Decoding Markets: Riding the Wave

Estimated reading time: 6 minutes

All Boats Aren’t Built the Same

It doesn’t take Captain Obvious to see which way the wind – or rather, the wave – has been blowing in the stock market. Returns have been quite positive over the last month or two for most stocks, but some parts of the market have seen particularly big swells.

High-growth technology companies, especially those deeply involved with artificial intelligence, have been market leaders since the April 8 bottom. Like the broader market, these stocks have benefited from tariff pauses, but renewed investor enthusiasm for AI’s vast potential, and robust earnings reports from key AI players, have been an added boost. 

On the year, a basket of AI stocks is up 7.4%, while the broader S&P 500 is barely positive, and the “Magnificent Seven” tech stocks are actually down 3.2%.

Cumulative Year-to-Date Returns

It can be challenging for investors when a concentrated part of the market does so well. Do you take profits or hold, hoping for further gains? History offers valuable context. Past market cycles have seen specific sectors lead market advances, sometimes with remarkable intensity, that can last for a long time. 

The dot-com bubble of the late 1990s and early 2000s is a prominent example. An explosion of enthusiasm for internet-based companies fueled unsustainable valuations, sometimes with little to no earnings to show for it. But now, established tech giants are spearheading AI investment and generating substantial earnings and cash flows in the process. In the dot-com era, this wasn’t the case.

Expecting Higher CapEx

A defining feature of the current technology landscape is the colossal increase in capital expenditures (CapEx) by the Magnificent Seven and other leading tech companies. This translates into massive investments in the foundational elements of AI: power-intensive data centers; next-generation servers; R&D; and of course, purchasing chips. 

Despite broader macroeconomic uncertainties, which initially led some investors to question if the AI build-out would slow, recent financial guidance from big tech companies solidified their commitment to ramp up investment even more.

Consensus expectations for the biggest players reflected this news, with the big four hyperscalers now expected to spend $309.6 billion on CapEx in 2025, versus $299.9 billion at the end of April. 

Hyperscaler CapEx Consensus

However, there are obvious pitfalls associated with the aggressive investment plans of these companies. Concerns about a possible overbuild have been voiced, with Microsoft CEO Satya Nadella explicitly suggesting the industry could be heading in that direction. This presents a conundrum: The timing and extent of any potential over-investment are unknowable in advance, and it’s an open question when investors may price in the risks associated with unproductive capital allocation.

In the immediate term, the robust spending plans makes it unlikely that the AI theme will fall apart. But the future, as it usually is, is more uncertain.   

To Diversification — and Beyond!

The stellar performance of the technology sector, supercharged by the AI narrative, makes it incredibly tempting for investors to heavily weight their portfolios in this area. The dominance of the Magnificent Seven over the last several years, for example, can foster the belief that concentrating on a few leading stocks or a single hot sector is the way to go. These seven companies now represent over 30% of the S&P 500’s market capitalization, and the weight of the top 10 stocks in the index is at multi-decade highs — drawing comparisons to the dot-com bubble. 

Concentration has its drawbacks. Just like you can benefit on the way up, you’re vulnerable to drawdowns stemming from idiosyncratic risks. For instance, if investors become more skeptical of mega-cap tech companies’ ability to monetize these investments, related stocks could suffer disproportionately. 

Importantly, diversification isn’t just a defensive strategy. It can position a portfolio to potentially benefit if (or when) currently lagging sectors heat up. That it can also offer protection against unforeseen sector-specific downturns, such as the tech-driven bear market of 2022 or the banking turmoil of 2023, is the cherry on top.   

This point bears repeating: Market leadership is rarely permanent. History is filled with examples of sectors and individual stocks that led the market for a period, only to be eventually overtaken as conditions change. From industrial and energy companies in the 1970s and 1980s, to technology in the late 1990s, commodities and emerging markets in the 2000s, back to tech in the 2010s, and so on, things can change.

Artificial intelligence is undoubtedly a powerful force, but the same shifts that brought tech back into a leadership position can one day turn against it. Being mindful of that and prudently taking advantage of the benefits of diversification can help investors be prepared for whenever that moment comes.

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