DeepSeek's sell-off reflects concerns about the US stock market

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The writer is an FT contributing editor.

The current sell-off in the technology sector, fueled by the growth of Chinese artificial intelligence startup DeepSeek, is reminiscent of a heightened stock market concern. The largest 10 stocks comprise two-fifths of the S&P 500. Such attention is unprecedented in our time. Equally weighted index products, which invest the same amount of money in each stock in a benchmark, are considered a way to de-risk a more concentrated portfolio. Should investors heed these calls?

More concentrated stock markets create less diversified passive portfolios. But this shouldn’t be a problem for either returns or risk-adjusted returns. Having one-third of your portfolio in stocks that generate high double-digit returns has been great for active investors in recent years, for active managers who have weighed Big Tech below their weight.

And there are good reasons why big companies are so respected. Today’s superstar corporations dominate global economies. They produce and control valuable intellectual property and have demonstrated the ability to commercialize it. Their income is growing rapidly and continuously. Market prices tell us that investors believe that this trend can continue.

But the most valuable companies today will be the most valuable 10 years from now. Research Last year, Bridgewater Associates examined the performance of America’s most respected businesses going back to 1900. By assembling a new group at the beginning of each decade and tracking their performance, the authors found a market-weighted basket of the 10 largest stocks. The market underperformed by an average of 22 percent over the next decade. Turn the clock forward three decades and this underperformance has grown to 53 percent.

Such flexibility is healthy. The superstar tech companies of yesteryear, such as Eastman Kodak, Xerox and Lucent, have been replaced by today’s Apple, Amazon and Alphabet. Some combination of spirited competition and effective antitrust machinery on the market side are key to economic growth.

Today’s megacaps can succeed either in their forefathers, either in displacing and disrupting competitors, or in stifling competition and holding the government back. But to believe so is to believe that this time will be different. And that’s a big call for long-term investors considering equal-weighted index products. A return to a less concentrated market would require underperformance on the part of larger companies. This is what boosts performance with equally weighted index trackers.

No one knows whether today’s megacap tech titans will maintain or even grow their market presence. A year ago, the rubber band seemed to be stretched. Since then, the so-called Magnificent Seven have By 2024, they have returned an average of more than 60 percent. There is certainly no foolproof numerical model that predicts the future. And so, like most investing, it comes down to a judgment call.

Goldman Sachs published the call in October. In the judgment, today’s index focus is lost, and the impact this has on long-term return estimates is profound. The bank’s forecasting team, led by David Costin, estimates that the S&P 500 will return just 3 percent annually over the next 10 years. If there is no change in index focus, their call was to return 7 percent per year. Thus, the baseline expectation is for stocks to underperform U.S. Treasuries — a historical rarity.

One of the attractions of investing in market capitalization is the free ride of active investors’ analytical efforts in efficient markets. Passive investors do not need to consider the future of any company. Investing in an equity index fund, by contrast, implicitly rejects the notion that the stock market is efficient.

Equal weight index products are a way to get exposure to US stocks without betting that this time will be different. They provide investors with diversification, but the Magnificent Seven risk extinction if they continue their upward trajectory. As the late Charlie Munger once observed, “Diversity is for the ignorant investor. His point is that diversification isn’t stupid, but rather that it undermines any insight that professional investors might have. Munger’s theory dictates that an uninformed investor would be better served by investing in a market-weighted index. For those looking to capitalize on the view that today’s high concentration returns to the mean, equally weighted index products may be more attractive.