Equity investors have enjoyed a remarkable run over the past two years. The S&P 500 delivered impressive results with total returns of 26% in 2023 and 25% in 2024, marking only the seventh time in history with consecutive years of >20% returns. The S&P 500's stellar performance this decade, with a 13% annualized return, has significantly boosted equity portfolios. However, due to the outsized returns of the largest companies, the composition of many portfolios has significantly changed.
While the S&P 500 thrived in 2024, the "Magnificent Seven" tech giants soared even higher up 63%, with NVIDIA leading the pack at a staggering 126% gain in 2024. This surge has amplified market concentration, with the top 10 companies now representing 39% of the S&P 500's market capitalization – a significant jump from 20% in 2014.
This concentration is a double-edged sword. While investors who rode the wave of these high-flying stocks enjoyed substantial gains, their portfolios are now vulnerable to the performance of just a handful of companies. While companies like NVIDIA, Apple, and Microsoft boast impressive profitability and growth, their high P/E ratios also suggest that investors are expecting continued perfection. This leaves little room for setbacks.
Enter Deepseek. News broke at the end of January that a Chinese ChatGPT competitor called Deepseek claimed to replicate ChatGPT's output at a fraction of the cost and energy consumption. While the veracity of these claims remains uncertain, the market reacted swiftly last Monday, with NVIDIA down 17% and the NASDAQ down 3.1%. Regardless of it’s long term implications, the emergence of Deepseek underscores a critical point: high-flying stocks, especially those with valuations built on lofty expectations, are inherently vulnerable to unexpected events.
In today's concentrated market, where these giants dominate portfolios, such shocks can have an outsized impact. Just as the Magnificent Seven propelled market gains, they can also amplify losses.
What's an investor to do? After two years of exceptional returns, now is a good time for investors to review their portfolio:
The long-term impact of Deepseek on the AI landscape remains to be seen. However, it serves as a timely reminder of the challenges inherent in a concentrated, high-valuation market. When prices are built on the expectation of perfection, it’s a good idea to make sure your portfolio will be okay if perfection doesn’t happen.
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A Big Night for Republicans. A Big Day for Equities.
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