industry, moving from infrastructure buildout to practical applications that generate revenue. This mirrors historical technology cycles where hardware eventually commoditized while software and services captured higher margins. For investors, this creates opportunities beyond the concentrated Magnificent Seven stocks that have dominated returns.
The broader market rotation away from mega-cap tech stocks toward value and other sectors could reduce systemic risk and create a healthier, more balanced market. With 70% of S&P 500 stocks gaining during Monday’s selloff, the DeepSeek episode may have inadvertently triggered the market broadening that analysts have long anticipated, benefiting sectors like healthcare, financials, and industrials that have lagged during the AI rally.
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