Can China’s engineering state break US AI dominance?

AI has been the dominant investment theme of the post-COVID period. The rapid improvement in large language model (LLM) performance from the early days of GPT-3.5 back in 2022 has propelled stocks such as Nvidia* to dramatic highs owing to a manic investment boom.

Buildouts of datacentres has become a global priority, particularly in the US, as storied companies such as Meta* and Google* are putting their substantial balance sheets behind a technology whose outer limits promise rewards like those of science fiction. A mood of exuberance, not unlike the wave that overcame markets in the late 1990s, permeates the macro discourse.

An uninvited guest

But like a spectre at the feast, China has been haunting the minds of investors in the AI boom. Since the DeepSeek* moment earlier this year, the fear that a crack team of China’s best researchers might beat Silicon Valley’s brightest minds has lingered in the minds of market participants.

So far, chip controls, first enforced by the Biden administration and extended under Trump, have curbed the growth of an ambitious US rival on the Chinese mainland. DeepSeek, the originator of the panic in February, had relied on American chips to build its V3 model, chips they cannot replace easily without circumventing US export controls.

However, China has not taken America’s actions lying down, and has begun assembling its own answer to the Western giants of ASML*, TSMC* and Nvidia*. Huawei*, China’s telecoms and hardware giant, is assembling its own cluster of semiconductor production, and reported on its progress towards a chip for domestic use that can rival Nvidia. The boastful roadmap included large output bumps for their Ascend AI chip series, alongside a folding in of capabilities previously thought to be lacking in Huawei, like the production of High-Bandwidth Memory (HBM).

Such revelations have delivered a shock to Western analysts and a reminder of the capabilities enmeshed inside what Dan Wang has described as China’s ‘engineering state’.

Expect the unexpected

If such breakthroughs were substantiated, would this pose a meaningful risk to US dominance in the AI race? It’s possible, but our expectations are that the US will maintain its lead, at least in the short term.

Nvidia’s chips are already fully ramped. Most of the world’s leading semiconductor fabs are working 24/7 to make them, with error tolerances and testing already fully worked out. Huawei will have to go through a similarly arduous process when producing its own chips, potentially stunting the pace of its rollout.

Moreover, chips produced at Nvidia, Google and Amazon* will remain (even with the Huawei announcements) world class and, in a world where chips are improving exponentially, can do the work of a dozen Huawei Ascends.

Regardless, China continues to signal it’ll give the US a run for its money in its quest to dominate AI. For as long as that’s the case, there are risks of further DeepSeek moments for the market to contend with.

We still hold a constructive view on the theme, despite the potential for further DeepSeek moments to shock market confidence. We expect the wider benefits of AI-enhanced productivity to make themselves felt in the coming years, supporting equity valuations while tamping down inflation. If suppliers are the racing to produce the best product, it is often the consumer who is the real winner.

 

*For illustrative purposes only. Reference to a particular security is on a historic basis and does not mean that the security is currently held or will be held within an L&G portfolio. The above information does not constitute a recommendation to buy or sell any security.