The recent surge in investment enthusiasm surrounding artificial intelligence (AI) in China has been magnified by Alibaba's exceptional performance, which exceeded market expectations and unveiled a bold "Super AI Blueprint." This development has ignited a wave of excitement in the Chinese stock market, reminiscent of the 2023 tech stock frenzy in the United States. While American markets experienced a robust bull run earlier this year, they have recently faced significant headwinds, with Goldman Sachs warning of a potential correction due to substantial capital outflows and historically high valuations.

In this context, the emergence of local Chinese AI startup DeepSeek brings fresh hope. The company is pioneering a new paradigm of "low-cost" and "high-efficiency" AI model computing, integrating deep AI innovations across various sectors like healthcare, finance, and education, as well as consumer electronics. This shift could potentially transform sales and profit margins across Chinese semiconductor, SaaS, and cloud computing industries, reigniting global investor enthusiasm for Chinese stocks. Notably, sentiment has become increasingly positive towards major players like Alibaba and Tencent, which boast formidable cloud AI computing capabilities.

Since DeepSeek-R1's debut, the landscape has dramatically shifted. Investors have begun to question the sustainability of the intense spending on AI initiatives by U.S. tech giants like NVIDIA, Microsoft, and Google—the so-called "Seven Giants." Apart from Meta, these companies have all seen their stock performances significantly lag behind the S&P 500, contributing to a broader negative sentiment that has weighed on the sector. When we compare the performance of these U.S. giants with that of Alibaba and other Chinese tech firms, it’s clear that the latter is gaining momentum.

DeepSeek's approach, which focuses on "extreme software engineering, parallel optimization, and refined data curation," aims to minimize the "ineffective consumption" of general computing power. The startup has set out to challenge the traditional model of exorbitant expenditures in the AI realm. With a minimal investment of under $6 million, using 2048 chips that perform below the capabilities of NVIDIA's H100 and Blackwell series, DeepSeek has developed an open-source AI model that rivals OpenAI's offerings. This is particularly impressive when compared to the staggering $1 billion in training costs incurred by competitors like Anthropic and OpenAI. DeepSeek’s output token pricing—$2.19 per million tokens—contrasts sharply with OpenAI's GPT-4 pricing at $60, underscoring its disruptive potential.

Recent trading activity has showcased the dynamic shifts in the market. The Nasdaq Golden Dragon China Index climbed 1.6%, buoyed by Alibaba's 8.1% jump, driven by robust earnings and ambitious AI initiatives. In Hong Kong, Alibaba's stock surged by more than 10%, contributing to a broader gain in the Hang Seng Tech Index and overall market momentum. In stark contrast, the Dow Jones Industrial Average fell by 1.01%, and both the Nasdaq Composite and S&P 500 indices reflected ongoing struggles.

Bank of America has pointed to a strengthening rationale behind acquiring Chinese stocks, particularly in the tech sector, potentially inviting long-term investors back into the fold. This shift suggests a significant transformation in attitudes towards Chinese assets, transitioning from "tradable" to "investable." Such changes are notable since foreign investment firms often take months or years to reassess their strategies regarding long-term holds.

Jeff Weniger, the chief equity strategist at WisdomTree Asset Management, advocated a shift in perspective. He noted that the "Ten Tech Titans of China" have begun to overshadow the "Seven Giants" of the U.S. This phenomenon, which started a half-year ago, has yet to receive the attention it deserves.

Moreover, Morgan Stanley's previous cautious stance on Chinese assets has shifted after the DeepSeek impact. The firm has revised its outlook for China's stock market to reflect more sustainable growth fueled by AI investment enthusiasm. Its revised year-end targets for major indices reflect confidence in a resurgent market. The Hang Seng China Enterprises Index's target has been adjusted from 6,970 to 8,600, while the Hang Seng Index target has climbed from 19,400 to 24,000. The firm’s expectations for the CSI 300 index remain at 4,200.

The so-called "ABC Strategy," which previously discouraged investment in China, has been reframed by some investors as "A for AI, B for BABA (Alibaba), C for China," illustrating a shift in focus towards key players in the burgeoning AI landscape.

DeepSeek's revolutionary low-cost AI models are revolutionizing how global investors view Chinese stocks, particularly as they become more wary of inflated valuations in the U.S. tech sector. The launch of DeepSeek has sparked an unprecedented wave of investment into Chinese AI, further enhancing the bull market outlook for both Hong Kong and mainland stocks.

Alibaba's stellar earnings report underscores the transformative potential AI holds for various industries in China. In its latest financial disclosures, the company reported a significant revenue increase of 8% for the third fiscal quarter ending on December 31, 2024, with operating profits soaring by 83% year-over-year. The net profit attributable to shareholders skyrocketed by an impressive 333%, showcasing the company’s substantial growth trajectory.

Executive Chairman Daniel Zhang elaborated on Alibaba's strategic intent to commit heavily to AI infrastructure over the next three years, projecting investments that will exceed prior decade totals. This proactive approach highlights Alibaba's ambition to capitalize on the AI wave sweeping across China, anticipating a significant elevation in profit margins.

Goldman Sachs, reflecting on the ramifications of DeepSeek's innovations, has turned bullish on the Chinese stock market. Its analysts project that widespread AI adoption could enhance annual earnings across Chinese stocks by approximately 2.5% over the next decade. They have increased their target levels for the MSCI China Index and the CSI 300 Index, suggesting substantial upside potential in the ensuing year.

One of the largest hedge fund managers, Man Group, has expressed optimism regarding the prospects for investment in Chinese stocks. Edward Cole, the firm's stock allocation head, affirmed that Chinese equities represent one of the most compelling trades this year, propelled by the anticipated resurgence of investment driven by innovations in AI. Investors' redirected enthusiasm, coupled with Chinese government stimulus measures, creates a favorable backdrop for market growth.

From a valuation standpoint, the Hang Seng Tech Index is currently trading at around 17x forward earnings and 1.1x price-to-sales, which is below its historical averages. In stark contrast, the Nasdaq 100’s forward P/E is a lofty 28.2x, illustrating a clear valuation discrepancy.

UBS analysis indicates that advancements in AI often lead to significant gains in stock valuations. Historical trends from the 4G, 5G, and cloud computing eras show related stocks outperforming the broader market by 50% to 100%. Following DeepSeek's R1 model launch, Chinese AI-related stocks have surged by roughly 15%, substantially outpacing the 9% return of the MSCI China Index. UBS predicts that the growth phase for AI-related stocks in China is still in its early chapters, with considerable room for valuation increases, particularly among software stocks like Alibaba.

As both Alibaba and Tencent advance their applications of cutting-edge AI models, fortified by robust cloud AI infrastructure, they stand to dominate markets that could rival the scale of Amazon AWS and Microsoft. Currently, Alibaba's market value hovers around $320 billion, while Amazon and Microsoft command valuations of $2.36 trillion and $3.10 trillion, respectively. This signifies how deep the potential for growth and investment in China's tech sector truly is.