Axis Tactics 27th January, 2025 - Interim Comments on Today's DeepSeek-inspired Market Activity
DeepSeek's Impact & A Comment on the S&P 500 Index's Valuation
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Swift Recap on Some Recent Recommendations
Nvidia, named and cautioned about in our Newsletter of 15th October 2024 (“The Problem with Ubiquity”), had a nice fall today of over 18% but is currently recovering a little.
While we certainly didn’t know very much about DeepSeek until this weekend, our working hypothesis was that competition and disruption was invariably going to come from somewhere to disturb Nvidia’s lofty valuation.
DeepSeek, per se, may not ultimately be the wrecking ball for the Magnificent 7 - but the sheen of supremacy has certainly taken a dent and we would expect valuations to settle back to less fanciful levels, over time.
If DeepSeek’s arrival heralds a paradigm-shift within AI Architecture, the tail risk is that some of the highly priced names in the AI space may be in process of finding out that their IP has become instantly obsolete.
Volatility has also proved to be a prudent place to park some risk capital when the raw Index values are low. Readers will note our usage of VIX Futures & Options as well as options dynamics, to best manage turbulent markets. We explained this in our Newsletters of 19th December (19th December “The Morning after the Fed”) where we successfully held Long VIX and Equity Index Shorts everywhere and also on 12th January (12th January “Recent Positions & Strategy Update”) where we expected Q1 (2025) and Q2 (2025) Volatility to be “markedly higher”.
This view led us to be positioned from late last week with Long Volatility (via VIX Futures).
The unleveraged VIX Index today was up 26% intra-day. The tradeable futures contract was up 21% intra-day (which would be +105% return, using prudent 20% margin).
We will continue to take Long VIX Positions on selected pullbacks in the Volatility price and/or when we are concerned that Equity Markets Indices are at unsustainable valuation levels.
US Equity Outlook
Today’s market movements might, at first glance, seem extreme. However, they are not so. Actually not even close. The damage was extremely well contained within some key Tech Names.
The S&P was down somewhere in the order of ~150 points in EU time. If this was a broad and chronic meltdown, we would have seen much more drama in the Bond Markets and Volatility (which did move ~25%) would have moved >50%.
Readers (and viewers of recent media appearances) will recall that we have made reference in the past to the equal-weighted S&P.
The equal weighted S&P 500 Index is down 0.1% today. Unaffected and minding it’s own business. This relative outperformance is indicative of a shift from Growth to Value, a diversification away from Tech concentration. Put another way, the remaining 493 Companies in the S&P are deemed to be capable of handling the changing dynamics in the AI landscape and might arguably be benefiting from the “USA First” Agenda of the Trump Administration
A couple of graphics, prepared on Bloomberg, elegantly illustrate how investors can go from here:-
The question raised by this graphic is will today’s events signal a turnaround in the relative performance of Growth to Value? Our view is that it is now time to take a greater allocation within Value and to re-visit this incrementally, with a Medium to Long Term Investment Horizon. This applies, in our view, globally.
Even within Technology, one must ask if AI can be managed by most people with simple kit rather than the posh stuff? Are the Hyperscalers and even end users still obliged to make huge Capex commitments into top flight GPUs? Is this Capex still worth it? Or will any modest GPU work just fine?
DeepSeek seem to have managed quite well with a miniscule budget and a smaller electricity bill - so perhaps many other can too.
Warren Buffett has referred many times to “moats” as one of his favoured investment criteria.
DeepSeek’s developments might mean that the perceived barriers to AI entry do not really exist.
Despite the down-beat tone for Tech today, one doesn’t necessarily need to abandon Tech in totality but we suggest instead that those with this bias instead be vigilant for opportunities where valuations are grounded and the business use cases are sustainable in an Open Source World.
Onto Valuations…
The Valuation of the equal-weighted S&P, where the Mag 7 weightings have been pared back, is not excessive, appearing to be close to its 10 Year Average.
This leads us to be confident in our long-held approach to remain prudent and be paid to play while our funds are invested (Dividends, Buybacks, M&A potential, EM High Yield Equities/Debt). Growth at a Reasonable Price can be found here and in similar Indices globally.
Insurers, Healthcare, Pharma, Real Estate.
The FTC under a Trump Administration might also be more sympathetic to M&A Activity, thereby opening the door to Merger and Event Driven Arbitrage Investments.
If you seek Growth at absolutely any price - those would be the Tech and High Valuation names that are down double digits today. When they are cheap enough, we will be happy to re-evaluate them too.
But for now, instead of Growth and Momentum, we’re choosing patience. And Value.
A footnote on the moves in Gold, Silver, Fixed Income & Crude Oil - Although meaningful, still very much in keeping with normal & contained market behaviour rather than panic, contagion or capitulation: Simply a range of Forced Liquidations, Margin Calls, Algo Model Trading and Safe Haven Buying.
Such data also reinforces our observation that, so far, this is a narrow-focused AI story without excessive bleed into other sectors.
Some Equities, ETFS and Short Dated Fixed Income Suggestions with >8% Yield will follow in a coming Newsletter, later this week.
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