One of the benefits of index investing

is supposed to be broad diversification.

But right now 36% of the S&P 500 index

consists of just seven stocks. If we

look at the total US market, that number

is 32%. That is the most extreme level

of index concentration in US market

history going back to 1927.

US stock market valuations are also

nearing their 1999 peaks which were of

course followed by a decade of flat at

best US stock returns. I get it. This

does seem concerning. If that handful of

stocks declines in value, the effect on

the overall market could be substantial.

This is a movie we have seen before up

here in Canada. In July of the year

2000, one stock made up about 36% of the

entire Canadian market index,

subsequently crashing, eventually

becoming worthless and dragging the

market down with it. The good news is

that mitigating the worst of these

situations is not actually that hard.

I'm Ben Felix, chief investment officer

at PWL Capital, and I'm going to tell

you how to prepare for the aftermath of

the AI bubble.

[Music]

All

right, I've got to come clean up front.

I don't actually know if there is an AI

bubble. Nobody does. That's only

knowable in hindsight. That being said,

some wild stuff has been happening in

the US stock market. Companies have been

spending at a blistering rate to build

out the infrastructure needed to

capitalize on the supposed AI

revolution. This type of spending often

coincides with the development of

revolutionary technologies. Railroad and

internet stocks followed a similar path

of high asset prices, massive

investment, and an eventual painful fall

in asset prices, which we might describe

as a bubble after the fact. Stock price

bubbles, or periods of unusually high

stock prices followed by much lower

prices, are an age-old feature of

financial markets. They are often, but

not always, sparked by some new

technology that promises huge profits

for those developing it. The history of

technology bubbles goes back to at least

the 1700s and has followed a similar

pattern with each successive major

technological innovation. In this video,

I want to talk about the two main

features of the current US market which

seem to be causing some investors to

worry. One is market valuations. The

other is market concentration. These are

two loosely related measures. Market

valuations measure how expensive it is

to buy the expected future earnings of

companies. And market concentration

measures how concentrated the market's

total value is in a small number of

stocks. High market valuations are

generally associated with lower future

returns, while market concentration has

a much noisier relationship, if there's

any relationship at all. Market

valuations and market concentration may

both increase around the development of

new technologies simply due to the fact

that as some companies rise in value due

to their association with the new

technology, they will make up a larger

portion of the market. Bubbles are

exciting on the way up, often inducing

FOMO, fear of missing out that may

further feed into the bubble dynamics,

and then they are painful on the way

down, both psychologically and often

economically or financially for the

people who invested in them. Bubbles are

not all bad, though. High stock prices

that arise from speculation about the

profitability of a revolutionary

technology can help to facilitate that

technologies development and deployment

into the economy. Classic examples are

the massive spending on installing fiber

optic cables in the late '90s and on

installing railway track in the 1840s.

In both cases, many of the companies

involved were able to raise a ton of

money and achieve temporarily high stock

prices as excited investors piled in,

but their share prices subsequently

crashed. Bubbles do tend to come with

waste. Too much unused fiber optic

cable, too much redundant railway track.

But despite the waste, the

infrastructure for the respective

technologies does get created, paving

the way for a potential economic golden

age to follow. These productive bubbles

are probably on net a good thing for the

economy, even if they can be painful for

investors. The pattern of investor

excitement and high stock prices

surrounding technological revolutions or

potential technological revolutions goes

back hundreds of years and it always

follows this similar path. Stock prices

are driven up by some combination of

high profit potential from the

revolutionary technology and once it

starts rising, speculation that the

associated stocks will continue rising.

Eventually, prices do come back to

Earth, resulting in low returns for

anyone who bought near the top. Whether

that's what we're seeing in the US right

now, again, can only be known in

hindsight. Prices could remain high. The

rapid rise in prices of the top US

stocks has also been accompanied by

rapid earnings growth. It's not pure

hype. There is some economic substance

here. What we do know is that a large

portion of the US market's return,

earnings growth, and capital expenditure

has come from AI related stocks since

the launch of Chat GPT. A September 2025

report from JP Morgan explains that AI

related stocks have accounted for 75% of

S&P 500 returns, 80% of earnings growth,

and 90% of capital spending growth since

CHACPT launched in November 2022. We

also know that US stock market

concentration which was already high has

shot up even further. Stock market

concentration and high stock valuations

are again different issues but they can

be related by the fact that a rapid rise

in valuations for a small number of

firms can also lead to market

concentration. To be completely clear in

case I wasn't already, I am not taking a

position on whether we are witnessing a

bubble in the US stock market. But I

think it's useful to look at past

instances of high stock market

valuations and market concentration to

understand the potential implications

and lessons. The Canadian example that I

mentioned earlier is even more extreme

than what we're currently seeing in the

US market. Northern Electric and

Manufacturing Co. was spun off from Bell

Canada in 1895.

In 1998, it was renamed Nortell

Networks. During the dotcom bubble,

Nortell's early work in optical

networking technologies propelled it to

the forefront of the internet

infrastructure revolution. It was making

truly useful stuff that the world needed

or thought it needed. Its stock price

soared, creating huge amounts of wealth

for investors and for the many employees

who received stock-based compensation.

Incredibly, the company peaked at over

36% of the Canadian stock market index

at the time called the TSSE 300. Nortell

and thus the Canadian stock market had

extremely high valuations in August of

the year 2000, peaking at a Schiller

cyclically adjusted price earnings ratio

of 60.62, far surpassing the peak

valuation of the US stock market during

the same dot period. The Schiller

cyclically adjusted price earnings ratio

measures market prices against the

index's 10-year average real historical

earnings on the assumption that

long-term earnings growth tends to be

steady. A high Schiller PE means that

investors are paying a lot more for

future earnings and should therefore

expect lower future returns unless

earnings end up being unusually high in

the future which can happen. Nortell's

downfall started with a string of

unprofitable internet related

acquisitions and was accelerated by the

dotcom bubble popping. The result for

the Canadian stock market was

devastating. The Canadian TSE 300 index

dropped by 43% between September 2000

and September 2002. Pat obviously hurts.

There are two lessons that I think are

important to explain here. First, while

this drop was definitely painful. I

don't want to minimize that. The market

recovered by July 2005 and it went on to

deliver strong returns while the US

market, as I'll detail in a minute,

struggled for more than a decade.

Despite having been more concentrated,

the Canadian market was more resilient

than the US market. The Nortell crash

was, in hindsight, a short blip in a

long track record of strong performance

for Canadian stocks. Second, while the

Canadian market as a whole was hurt by

its exposure to Nortell, Canadian value

stocks, a Canadian value stock index, so

stocks with low prices relative to their

fundamentals, did not crash when the

overall market did, and it actually

delivered even stronger returns than the

market on the recovery. This will come

up again in my next examples, too. The

US market did not have such extreme

concentration in 1999 as it does today

or as Canada did back then. But it did

have high stock prices which were in

hindsight mostly unjustified by

fundamentals. Some companies like

Microsoft and Amazon came through the

other side and proved that there was

real transformational potential in the

internet. But the vast majority of

companies that tried to capitalize on

the internet failed. This led to the

famous dotcom bubble and the subsequent

lost decade for US stocks. The US market

crashed starting around March of 2000

and measured in Canadian dollar terms

remain flat or below flat until July of

2013. That is another brutal period of

technologyinduced high prices leading to

low realized stock returns for investors

who bought at the peak. In this case,

unlike with Nortell, the recovery was

not so swift. Part of the problem is

that the great financial crisis

intervened as stock prices were starting

to recover. Either way, this technology

bust was painful for US investors or

investors in US stocks in general and

even more so for investors focused on US

technology stocks. It would have taken

them even longer to recover. Similar to

the Canadian example, an investor in US

value stocks and to an even greater

extent, US small cap value stocks fared

much better over this long period of

poor performance for the market as a

whole. They earned positive returns

while the market was flat at best for an

extended period of time. It's also worth

reiterating that Canadian stocks

performed reasonably well over this

period. Diversification is known as the

only free lunch in investing for good

reason. The main problem with

diversification is behavioral. It

inherently means that you always own the

stuff that's performing well and the

stuff that's performing poorly, which is

not always so easy to do. Okay, so these

two examples, the Canadian and the US

example, they had high market valuations

in common, but the Canadian market

became much more concentrated than the

US market. In the past, the US market

has reached high concentration levels

without going on to deliver poor future

returns. Not quite as high as today, but

still high. I looked at this within the

US market going back to 1926. I sorted

10-year future returns on the starting

level of market concentration in the top

seven stocks. There's a very slight

negative correlation between market

concentration and future returns, but

it's not statistically significant,

meaning there's a good chance it's just

noise in the data. But statistical

significance aside, it's still a weak

relationship economically. A point that

often seems to get lost in discussions

of the US markets concentration is that

many other markets around the world are

far more concentrated. I mean, I gave

you guys the Canada example, and yet

they still managed to deliver positive

returns, in some cases even more so than

the US market. Looking back at the last

10 years of returns, just as an example,

the weight of the top seven stocks in

the 10 largest stock markets, excluding

the US, was 40.94%.

So higher than the US in November 2015,

so we're looking back 10 years in

history. Switzerland was the most

concentrated market at 60.11% in the top

seven stocks, and Japan was the least

concentrated at 16.91%.

The return from November 1st, 2015 to

November 26, 2025, measured in USD was

8.44% on average for all of these

countries. That does trail the US market

return, but still delivers a

meaningfully positive equity risk

premium. Taiwan was one of the most

concentrated markets in November 2015,

and it outperformed the US market over

the subsequent 10-year period. The

overall relationship between market

concentration and future returns across

countries seems to be noisy at best. An

interesting sort of anecdotal

perspective is AT&T which was broken up

into smaller companies starting in 1982.

It was the largest company in the US

market at that time and in prior decades

not when it was broken up but in prior

decades it made up a larger portion of

the US market than Nvidia makes up

today. The interesting question is was

the US market less risky after the

breakup? I think that would be pretty

hard to argue. You could maybe even

argue the opposite. Something that does

appear in the data at least post 1950 is

the returns can suffer over periods

where concentration is falling. I think

this again makes sense. If concentration

comes from rising valuations for a

handful of firms, falling valuations for

those firms would lead to lagging

returns. But even then, we're talking

about less positive returns, not a total

disaster. The relationship between

market valuations and future returns is

stronger, at least economically, both

across markets and within the US market.

To illustrate this, I looked at the

relationship between the starting

cyclically adjusted price earnings

ratio, the CAPE ratio, and the 10-year

return for the 10 largest developed

stock markets going back to 1982. I

looked at rolling periods with a one-mon

step. I acknowledge that there are

potential problems with this setup, like

difficulties in comparing the cape ratio

across countries. And from a statistical

perspective, the fact that I'm using

these overlapping samples, the rolling

periods of the one-mon step, it does

make any conclusions drawn from the data

statistically questionable. Now, that

being said, there is a clear monotonic

relationship between starting cyclically

adjusted price earnings ratio, so

starting valuations, and future 10-year

returns. When the cape ratio is higher

at the start, future returns are lower.

Again, this does not mean that the

market must crash tomorrow or next week

when valuations are high, but it might

mean that it makes sense to moderate our

expectations for future returns from the

US market in particular due to its

currently elevated valuations. The

Japanese stock market had a crazy run

leading up to 1990, eventually becoming

the largest stock market in the world by

market capitalization, surpassing even

the US market for a period of time.

Japan was viewed as this unstoppable

economic powerhouse and its stock market

valuations reached levels rarely seen

elsewhere in history. I'm not saying the

US is today's Japan, but I think it's an

important example to think about. At the

end of 1989, the Japanese market did

crash. So, it had these crazy high

valuations and then it prices do start

to come down. The market really does

crash. The crazy thing about the Japan

example though is that it has not

recovered in real terms. So if we adjust

for inflation to this day, so it crashes

in the end end of 1989 and now we're in

almost 2026 and if you adjust for

inflation, the Japanese market is still

not recovered from the crash or it's

it's flat after the crash. Now two

things would have saved an investor in

Japanese stocks in 1989. diversification

across markets. A globally diversified

investor did just fine as the US market

kind of took the torch of stock market

dominance back from Japan with a a

vengeance. The US went on to absolutely

uh perform exceptionally well as Japan

had done previously. And then the other

thing that would have helped is

diversification within the Japanese

market itself. Despite Japan's stock

market struggles over this long period

of time, as with my previous examples,

Japanese value and small cap value

stocks have actually performed fine over

this period. Now, again, this does not

mean that I'm suggesting getting out of

the US stock market. I we could have had

a very similar conversation to what

we're having now in 2021 when US market

valuations were high again, not quite as

high as today, but still high. Uh that

would have been a mistake. US stock

returns have continued to be very

positive since then. But what it does

mean is not expecting the same rocket

ship returns that the US market has been

delivering to continue forever. The US

stock market currently has these two

defining features that are causing some

investors to worry. High stock

valuations and high market

concentration. Market concentration,

while seemingly problematic due to the

potential impact of a few large firms

faltering and bringing the market down

with them, has not historically been as

much of an issue as you might expect.

Anecdotally, the Canadian market

recovered from extreme period of market

concentration and high valuations during

the do-com bust more quickly than the

less concentrated US market. Looking

more broadly at the 10 largest non US

stock markets for the last 10 years, the

relationship between concentration and

future returns is seemingly

non-existent. Looking at US returns from

1927 to 2024, there is a weak economic

relationship that is not statistically

significant between market concentration

and future returns. Stock market

valuations on the other hand are more

impactful and that is another concerning

aspect of the US market right now. High

current valuations, while not a perfect

predictor of future returns, do seem to

be at least somewhat related. This

relationship, while it's economically

strong, doesn't really hold up to

statistical scrutiny for the simple

reason that we don't have that many

independent samples to draw conclusions

from. Past market valuations tell us

only a little bit about the future. It's

always possible, as the US market has

demonstrated in recent history, for high

valuations to be followed by high

returns and continued high valuations.

Even if history tells us that that is an

unlikely outcome, it is what we have

seen. The main lessons from the

information in this video, I think, are

diversification and discipline, which I

think are related. A properly

diversified investor should be

comfortable sticking with their

portfolio through good times and bad,

knowing they will always hold the

losers. You have to accept that whatever

is not doing well, if you're

diversified, you probably own that. But

you also own the winners. And people who

are comfortable with their investment

strategy understand that the winners

that they own are going to have an edge

over the losers in the long run, which

is something that has been true

throughout history. Thanks for watching.

I'm Ben Felix, chief investment officer

at PWL Capital. If you enjoyed this

video, please share it with someone in

your life who's concerned about the AI

bubble.