Here’s Why Concentration Risk Matters

Lately, investors have had no shortage of headlines to process. Geopolitics, interest rates, and questions about the economy have all competed for attention. Those stories matter, and they can certainly move markets in the short run.

But beneath those headlines, another shift has been taking place. And that’s that market leadership has been changing in a subtle way.

And this change is worth paying attention to because leadership changes are often where concentration risk gets exposed. That’s because the stocks and sectors that led in one environment do not always lead in the next. And when the market begins to reassess those winners, the repricing can happen quickly.

This is one reason diversification still matters, especially in a year like this.

A Reminder From Software Stocks

One of the clearest examples has come from the software industry, which has fallen nearly 30% from its peak since last October. The move makes it one of the largest non-recessionary drawdowns in the group in more than 30 years.

And that historical context matters because the two biggest software drawdowns before this one happened during recessions, in the dot-com bust and the 2008 financial crisis, when earnings were under pressure and businesses were pulling back on spending.

Now, it’s worth noting that the 2022 decline was different because that selloff was driven by the Federal Reserve’s aggressive rate-hiking cycle, and software stocks fell nearly 40%.

This time, however, the catalyst appears to be different. The market is not primarily reacting to recession fears or rising rates. Rather, it appears to be reacting to uncertainty around artificial intelligence and what it could mean for future business models as we’ve discussed in previous reports.

What Changed Earlier This Year

The selloff in software picked up speed in January and February after a series of AI product launches suggested that general-purpose AI tools may be able to handle tasks that had previously required specialized software, often at a lower cost.

That mattered because it changed the market’s framing.

For the past two years, AI had largely been viewed as a productivity tool, something that could help existing businesses become more efficient. But earlier this year, investors began asking a different question: what if AI does not simply improve some business models, but starts to pressure or replace parts of them?

Software stocks felt that shift first. Then the concern spread into other areas, including financial data providers, commercial real estate services, and logistics companies.

In other words, this was not just about one corner of the market having a bad stretch. It was a broader reminder that when investors begin to question the durability of future earnings, yesterday’s leaders can suddenly look much more vulnerable.

Where Things Stand Now

By late February, some of the more extreme fears around AI disruption began to cool, and markets started to stabilize. Analysts pushed back on the most aggressive replacement narratives, and the conversation became more measured.

The question shifted from whether AI would replace entire industries to which businesses are genuinely vulnerable, and which may be able to adapt, defend their position, or even strengthen it.

Since then, some of the hardest-hit stocks have rebounded. Even so, the software industry remains down more than 25%, and the broader question is still unresolved. AI is likely to remain a force that shapes leadership across markets, especially in software and other professional-service-oriented industries.

What This Means for Your Portfolio

For investors, the lesson is not that every new innovation requires a major portfolio change.

The lesson, rather, is that market leadership can shift quickly, and concentrated positions can become more vulnerable when the narrative changes. Even strong, well-established businesses can be repriced in a short period of time when the market starts applying a different set of assumptions to future earnings.

At the same time, this period has also been a useful reminder of why diversification works. The pressure has been meaningful in some concentrated parts of the market, but much more limited for diversified investors. International stocks and the average S&P 500 stock have posted gains, while small caps, the broader S&P 500, and the Nasdaq 100 are each down only modestly.

That does not remove uncertainty. But it does reinforce an important principle.

A disciplined portfolio is built not just for the trends we expect, but for the leadership changes we do not. And in an environment like this, diversification across sectors and asset classes remains one of the most practical ways to manage risk without losing sight of long-term goals.