DeepSeek and beyond: how China can crash America’s AI party

AI mania is propelling equity markets from Wall Street to Shanghai.

Until January this year, the United States held the trump card, commanding the lead in AI developments. Then came the “DeepSeek” moment, when a Chinese company stunned the world with its low-cost, open-source large language model (LLM).

The launch triggered a surge in China’s equity markets. Huawei Technologies soon followed, unveiling its new Ascend chips, built specifically for AI applications – a potential rival to Nvidia’s advanced semiconductors. Nvidia remains the world’s most valuable company, because it has virtually cornered the AI chips market, though China’s achievements may begin to chip away at that lead.

The world’s second-largest equity market has been growing rapidly. In the year to September, Hong Kong and China’s stock markets added about $3trn (€2.6ttn) in market capitalisation, according to Goldman Sachs analysts.

Chinese market capitalisation now stands at $11trn, compared with Japan’s $6trn and the US’s $60trn.

In a recent note on the Chinese equities market, Kinger Lau, chief China analyst at Goldman Sachs, says reflation expectations and AI self-sufficiency are the key catalysts for this surge.

Zhikai Chen, head of Asian and EM equities at BNP Paribas Asset Management, who also runs an Asia Tech Innovators Fund, says DeepSeek has created “a new appreciation” for the open source AI models that the Chinese corporates are putting up. Their models are ranked highly by independent bodies in terms of applicability, responses and accuracy, and that has captured the imagination of investors.

Kai Wang, Asia equity strategist at Morningstar, a data research firm, points out that technology and communications have been the two highest-returning sectors this year, mostly driven by AI themes such as DeepSeek, semiconductor manufacturing, and AI-related cost efficiencies. “The tech sector is about 20% of the China index, but including some communication services that qualify as tech, it’s about 25–30%, or roughly $3trn in market cap”, says Wang.

It’s not all about AI

Beyond AI, broader market forces are also at play.

Roxy Wong, portfolio manager at BNP Paribas Asset Management (BNPPAM), credits the upswing to a re-rating of large Chinese companies such as Alibaba and Tencent, alongside mid-cap names with direct AI exposure.

“The broad market is benefitting from the re-rating. Back in 2020, for example, Alibaba traded at 40 times earnings when foreign money was flowing into the market. Subsequently, Alibaba’s multiple dropped below 10 times. We think the re-rating is part of the catalyst for market strength,” says Wong.

BNPPAM’s Chen notes that companies once out of favour, like Tencent, have rebounded and now trade near record highs.

The recovery has led to a reassessment of Chinese equities among global institutions. Not long ago, Cheng recalls, foreign investors “would roll their eyes” at any mention of Chinese equities. Today, that scepticism has given way to as a fear of missing out.

Goldman Sachs’ Lau adds that Chinese and foreign institutional investors have been the key liquidity sponsors of the rally.

He points to Rmb160trn in deposits and Rmb330trn in real estate as capital that could “anchor” Chinese share markets.

Goldman Sachs remains “overweight” with respect to Chinese A and H shares, those traded both on the Hong Kong stock exchange and on one of mainland China’s exchanges. If institutions increased allocations from the present 14% to 50% — the emerging-market average — his team estimates Rmb32–40trn of potential buying in onshore equities.

Healthy and sustainable recovery

This recovery has already outpaced the previous longest run of 124 days that took place in 2014.

Lou Jing, investment director at Value Partners, sees the current resurgence as “healthy and sustainable.”

To put this in perspective, broad-based indexes have underperformed compared to technology-focused ones. While the CSI 300 (top 300 stocks on the Shanghai Stock Exchange) is up 15% year-to-date, the ChiNext (index of the 100 largest and most liquid A shares) has surged 40%, having reached 18% and 51% respectively, in early October. At one point this year, A-share non-ferrous metals and telecoms had risen 67.5% and 62.6% respectively, compared to declines in coal and food & beverage.

Jing stresses that today’s rally differs from 2023’s post-reopening rebound. He says: “Then, expectations far outpaced fundamentals. By contrast, the current uptrend is underpinned by stable economic fundamentals, transparent policy measures, an improving external environment and sustained capital inflows. These factors provide a more robust foundation for continued market appreciation.”

Alexander Treves, investment specialist at JP Morgan Asset Management, concurs. “There are reasons to be more optimistic about the sustainability of the current rally. Encouraging signs of earnings upgrades in certain sectors give us greater confidence this recovery may have more staying power than previous short-lived rallies”, Treves says.

Jing argues the market will become more balanced as the economy recovers. “Corporate balance sheets are improving, driven by stronger profitability and free cash flow. This should support previously underperforming sectors”, he says.

Unique and compelling opportunity set

“A consensus is growing that the opportunity set around China is unique and compelling, especially relating to the evolving technology ecosystem being developed in the country,” says Martin Franc, commenting on Invesco’s 13th annual Global Sovereign Asset Management Study, published in July. Investors, he adds, are becoming increasingly convinced of China’s innovative leadership in major technology segments and “don’t want to be left behind.”

The study, based on responses from 83 sovereign wealth funds (SWFs) and 58 central banks managing $27trn collectively, finds a “significant majority” of SWFs expect to increase their China allocations over the next five years.

These investors, led by those in APAC and Africa but also including North American institutions, are prepared to look beyond political tensions and focus on structural opportunities. “It reflects a more deliberate, sector-focused approach, targeting areas where China is positioned to achieve global leadership,” the report notes.

China is no longer seen as merely catching up. In semiconductors, cloud computing, AI, electric vehicles and renewable energy, SWFs increasingly view China as a global leader. This view is underpinned by state support and China’s ability to rapidly scale innovation, according to the Invesco report.

Respondents to the Invesco survey unequivocally see China as the future leader in clean energy and green technology, saying it will dominate solar, wind, EV and battery markets for decades. Others say “it’s only a matter of time” until China closes the gap with the US on semiconductors, cloud, and AI, given the resources and policy support available.

Caution over foreign inflows

But some investors remain circumspect.

Stephen Jen, CEO and Co-CIO of Eurizon SLJ, is cautious on foreign inflows. “Most of our continental European investors have refrained from re-entering China due to geopolitical concerns. On a price-earnings basis, Chinese equities are no longer very cheap, though still cheaper than the West”, he says.

Jen, whose London-based firm manages three China funds, adds: “While we may finally be seeing signs that the housing market is bottoming, sentiment is still weak and fragile. Equities have rallied mainly because of Beijing’s policy U-turn on regulatory tightening since 2021. The second reason is the vast cash hoarded by Chinese consumers. With no place to go, equities have become ‘combustible.’”

Value Partners’ Luo Jing shares his observation. “Retail investors have been a key contributor to incremental liquidity, particularly in tech and AI stocks. But their participation is increasingly through ETFs rather than direct purchases”, he says.

Morningstar data show that since January, some 500 vehicles were launched, raising about $272bn to invest in Chinese equities. However, this figure likely represents only part of the total raised, as many fund managers did not disclose their amounts.