The unveiling of DeepSeek's R1 large learning model by a foreign competitor, which operates more efficiently than comparable models, caused a sharp selloff in the tech sector of the S&P 500. The index experienced its worst single-day drop since 2020, falling by 5.6%.
Despite this initial reaction, UBS maintains a supportive view of the US AI-driven investment and stock market performance, suggesting that the United States is still well-positioned to lead in developing new models.
UBS's analysis indicates that while the credit market has exposure to the tech sector, it is significantly less than that of the equity market. On the same day, credit market spreads were less affected, widening only +/- 1 standard deviation compared to the nearly 2 standard deviation selloff seen in the S&P 500.
This is attributed to the lower concentration of tech within the credit market, with US investment grade (IG) having 9.2% and US/EU leveraged loans (LL) having 18.8/10.6% exposure, respectively.
Despite the volatility in the equity market, the credit market has shown resilience, with UBS reiterating an underweight stance on US IG credit space due to its high quality but tight trading debt. The analysis also points out that tech sector defaults have been concentrated in the US LL market over the past year.
However, with low-quality tech debt making up only 1.1% of the US LL market, the near-term default risk is expected to remain limited.
Moreover, UBS highlights that while sector concentration risks exist in loans and private credit, particularly within tech and software services, these markets typically reprice with a lag. It is suggested that any de-rating in highly leveraged private tech names is likely to be reflected in Business Development Company (BDC) equities before loan prices. Notably, BDC equities ended Monday's trading with a slight increase.
Lastly, UBS acknowledges the potential risk of a higher volatility regime but notes that the equity market correlation has decreased following Monday's selloff. Bond market volatility also rose on Monday, but interest rates rallied, supporting credit total returns and reducing refinancing risk.
UBS concludes that improved efficiencies in the AI space should be deflationary, which is favorable for credit, and that robust technical support for credit should persist if equity market volatility remains contained.
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