January 26, 2025

QuickTakes

MARKET CALL: Will DeepSeek Sink

The Unsinkable Mag-7?

The Q4-2024 earnings reporting season is going well so far. It started out two weeks ago with better-than-expected big bank earnings. As a result, industry analysts increased their consensus expected Q4 earnings growth rate for the S&P 500 companies collectively from 8.2% y/y to 9.1% y/y (chart). We raised our expected earnings growth rate from 10.0% to 12.0%.

The next round of fun begins this week and next week when the Magnificent-7 report Q4 results: Microsoft, Tesla, and Meta (Wednesday, January 29), Apple and Amazon (Thursday, January 30), and Alphabet (Tuesday, February 4). Nvidia won't report until February 26. The question is whether they will disappoint because their capital spending on AI is soaring faster than are their revenues. That could squeeze their collective profit margin. The forward profit margin of the Mag-7 has soared from 18.0% at the start of 2023 to 25.5% during the January 25 week.

The consensus of industry analysts who follow the Mag-7 is showing that their short-term forward earnings growth rate (STEG) is 18.9% as of the January 24 week, down from almost 25.0% at the start of this year (chart). Interestingly, the STEG of the overall S&P 500 has risen from around 10% to almost 15% over this same period. Analysts must be raising their STEG for the S&P 493.

If the Mag-7 disappoint, they could drag the S&P 500 down significantly since they account for a whopping 30.5% of the market cap of the index (chart). They also account for a hefty 21.6% of the forward earnings of the S&P 500 but only 11.5% of forward revenues.

On balance, we expect that the Mag-7 will deliver solid earnings, as suggested by the record high in their combined aggregate forward earnings of $500.1 billion during the week of January 24 (chart). The forward earnings of the S&P 493 was $1,819.3 billion that same week.

The new issue for the Magnificent-7 is whether DeepSeek will deep-six their AI aspirations. This Chinese company recently shocked the tech industry when it reportedly spent only $5.6 million over two months to develop its latest LLM, which outperformed rival US LLMs from Meta and ChatGPT. The company kept costs down by using less powerful Nvidia H800 chips. Its LLM is available on an open-source basis.

This might be bad news for the Mag-7 that had plans to dominate the AI market with their (expensive) AI services. On the other hand, it might mean that AI systems will be more accessible and cheaper. If so, the best way to play AI might be the S&P 493 companies that will be cutting their costs and boosting their productivity using this new technology.

It might be good news for the Mag-7 that can learn from DeepSeek to design AI systems with cheaper GPUs. That would reduce their capital spending and boost their profits. It might not be a happy development for Nvidia.

The Wall Street Journal posted an excellent article on this subject at 12:00 a.m. this morning titled “Silicon Valley Is Raving About a Made-in-China AI Model

DeepSeek.” Marc Andreessen, the Silicon Valley venture capitalist who has been advising President Trump, in an X post on Friday raved: “Deepseek R1 is one of the most amazing and impressive breakthroughs I’ve ever seen—and as open source, a profound gift to the world.”  

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