Is Investor Complacency Starting to Show Up in Markets?
A handful of trade deals have materialized, and the most severe elements of the ‘trade war’ have been dialed down. But we still inhabit a world of economic uncertainty.
The U.S.’s effective tariff rate is substantially higher than it was six months ago, the U.S. and China have yet to reach a trade agreement, and new tariffs and economic policies continue to surface. Businesses are still trying to make sense of the shifting policy landscape, which is a factor that can impede long-term planning and investment.
And yet, stocks keep rallying.
In previous columns, I’ve offered a few explanations for the strong performance off April lows. In the first four months of the year, fears about tariffs were disproportionately high. Then we got the 90-day pause, more extensions, a few deals, and dialed down tariff rates. The entire episode registered to markets as a series of “better-than-expected” outcomes, which almost always drives stocks higher. I’ve written it many times—stocks love to climb the wall of worry.1
But the market’s strength in recent weeks looks a bit different.
There is still plenty of uncertainty regarding effective tariff rates and sectors that may be targeted, but investors seem largely unfazed by each new tariff announcement. Some market participants may be accepting that tariff rates will remain relatively high and that there will be no economic price to pay, now or in the future. But it could also be a sign of growing complacency, which if true, could be worrisome.
I’m not saying investors need to anticipate an economic downturn. I’ve recently written about the resilience of the U.S. economy, which could continue for years. I’m more concerned about investors ruling out even the possibility of an economic impact due to tariffs, assuming instead that everything is working, and will continue working, smoothly. From a sentiment perspective, this could lead to fading pessimism and growing optimism, which is another way of saying that the wall of worry may be shrinking. That’s usually a signal to look at the equity market more cautiously.
Perhaps the most “risk-on” segment of the market today is a familiar one: large-cap technology stocks. The rally we’ve seen recently gives the perception that all trade headwinds are gone, and it’s all clear from here. With big tech’s recent gains, the U.S. equity market is now the most concentrated it has been in over 50 years, with the top 10 stocks making up roughly 37% of the total market cap of the S&P 500 index. This concentration has grown much faster than the earnings those companies contribute to the index (28%), leaving one of the widest valuation and weighting gaps since 1970.
This is the type of strength investors should observe with caution. History shows that when concentration and relative valuations hit these kinds of extremes, like we saw in the late 1960s and the dot-com era, it often precedes a long stretch of underperformance for the biggest names, with stronger relative returns for the rest of the market (in this case, “the other 490”). In fact, during the most concentrated third of historical market conditions (top 10 stocks at 23–39% of index weight), the equal-weighted bottom 490 outperformed the top 10 in 88% of rolling five-year periods.
Again, I don’t mean to fire a warning signal. Big technology companies could continue to deliver, and AI’s impact on the economy and profits could be even bigger than many are anticipating. But history tells us the path is never a straight line, and leadership at this scale will be difficult to sustain over the long term.
For investors, I think it’s a reason to check your portfolio’s balance. In environments like this, trimming back some of the biggest winners, taking profits, and reallocating to areas with better value can reduce risk without sacrificing long-term upside.
Bottom Line for Investors
I’m not ready to declare that optimism is giving way to euphoria in markets today. There are still plenty of skeptics, and I think tariff uncertainty is still meaningful to a healthy segment of investors. But when optimism starts to take hold across the board, especially without a material improvement in underlying economic conditions, history suggests that caution is warranted. Our team is watching these signals closely.
As far as big tech’s outperformance, markets can stay concentrated for a while, and economic data can remain choppy without derailing a bull market. But when leadership narrows, valuations stretch, and the economic picture is cloudy, I’d expect conditions to get a bit choppier. We continue to rebalance portfolios and diversify into attractively valued areas, all while staying disciplined.
Disclosure