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DeepSeek sell-off reminds investors of the biggest earnings story holding up the stock market

2 days ago

Monday's swift sell-off in the markets serves as a reminder for not only what's been the driving force of the bull market thus far, but also what investors have been expecting to come in 2025. It's all about Big Tech earnings.

New developments from Chinese artificial intelligence DeepSeek sparked the rout as investor concerns over brewing competition in the AI space for Nvidia (NVDA) and other Big Tech names prompted a pause in the US AI trade.

Nvidia stock dropped more than 16%. Meanwhile, fellow "Magnificent Seven" members Microsoft (MSFT), Alphabet (GOOGL,GOOG), and Tesla (TSLA) were all off 2% or more in midday trading. Broadcom (AVGO), another large player in the AI space, was down more than 16%.

"When expectations are high, one skeptical headline can knock the market off its axis," Ritholtz Wealth Management chief investment strategist Callie Cox wrote in a note on Monday. "That’s exactly what we’re seeing today."

A slowdown in Big Tech's rapid earnings growth has been a risk to the market that strategists have been talking about for more than a year. With index valuations near multi-decade highs and the 10 largest stocks comprising nearly 40% of the S&P 500, strategists have argued the rapid rally in stocks is increasingly on thin ice.

"You have so much concentration in one area of the market — this has been the AI dominant themed market — and all of a sudden you bring in some uncertainty to that market, the initial reaction is to sell first and ask questions later," Truist co-chief investment officer Keith Lerner told Yahoo Finance.

Unlike other risks like higher interest rates or sticky inflation, there hasn't been a clear story for why the exceptional Big Tech earnings growth story would collapse. For now, DeepSeek's new AI model appears to be a tangible reason for investors to question whether the high earnings expectations will truly follow through.

"The biggest risks are the ones that we're not talking about," Lerner said. "And everyone thinks it's tariffs and China. And, you know, really, what we're finding out is [DeepSeek] wasn't on anyone's bingo card."

NEW YORK, NEW YORK - JANUARY 22: Traders work on the floor of the New York Stock Exchange during morning trading on January 22, 2025 in New York City. Stocks continued an upward swing opening up high a day after the Dow Jones closed up 500 points and the S&P 500 approaching an all-time high. The rise comes after OpenAI CEO Sam Altman, SoftBank CEO Masayoshi Son and Oracle Chairman Larry Ellison made an announcement alongside President Donald Trump that they will create a new company, called Stargate, to grow artificial intelligence infrastructure in the U.S. (Photo by Michael M. Santiago/Getty Images) — NEW YORK, NEW YORK - JANUARY 22: Traders work on the floor of the New York Stock Exchange during morning trading on January 22, 2025 in New York City. (Michael M. Santiago/Getty Images) · Michael M. Santiago via Getty Images

In 2024, Magnificent Seven earnings outperformed the rest of the S&P 500 index by 30 percentage points, per research from Goldman Sachs. And while that margin is expected to slow in the year ahead, causing some to call for a broadening out of stock market returns, Big Tech earnings growth remains a key pillar of the bull market thesis.

The "Magnificent Seven" stocks are expected to grow earnings by 21.7% in the fourth quarter compared to the 9.7% earnings growth projected for the other 493 tech stocks. The year-over-year growth rate for the "Magnificent Seven" is expected to slow in the first quarter before accelerating once more to year-over-year earnings growth of more than 24% in the third quarter.