The Risks Beneath Strong Index Returns – Where the Risk Is, Why It Matters, and How Beacon Addresses It

U.S. equity markets continue to post strong headline performance, but beneath the surface, this performance is primarily associated with artificial intelligence. A small group of mega-cap companies now accounts for a historically large share of index returns, index weights, and investor attention. In this post, we will address several questions: Why does concentration risk matter? Where is current concentration coming from? What risk does it pose to investment portfolios? How do the Beacon strategies manage this risk?

Why Concentration Risk Matters

The primary danger of concentration risk is not volatility alone, but also fragility. When earning even index-level returns depends heavily on a small number of companies or themes, unexpected disappointments can have an outsized impact. Regulatory changes, earnings misses, valuation resets, or shifts in capital spending can ripple through concentrated portfolios quickly.

From a behavioral perspective, concentration risk also increases the temptation to performance chase. Strong recent returns can reinforce the belief that leadership will persist indefinitely, encouraging investors to add exposure precisely when expectations and valuations are already elevated.

Importantly, diversification benefits decline as concentration rises. Even diversified-looking portfolios can behave like single-factor bets when correlations increase and leadership narrows. This is especially relevant during periods of market stress, when investors often discover that perceived diversification was less effective than expected.

Contemporary Concentration Risk

Concentration risk today is most visible within major equity benchmarks. The largest companies now represent an outsized portion of broad market indices, meaning index-level returns are increasingly driven by the performance of a relatively small group of stocks. As of December 31, 2025, the top 10 stocks in the S&P 500 accounted for nearly 40% of the index, levels not seen since the late 1990s technology bubble. When those companies perform well, index returns can look deceptively healthy even if the median stock is lagging.

This risk is not limited to market capitalization alone. The Technology and Communication Services sectors make up almost 45% of the index as of December 31, 2025, again the most concentrated the index has been since the turn of the century.

This current concentration is directly tied to the artificial intelligence investment theme: capital spending expectations, productivity optimism, and long-term growth assumptions are being rapidly priced into a narrow set of companies viewed as primary beneficiaries. In this case, the beneficiaries are the primarily those dominant firms with the capital resources and strategic positioning to fund massive AI infrastructure buildouts. While these themes are compelling, they introduce the risk that portfolios become overly reliant on a single economic narrative continuing uninterrupted.

Market Concentration and AI

Artificial intelligence represents a powerful secular trend with the potential to reshape productivity, labor markets, and corporate profitability. However, market enthusiasm has front-loaded expectations into valuations for a small subset of firms. This creates an asymmetric risk profile, where upside becomes increasingly dependent on flawless execution and sustained growth assumptions.

Current capital expenditure levels underscore this tension. The largest technology firms are committing unprecedented resources to AI infrastructure—data centers, specialized chips, and computational capacity—with aggregate capex reaching levels that dwarf historical technology buildouts. While some revenue monetization has begun, the gap between capital deployed and incremental revenue generated remains substantial. This creates a critical timing question: how quickly will AI investments translate into earnings growth that justifies both the capex and the current valuations? Extended payback periods or slower-than-expected adoption could compress returns and challenge market assumptions.

The confluence of extreme market concentration and unprecedented AI capital expenditures creates a uniquely fragile setup. Index performance has become tethered to a small number of firms making massive, long-duration bets on technology infrastructure whose revenue payoff remains uncertain. If these investments deliver transformative productivity gains and revenue growth, current valuations may prove justified. However, the asymmetry cuts the other way: any material disappointment in monetization timelines, adoption rates, or competitive positioning would impact not just individual holdings but broad market performance given the structural concentration. This is not a prediction of failure, but rather an acknowledgment that today’s market structure offers limited margin for error relative to the embedded expectations.

Much like the dot-com bubble of the late 1990s, the current market structure creates a dual dependency: index-level performance relies heavily on a narrow cohort of stocks, and those stocks’ valuations increasingly depend on the successful monetization of unprecedented capital expenditures. In addition, history suggests that transformative technologies often create long-term value, but the path is rarely linear, and early leaders do not always remain dominant.

How Beacon Models Address Concentration Risk

At Beacon, our investment framework is designed to manage concentration risk across multiple dimensions. Our models emphasize risk-aware exposure rather than static allocations tied to market capitalization alone. By dynamically adjusting equity exposure based on market conditions, these models seek to reduce reliance on narrow leadership during periods of elevated risk.

Beacon Signal strategies employ equal weighting across its equity allocations, providing structural protection against the concentration risks embedded in traditional market-cap-weighted indices. Rather than allowing portfolio exposure to become dominated by the largest companies—regardless of their valuation or capital deployment decisions—the strategy distributes risk evenly across positions. This approach ensures that no single sector or thematic concentration (such as the current AI infrastructure buildout) can disproportionately influence portfolio outcomes. This equal-weight discipline complements the strategy’s tactical framework: the trading signals determine when to hold equities, while equal weighting determines how those equity exposures are structured to avoid unintended concentration bets.

Like Signal, Precision strategies also employ equal weighting across their equity sector allocations to but also adjust holdings at the sector-level using the Precision Trading Gauge which allows us to identify areas where risk and reward appear more balanced, rather than defaulting to the largest or most crowded segments of the market. This helps mitigate the impact of extreme concentration while maintaining exposure to long-term growth themes, including AI, when conditions are supportive.

Our Outlook models add an additional layer of diversification by broadening the opportunity set beyond a single equity-centric narrative. By allocating across equities, fixed income, and diversifying assets, Outlook is designed to reduce dependency on any one market regime or leadership cohort. In periods when equity concentration becomes elevated, diversified return drivers can play a more meaningful role in overall portfolio outcomes.

Importantly, Outlook is not intended to make short-term calls on which sector or theme will lead next. Instead, it seeks to balance participation and resilience by maintaining exposure to multiple sources of return that respond differently across economic and market environments. This structure can help dampen the impact of sharp reversals in concentrated equity leadership while still allowing portfolios to benefit when risk assets perform well.

Additionally, our stop-out and re-entry discipline across models is intended to address the behavioral challenges associated with concentrated markets. When risk rises meaningfully, portfolios are positioned to prioritize capital preservation. When conditions improve, exposure is reintroduced systematically, rather than emotionally.

The Bottom Line

Concentration risk is not inherently a signal to avoid markets or innovation. Instead, it is a reminder that strong index performance can mask underlying vulnerabilities. In today’s environment, thoughtful diversification, disciplined risk management, and an awareness of behavioral traps are increasingly important.

By combining systematic signals with diversified sector exposure and a long-term perspective, Beacon’s models aim to participate in growth while remaining resilient when leadership narrows. In a market driven by a few powerful narratives, risk management matters as much as opportunity.

The views and opinions expressed are my views and opinions as an individual and do not reflect the views and opinions of Beacon Capital Management, Inc.

Beacon Capital Management, Inc. is a registered investment adviser. Information presented herein is for educational purposes only.  Beacon Capital Management does not provide tax advice and strongly urges that retail investors consult with their tax professionals regarding any potential investment.

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