By several measures this letter will show how the US stock market is in a bubble and prone to a collapse. We believe that this past week’s announcement by DeepSeek of a low-cost large language model could be the proverbial straw that breaks the back of this parabolic mega cap market leading to a pronounced and protracted period of underperformance in US cap weighted indices like the S&P 500 and NASDAQ 100. Further, historic analogues for post stock market bubbles, like the 1970s and the 2000 to 2009 period, argue for rotating away from the Magnificent 7 and cap weighted indices and into emerging and international markets as well as into commodities, like precious metals and energy, small capitalization, and value stocks.
The US equity market, led by the Magnificent 7 stocks and cap weighted indices, is priced for perfection. The Fed Model, popularized by Dr. Edward Yardeni, also known as the Risk Premium Model, shows that the US stock market has not been this overvalued since the 2000 stock market bubble. What this model shows is that the 10-year US Treasury Yield is greater than the earnings yield of the S&P 500. The chart below shows how the model warned of extreme equity overvaluation in 2000 with ratings in the negative 2 range. Furthermore, this risk premium model showed accurate buy signals in 2009, 2012, and 2020, when the market was deeply oversold and cheap due to the great financial crisis in 2008-2009, the European debt crisis in 2012, and the Covid collapse of March 2020, respectively.

The appeal of the Risk Premium model is that it compares the earnings yield of the S&P 500 to 10-year US Treasury yields. With a negative 0.08% Risk Premium, either a rise in interest rates or a collapse in earnings could move the risk premium to a more negative number consistent with the 2000 market peak. Interest rates could move higher with higher inflation, perhaps driven by tariffs, or a failure to produce cheaper goods in the US like energy.
The risk, which may now be unfolding, is that DeepSeek’s cheaper technology will undermine the high GPU prices commanded by Nvidia. Lower prices will lead to lower earnings and an earnings deceleration which we have already identified in July as a source of potential stock price weakness for Nvidia. Declining prices in a cherished commodity is classic bubble behavior. Both share price momentum and earnings momentum are inextricably and symbiotically linked, and it seems increasingly likely that the upward trajectory in both earnings and stock prices is about to break.
The Shiller CAPE ratio and the Buffett indicator shown below also reflect nearly peak historically high equity market valuations. Shiller’s CAPE is now 37, comfortably above the 1929 peak.


Historic Analogues: The chart below of the ratio of the S&P 500 divided by the Producer Price Index shows historic cycles of inflation and deflation. During periods of deflation the stock market shown by the S&P 500 rises and commodity prices are weak. Conversely, during periods of inflation, commodities like gold and oil rise while the S&P 500 is flat.
The chart below shows how during the inflationary 1970s, stocks did poorly while gold and oil performed well. Likewise, in the 2000 to 2009 period, gold and oil did well and the S&P 500 did poorly. Our research suggests that we are transitioning into a new inflationary cycle where commodities will outperform stocks and stocks will underperform. Inflationary periods historically follow stock market bubbles.

Julian Bridgen of Macro Intelligence 2 has charted the performance of global equity performance during the 2002-2009 inflationary cycle below. The chart below shows outperformance in emerging markets and international equity markets like Japan and the UK. Consequently, we are looking abroad for equity exposure as we reduce exposure to large cap US stocks.


The Cap Weighted Feedback Loop
The S&P 500 and NASDAQ 100 allocate fund flows on a capitalization weighted basis. As such, the largest companies get the largest amount of capital. This means the largest companies get the most capital and their strong earnings lift these indices in a positive feedback loop. This self-reinforcing trend maps out a parabolic move until it reverses and turns south. With the rising prospects of an earning slowdown in Nvidia and the hyper scalers, these cap weighted indices could soon lose their positive momentum and begin to drop with increasing momentum. From its peak in 2000, the NASDAQ 100 (QQQ) declined 83% over two and one half years and the S&P 500 declined 52%.
Commodity traders will say the solution to high prices is high prices, because inherently, those premium prices attract new suppliers who ultimate compete in those markets. With DeepSeek’s stunning announcement of its R1 low cost Large Language Model (LLM), this announcement may indicate the commoditization of artificial intelligence and the vulnerability of Nvidia’s high priced GPU franchise. DeepSeek could quickly undermine Nvidia’s franchise eroding its pricing power, high margins, and earnings momentum. It seems possible that the parabolic mega cap stock bubble which began in 2009 is in the process of bursting.
Reallocating and Charts:
Below are charts of the S&P 500 (SPY), the NASDAQ 100 (QQQ), the Magnificent 7 (MAGS) and Nvidia stock (NVDA). These charts are parabolic and we believe these investments are quite risky and symbolic of major market peaks.
Below is the S&P 500, which is up nearly tenfold since 2009.



Below is the chart of NVDA which is up twelvefold since October of 2022. NVDA’s rise closely tracked the initial release of Chat GPT November 30, 2022, just over two years ago. Not surprisingly, this cautionary letter is based on the introduction of DeepSeek’s low-cost large language model just last week.

To mitigate US equity risk, we advise reinvesting equity capital away from the sectors and securities above. Below are three charts of equities that are indicative of rotating to new value markets.
Gold miners are, historically, very inexpensive equities. With the sharp rise in gold prices in recent years and the continued upward price momentum in gold, gold miners have strong profit prospects by virtue of gold’s price ascent and the fact that gold miners have lagged the rise in the price of gold. Below is a chart for the VanEck Gold Miners ETF (GDX). There are many gold names we think could rally meaningfully this year, especially with the Junior miners.

Below is a chart for the China iShares China Large-Cap ETF (FXI). China has experienced a multi-year decline and consolidation and appears to be turning up. Our hope is that the Chinese market could experience a sharp rise like it did in the 2002-2009 period when the market rose sevenfold. Today’s China market has much larger and formidable competitors to US corporations and the market is trading at a CAPE ratio of 13 versus the US CAPE ratio of 37. China is not without risks, and geopolitical dynamics are a significant risk. However, we hope the new administration will be willing to engage directly with China economically and simultaneously derisk military threats.
We like several Chinese stocks including Daqo New Energy Corp (DQ), BYD Company Limited (BYDDY), Weibo Corporation (WB) and PDD Holdings Inc. (PDD).


Conclusion:
We believe there is a strong probability that DeepSeek’s low-cost large language model could be as impactful to Nvidia and the stock market as was the release of Chat GPT in October of 2022, before NVDA rose twelvefold in 26 months.
The potential commoditization of AI through cheaper low cost models could pop the bubbles in Nvidia, Magnificent 7 and artificial intelligence and lead to a market decline reminiscent of the 2000 technology bubble’s decline.
From our own experience as a tech focused hedge fund manager in 2000 who exited at the peak, my greatest regret was not looking to new markets in the years which followed the 2000 technology bubble. During that period gold rallied substantially, as did gold, value stocks and small capitalization investments.
So, while this moment may, in fact, mark the peak in the technology rally of nearly 20x in the NASDAQ 100 (QQQ) since 2009, there are great opportunities in dormant value sectors that have been forgotten. Gold miners, emerging markets, certain Chinese stocks, and high yielding debt and equity closed end funds exemplify the attractive investment opportunities which can provide an attractive diversified portfolio for those forward looking investors who are not prisoners of recency bias.