Following last week’s column on ‘Diworsification’, Deepseek slam dunked it.
There’s an old investing saying: “Trees don’t grow to the sky.” No stock, no matter how promising, can rise indefinitely. And yet, investors often get caught up in momentum, buying into the hottest stocks of the moment, only to find themselves battered when reality catches up.
The recent DeepSeek AI breakthrough serves as a reminder that markets driven by a single narrative, like AI, can be fragile, and diversification is the only true safety net.
Don’t get me wrong, AI in its truest most useful form, like taking all the fat off processes for example, is mind-blowing. Simply mind-blowing, but fully understood by very few. Very few even in the investment markets. Trust me. When the true AI value adders are identified – not expensive chip makers, there will be excellent gains across those providers and those that use AI well. Trust me. But you have to know what you are buying.
Being self-congratulatory over a stock which you bought, without understanding it, and seeing its value soar, is the exhilaration of skydiving without having checked your parachute. You can’t blame anyone.
For the past two years, AI has been the market’s golden child. Companies like Nvidia, Microsoft, and Alphabet have soared on the promise of AI dominance, pulling the broader market up with them. In 2023, Nvidia alone accounted for over 20% of the S&P 500′s gains – read that again.
The problem: When one sector (or worse, one company) is responsible for outsized gains, investors are no longer diversified - they’re betting on a single theme. The Magnificent Seven (Apple, Microsoft, Nvidia, Alphabet, Amazon, Meta, Tesla) now make up nearly 30% of the S&P 500 - the highest concentration since the dot-com bubble.
When the above CEO’s paraded around on the stage with Trump, it was my ‘pinch me’ moment of where the world had plummeted. They are waking up to a haddock round the face and will likely do what they can to curb Deepseek, such is the ‘democratic’ world we live in.
Momentum investing works. Until it doesn’t. When markets are rising, investors pour money into the best-performing stocks, pushing their valuations higher. Index funds, end up buying more of these stocks automatically, not because they’re cheap or have strong fundamentals, but because they’re going up.
This means investors aren’t making a conscious choice to own Nvidia or Microsoft at stretched valuations, they’re being dragged into it.
This is how bubbles form and pop.
When DeepSeek unveiled its low-cost AI model, Nvidia’s stock fell nearly 17% in a single day. Investors suddenly realised that AI competition wasn’t priced in, and valuations were stretched.
Ask yourself - would you buy a stock trading at 40 times earnings on its own? Would you bet that AI valuations will remain sky-high forever? If not, why let a passive fund do it for you?
History is filled with examples of stocks which looked unstoppable - until they weren’t.
The Nifty Fifty in the 1970s were “buy and hold forever” stocks, until high valuations crushed them. Less than half remain, and some have only kept there by going bankrupt on a few occasions in their group company. Dot.com and its nutty valuations of companies which weren’t even trading a year?
AI is revolutionary, but hype doesn’t equal sustainable growth. Just because AI is the future, doesn’t mean every AI stock will thrive, or that today’s leaders will remain dominant.
Diversify beyond the AI narrative.
The S&P 500 looks diversified, but it’s a tech-heavy bet. Consider sectors like healthcare, industrials, and energy, which aren’t riding the AI hype wave.
Think about fundamentals, not momentum.
Passive investing funds work, but only when markets are broadly diversified. When a few companies dominate, the risks rise.
AI is real. The technology is transformative. But markets driven by a single theme are always fragile. Don’t let momentum investing blind you to valuations and know what you are buying. Diversification is your best friend - because no stock, no matter how hyped, can grow forever.
Peter McGahan is chief executive of independent financial adviser Worldwide Financial Planning, which is authorised and regulated by the Financial Conduct Authority. If you have an investment question, call 028 6863 2692 or email info@wwfp.net