This column is from Trendlines, my business newsletter that covers the forces shaping the economy in Boston and beyond. If you’d like to receive it via email on Mondays and Thursdays, sign up here.
You don’t have to be an AI doomer to be wary of the artificial intelligence boom that’s driven the stock market to new heights.
Eight giant tech companies — led by Nvidia, Alphabet, and Apple — now make up 36 percent of the Standard & Poor’s 500 Index’s market value. Since the market bottomed in early April, these eight stocks have soared 57 percent, double the gain of the other 492 stocks in the index, largely on AI optimism.
But even the biggest bulls can’t shake the worry: Has AI gotten too big?
Why it matters: For a long time, the S&P 500 was a relatively cheap way to diversify your portfolio without the help of a dedicated investment adviser to pick your stocks. Financial pros generally recommend against putting too much of your money in a small group of investments, as a way of protecting against industry- or company-specific downturns.
But these days, an S&P 500 fund is less a diversified investment than a bet on whether AI will pay off for a handful of the world’s biggest companies. (The other stocks in the top eight are Microsoft, Amazon, Broadcom, Facebook parent Meta, and Tesla.)
This increasing concentration isn’t inherently bad. AI may well deliver the transformative productivity gains and profits that investors are anticipating.
“If the S&P is a proxy trade for AI, that’s kind of what it should be” because the technology’s potential impact is so broad, said Matthew Bartolini, global head of research strategists at State Street Investment Management in Boston.
Unlike the startups that inflated the dot-com bubble, AI’s pioneers are among the biggest and most profitable companies in the world that can fund the massive investments needed to push toward artificial general intelligence — a system smarter than we are.
But: The onus is on individual investors to reassess their diversification strategies when the market’s $63 trillion flagship index is heavily tilted toward a single group of stocks.
If AI companies stumble, the resulting selloff could drag down the rest of the market. Portfolios that seem safely anchored in broad market indexes could suffer outsize losses.
Adding to the concentration risk: The AI giants are increasingly intertwined through investments and business deals that could amplify any downturn.
Microsoft has poured more than $13,7 billion into OpenAI and depends on the startup for its Copilot AI products. Amazon, Google, and Nvidia have all invested in Anthropic, OpenAI’s main rival. Meanwhile, nearly every AI company relies on Nvidia’s chips, creating a technological chokepoint.
For some investors, it’s reminiscent of the interconnected risks that banks faced before the 2008 financial crisis, where institutions were simultaneously lenders, borrowers, and counterparties to each other.
Catch up: On Monday, Google parent Alphabet topped $4 trillion in market capitalization, joining AI chip maker Nvidia as the only current members of the exclusive club.
For comparison, the combined market cap of the Globe 25 Index of the biggest Massachusetts stocks is just $1.5 trillion.
After an inauspicious start in AI, Alphabet’s stock has climbed 57.5 percent since September as it narrowed the performance gap with OpenAI and Anthropic, which are both privately held, and rolled out chips to rival Nvidia.
The company got a boost earlier this week when Apple said it would use the Google Gemini 3 chatbot to beef up its AI capabilities.
Out of balance: The rally in Alphabet and its peers has been so swift that many investors may not realize just how dominant these companies have become in their portfolios.
The S&P 500’s weighting system, which is based on market capitalization, means that as these tech giants’ stock prices soar, they automatically represent a larger share of index funds.
It was an eye-opener for me when, as preparation for this column, I looked at my stock funds.
My biggest equity fund, DFA US Sustainability Core, has 30 percent of its assets in the top 8.
Six of the largest 10 holdings in BlackRock Tactical Opportunities — a fund my adviser chose for diversification — are tech mega-caps.
The biggest stocks in one of my international funds, another diversification play, are Taiwan Semiconductor Manufacturing and ASML Holding, two chip industry companies with a lot riding on AI.
Realignment: Diversifying away from mega-cap tech doesn’t require wholesale changes to your portfolio.
Consider adding equal-weighted index funds, which give the same stake to every company regardless of market cap. Adding small- and mid-cap stocks can broaden exposure to domestic economic growth, while international equities reduce reliance on the US tech cycle.
Funds that focus on value stocks — those trading at relatively low prices compared with their fundamentals but with potential for a turnaround — are another hedge against tech stocks commanding high price-to-earnings ratios.
Real assets such as gold, inflation-protected bonds, along with disciplined rebalancing can further spread risk.
Final thought: The goal isn’t to ditch the S&P 500 — just not to depend on it exclusively.
State Street’s Bartolini believes AI is too promising for investors to run away from.
“It would be like skipping railroads or oil companies when those sectors dominated the economy,” he said.
AI has altered the investing landscape, but the basic principles still apply: stick with your long-term plan, maintain diversification, and, above all, don’t try to time the market.
Sign in to read the full article.
Sign in with Google