Once in a while, a disruptor comes along and changes the way people think or the way things are normally done. That is the theme this week with the emergence of DeepSeek and how it may have changed how markets think about AI. This week's musings is inspired by the 2011 movie, "Moneyball." The movie achieved box office
success and critical acclaim.
This movie was filmed for $50 million, most of it in actors' salaries, and made more than double ($110 million) at the box office. It's also one of the more successful sports films in terms of the critics, being nominated for 6 Oscars - unfortunately not coming away with a win. In fact, this was only the 3rd baseball movie to ever be nominated for an Oscar - with the other two being "The Pride of the Yankees" and "Field of Dreams."
The movie was based on the 2003 best-selling book, "Moneyball: The Art of Winning an Unfair Game" by Michael Lewis. Lewis wrote other best-selling books about disruptors or disrupting events such as, "Liars Poker," "The Big Short," and "Flash Boys."
Since there was little money to shoot in all of the stadiums that the Oakland Athletics visited, Dodgers Stadium was dressed up to look like 8 different ballparks in the film.
Under the original director, Steven Soderbergh, all of the baseball players were intended to portray themselves. When the film was dropped by Columbia Pictures, it was decided by the new director, Bennett Miller, to hire actors for the players.
The movie takes some liberties with the actual facts depicted in the book. For example, unlike the movie, A's manager Art Howe was actually on board with the moneyball concept. The film depicts the A's scouts as archaic, yet the A's had one of the best minor league farm systems in the MLB.
Here's what we've seen so far this week..
Don't Interrupt. Over the weekend, the release of a new AI engine, DeepSeek, began to rumble through markets. The biggest revelations were that the new engine was more impressive than some existing AI engines and, reportedly, for much less cost and energy required.
After Billy introduces his new idea of statistics guiding player management decisions in "MoneyBall," he tells his staff, "When your enemy's making mistakes, don't interrupt them." That's the benefit of not necessarily being the first to bring something new to the market, but rather building upon the shoulders of those who innovate by disrupting the status quo. When it was initially launched at the end of last week, DeepSeek was advertised as out-performing OpenAI in nearly every major category. So far, that appears to be the case. But, the bigger issue is cost. Within the realms of Wall Street analysts, it is very much in debate as to whether DeepSeek was funded for the low cost ($10 million) that has been suggested publicly. DeepSeek was established in 2023 by Chinese Hedge Fund manager Liang Wenfeng.
The largest debate revolves around how many, if any, of Nvidia's GPUs were used to create the AI engine. Industry experts claim that the engine absolutely required Nvidia's GPUs in its initial development. This might call into question the initial $10 million cost figure. Regardless, the engine uses "open-source" coding, meaning the code for its models is freely available for use, modification, and viewing. This is a verifiable disruptor in the AI community. In addition, regardless of the initial costs, DeepSeek does offer fewer costs over time as the requirements for energy are less than existing AI models. As a result, DeepSeek has caused a stir on Wall Street as Mag 7 names were down more than 2.5% in Monday's trading. In our view, it's not so much the disruption, but the timing of the disruption that should matter most to investors. Mag 7 stocks have been trading at highly elevated multiples for quite some time and the introduction of a cheaper/better model has been putting downward pressure on existing prices of key Mag 7 names - most notable being Nvidia, down more than 14% since DeepSeek's emergence. Since its release last week, DeepSeek is now the #1
downloaded app on Apple. You might be thinking, "Well, this is actually good news for Mag 7 and it will increase awareness of AI." That might be true, but just this week Nvidia decided to make all of their AI training courses, which were once behind a pay wall, free to download. That is disruption. We can also take our ques from other disruptive events in history. Remember Netscape? It was the primary internet browser in 1995. The typical license for the software was $99/user. When Microsoft released their 1995 version of Windows, it included Internet Explorer, which was given away for free. In 1999, Netscape was worth $10 billion, but by 2008 the company was defunct. Remember Napster? A typical CD in 1999 cost $10-15 per album. Napster launched in '99 and ushered in peer-to-peer file sharing. This led to multiple lawsuits forcing Napster to shut down in 2002, but other file-sharing services emerged, forcing the music industry to stop producing mediocre albums and giving consumers the ability to purchase music on a song-by-song basis. As we pointed out last week, the point is to recognize when asset classes or sub-asset classes have become over-valued and to rotate to under-valued asset classes. With the introduction of DeepSeek, rebalancing portfolios from highly-appreciated assets to under-valued assets is likely long overdue.
Business As Usual? Of course, in a week already marred by volatility, we have a Fed meeting to deal with, as well. On Wednesday, the Fed maintained Fed Funds Rates at 4.5%. This did not come as a shock, as the market had priced in a no rate change scenario.
The FOMC statement was not much changed from the previous meeting, with the committee stating that "Labor market conditions remain solid." However, the one area of notable change was the phrase "inflation making progress" was replaced with the phrase "inflation remains somewhat elevated." Powell played off the change saying "it was not meant to send a signal." Fed futures continue to show the earliest probability of any rate cut to be at the June meeting. Some banks, including Bank of America, are stating they believe the rate cutting cycle is over.
Noted "Fed Whisperer" Nick Timiraos believes the Fed is "firmly on hold" with regard to policy rate decisions. So what are investors to do? Well, it's not business as usual anymore. In "Moneyball," Billy is introducing the new concept of statistics-based roster management to his staff. He gets agitated with them at one point and says, "Guys, you're just talking. Talking, 'la-la-la-la' like this is business as usual. It's not." With the Fed on the sidelines for the time being, fundamentals will matter more. As previously stated, valuations will become more of a concern. Yesterday's GDP report showed a stark contrast to the expected result. Earlier this week, the Atlanta Fed has revised their 4th quarter GDP number up from +3.0% to +3.2%. In reality, the number came in at only 2.3%.
While it's not the end of the world, the adjustments to Net Exports and Inventories pushed the number lower. Consumer spending was still on pace. Going forward, as fundamentals will matter, the key metrics to watch will be consumer and government spending. With the expectations of less government spending based upon early actions by the new administration in D.C. and the campaign promise to get the federal budget under control, consumer spending will be the key to economic growth. Expected reductions in individual and corporate tax rates would help substantially toward spending, but that situation will need to be monitored should there be any political roadblocks. Additionally, new tariffs could harm certain equity sectors. If we look back at the previous tariff wars in 2018-19, areas such as semiconductors, technology hardware, and autos under-performed, while areas such as utilities, telecom, and real estate out-performed. As we have been stating for several weeks now, recalibrating portfolios is essential to continued success in a market more focused on fundamentals, with the potential for higher volatility moving forward.
Hence, the birth of Moneyball...
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