On 4 October, 1957, the Soviet Union successfully launched Sputnik 1, the world’s first artificial satellite. The launch ushered in a new era of political, military, technological, and scientific developments, and started the US-USSR space race. On 20 January, Chinese technology start-up DeepSeek released two large language models (LLM), including DeepSeek-R1, a partly open-source large LLM that rivals the performance of the dominant tools developed by US tech giants but built with fractions of the cost and computing power.
China technology-led market rally: Frenzied adoption of DeepSeek and China’s leading technology firms developing other AI models has helped drive a technology-led rally in Chinese equity markets. The Hang Seng China Enterprise Index has returned 17.4% year to date1 and the MSCI China index has gained 13.5% year to date2, outperforming the S&P 500 (+4.2%), making it the best performer in Asia. The MSCI India index, meanwhile, is down 6.3%3.
Figure 1: China indices are this year’s top performers
DeepSeek’s AI breakthrough: The primary driver of this rally has been DeepSeek’s advancements in artificial intelligence (AI). Its new AI model, which is more cost-effective than its US counterparts, has sparked a wave of investor optimism. DeepSeek’s prowess has served as a wake-up call for investors who underestimated China’s leadership and growth potential in technology, leading to a broader re-evaluation of the beaten-down sector. We do not think DeepSeek-related AI apps or so-called ‘DeepSeek stocks’ will result in immediate revenue / profits, but the rally serves as a catalyst for investors to rethink China.
Hedge funds piling in: While scepticism remains, DeepSeek has spurred optimism for investors in China. Hedge funds have been piling into Chinese equities at the fastest pace in months in almost entirely long buys, driven by bullishness on the DeepSeek-related technology rally and hopes for more stimulus.
Rotation to China from India: This is helping drive a rotation to China away from India and a surge in China’s still comparatively cheap technology names as Chinese companies, including Tencent, Alibaba and Baidu, are fast catching up with the global AI frenzy after missing out over the past few years. China’s onshore and offshore equity markets have added more than US$1.3tn in total value in the past month alone, while India’s market has shrunk by more than US$720bn. The MSCI China Index is on course to outperform the MSCI India Index for the third consecutive month.
Chinese equities have been trading at extremely depressed valuations with most risks well discussed and reflected in the prices. The DeepSeek event has acted as a catalyst, boosting sentiment around Chinese equities.
Government support: After scaring investors with the regulatory onslaught of the Covid-19 years, Beijing may help push the new AI theme, as indicated by President Xi Jinping’s meeting with technology entrepreneurs including Jack Ma, founder of Alibaba, on 17 February. This may be taken as a sign the government is now pivoting to support private enterprises in an acknowledgement of their contribution to society and the economy, even the most rebellious ones. While expectations for further stimulus announcements in March are low, there is an expectation that the government will focus on consumption, helping restore confidence and deployment of the large savings pile, which may sustain the technology rally.
Less bad on trade: Adding to the wave of optimism are signs that US President Donald Trump’s tariffs on Chinese products – 10% in the initial salvo – may turn out to be less drastic than feared.
Risk-reward: Added together, China becomes more attractive than India in the current set up on a risk-reward basis. The valuation differential only adds to China’s appeal. The MSCI China index is trading at just 11x forward earnings estimates, compared with 21x for the MSCI India index. Market positioning is very favourable, as Asia and global emerging market investors are still underweight China. Mainland fund inflows have doubled year to date versus 2024, and the scope of stocks is expanding from mostly yield plays (last year) to technology and AI-related opportunities this year.
Figure 2: MSCI China vs. MSCI India and the S&P 500
DeepSeek is not better than Open AI but its lower costs increase the potential for widespread AI adoption which would boost Chinese companies’ earnings-per-share (EPS) as the new technologies cut costs, enhances productivity and spawns new revenue streams. If the government shows more support of private sectors, entrepreneurs may start investing again and China can move closer to escaping its economic funk.
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1 Bloomberg, as at 17 February 2025.
2 Ibid.
3 Ibid.
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