From blue wave to sea of red

The scale of the falls among some of the market’s biggest companies has been striking. However, investors should also consider those movements in the context of what has happened over recent years.

A relatively small group of large technology and semiconductor companies has grown to represent a significant proportion of the US equity market. Strong performance from these businesses has helped propel markets higher, but increasing concentration can work both ways.

When the largest companies prosper, their size can provide a considerable tailwind for an index. When they fall together, the same concentration can amplify weakness.

That does not necessarily mean the long-term prospects for AI or the companies developing the technology have deteriorated. Instead, the recent sell-off is a useful reminder that even companies with compelling long-term growth prospects can experience periods of significant volatility, particularly when valuations already reflect high expectations.

Weakness in large technology businesses has inevitably travelled beyond the US.

Technology-heavy Asian equity markets have been particularly exposed. The UK market, by comparison, has a much smaller technology weighting and should therefore be relatively insulated from this particular source of volatility.

Energy markets have also been responding to a different set of pressures. Following a sharp fall at the start of the week, energy prices have edged higher as investors continue to assess uncertainty surrounding Iran and what may come next.

Taken together, geopolitical uncertainty, questions around future AI regulation and highly concentrated equity markets leave investors with plenty to digest. However, following such a strong run for technology shares, some volatility should perhaps come as little surprise. Rather than trying to predict every change in market sentiment, maintaining a diversified approach can help investors navigate periods when markets become less certain.

Central banks provide another important backdrop. The Bank of England's latest rate increase itself did not surprise markets, although the unanimous nature of the decision was considered more hawkish than some had expected.

In the US, the picture is somewhat different. Falling equity markets have effectively tightened financial conditions, contributing to lower market expectations for future interest rate increases. A December rate rise is still expected and remains supported by strong economic data. However, beyond that, additional increases are likely to face greater scrutiny. Any meaningful deterioration in economic activity is likely to be reflected quickly in expectations for the future path of US interest rates.

For markets, that creates a balancing act. Strong economic data can provide reassurance over the health of the economy, but it can also give central banks greater scope to keep monetary policy tighter for longer.