Yesterday, my colleague Andrew Wilkinson and I taped an IBKR Podcast entitled “Where’s the Moat?” I highly recommend a listen. (The title arose from a Teams message that Andrew sent me on Monday morning as the market was reeling from the DeepSeek news.) For me, that discussion further kindled the question about whether Monday’s action revealed unexpected vulnerabilities in companies that seemed somewhat immune from competition.
In Monday’s piece, we wondered whether the activity was a blip, a turning point, or an inflection point, writing:
Going forward, we will need to decide if today’s events are a blip, an inflection point, or a turning point for the AI trade. My gut says “inflection point,” though it is clearly too early to draw real conclusions in the midst of a major sector’s repricing. At its best, DeepSeek will represent a boon for artificial intelligence, making it cheaper for all and thus improving the odds and the timeframe that its potential productivity boosts will be reflected in a wide variety of companies’ bottom lines. Maybe not the one’s that we’d all expected, however.
Unseating the dominance of the largest technology stocks, the “Magnificent 7” and the like will not be easy. They have been able to build significant competitive moats around their businesses, which is one of the key features that have enabled them to generate the outsized profits that are driving their premium valuations.
But it’s not impossible. Look at IBM as a precedent. Yes, it’s up enormously today, but it spent years as an also-ran. Yet about 50 years ago, it was THE seemingly unassailable way to play the nascent computer age. Expectations for the role of computers in society proved true, maybe not even optimistic enough, but IBM was blindsided by a Harvard dropout named Bill Gates who, with others like Steve Jobs, democratized computing power away from giant mainframes. Now of course, the companies they founded, Microsoft (MSFT) and Apple (AAPL) are among the Mag 7 leaders.
The PC revolution was powered by Intel (INTC) chips, which had their own unassailable role as a semiconductor leader for decades. And now, they’re almost considered a basket case compared to other chipmakers. Does anyone think of them alongside stocks like Nvidia (NVDA) or Broadcom (AVGO) or even a host of others?
Then fast-forward to the internet bubble of the late ‘90s. The run-up in stocks was based upon rosy predictions about how the newfangled internet would transform society. And it did – and then some. But the early winners weren’t the main beneficiaries. I’ve previously written about how I was using the de rigueur Sun Microsystems workstation, a Compaq PC, and searching with Yahoo. (No symbols for them because none are public companies any longer.) Neither Google (GOOG, GOOGL) nor Facebook (META) existed at that point. The latter two are seemingly invulnerable now, but they were once upstart disruptors themselves.
Moving forward to today, let’s stipulate that the AI revolution will be as consequential as hoped. Only time will tell, but the markets got previous big themes correct. However, DeepSeek reminded us that even disruptors are at risk of being disrupted. And it should serve as a reminder that if companies are earning outsized profits, it is inevitable that competitors will arise in hopes of reaping some of those gains.
So, could it be that the resource-heavy approach to AI be as obsolescent as the mainframe was vis-a-vis the PC? DeepSeek says yes. We’ll see.
Is the company that will come to dominate AI being birthed in a dorm room, a computer lab, or a garage somewhere? Maybe, if not probably.
Does this mean that investors who have been paying a premium for the earnings power of key companies should abandon that activity? Not necessarily. But Monday’s events reminded us that their competitive moat may not be as deep as previously thought.
Disclosure: Interactive Brokers
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