Quality is the Tortoise; Junk is the Hare

Overview:

The stock market has delivered another strong year in 2025. The major indices tell a positive story. But beneath the surface, the reality is more nuanced. The market's strength has been concentrated in a few technology and growth leaders, as well as speculative, low-quality names. We view this dynamic as unsustainable and believe a rotation toward broader market participation, particularly high-quality stocks, is underway. High quality investing ultimately wins the race. In this market environment, investors must remain disciplined and diversified.   

Extreme Market Concentration:

Market concentration in 2025 has reached historic extremes. A handful of mega-cap tech names have dominated the broad equity indices. The top 10 companies in the S&P 500 now represent a record 40% of the overall index. Shown below, according to 3Fourteen Research, 2025 ranks as the third narrowest market environment on record.¹ Since 1960, only 1998 and 2023 saw fewer S&P 500 constituents outperform the index than we're seeing today.

This top-heavy market structure masks the lackluster performance of the "average" stock. Euphoria around AI investments has propelled markets higher, with the surge in the Magnificent 7 stocks pushing valuations to near record highs. Interestingly, shown below by the London Company, the technology sector’s weight in the S&P 500 recently hit a record high, surpassing the peak of the tech bubble.² Together, tech and communication services comprise nearly 50% of the S&P 500.

Market Broadening:

The equity markets have been increasingly volatile in recent weeks. Momentum stocks, low-quality names, and high-valuation companies have sold off, including several AI-focused stocks. The major indices, however, are only down 2-3% from their all-time highs at the time of this writing. The returns in November by sector and theme have been a partial mirror image of the YTD returns, as shown below by Alpine Macro.³

Sentiment shifted away from some of the YTD outperformers amid growing skepticism that AI capex should maintain its parabolic trajectory, concerns about a shift toward debt-funded vs. cash flow-funded projects, and recognition that not every AI player will be able to recoup an adequate ROI.

We view this as an early sign of equity rotation and market broadening. More defensive sectors like healthcare and consumer staples have bucked the trend and appear to be forming a relative bottom. Historically, these rotations unfold over a series of months, not weeks.

Quality Investing vs. a Junky, Speculative Frenzy:

As we highlighted in our October Diversify State of the Markets, in addition to tech/AI and growth stocks, the YTD market rally has been driven by unprofitable companies, heavily shorted stocks, “meme” stocks, and companies with extreme valuations or weak balance sheets. This speculative rally attracted momentum-chasing investors, creating a self-reinforcing cycle of FOMO (fear of missing out) that intensified the frenzy.

One fascinating behavioral finance signal of the mania: Roundhill launched a meme stock ETF (MEME) in December 2021. That timing coincided almost perfectly with the Nasdaq's peak, right before the tech-heavy index tumbled 38% over the following year. MEME torched investor capital and was shuttered in November 2023, right as the Nasdaq formed a powerful bottom and delivered fantastic returns. Guess what’s back! Roundhill re-launched MEME on October 8, 2025. It may not be a surprise that it is getting crushed (-33%) as a rotation away from junk appears underway. What an incredible contrarian indicator MEME has been.

Meanwhile, well-run companies with strong free cash flow generation, healthy balance sheets, and consistent earnings have been left for dead and are currently out of favor. The chart below shows the trailing returns of quality vs. junk stocks.⁴ Quality stocks are currently underperforming junk stocks by an unprecedented magnitude. The last time we witnessed anything close to this level was during the 1999 dotcom bubble. We all know how that ended.  

Importantly, quality stocks have bounced in November compared to junk, reversing some of that YTD underperformance. As Fidelity’s Jurrien Timmer phrased it, “The air has suddenly been taken out of the speculative highfliers, such as the meme stocks, bitcoin sensitive stocks, SPACS, recent IPOs, non-profitable tech, etc. I would argue this is probably a good thing.” Our view is that speculation is not sustainable as an investment strategy, and history suggests it rarely ends well.

Over the long run, quality investing is a winning strategy with mountains of empirical research to support that view. This reminds us of the timeless wisdom from Warren Buffett: "The less prudence with which others conduct their affairs, the greater the prudence with which we must conduct our own." Now is most definitely not the time to abandon quality investing, in our view.

The Tortoise and the Hare:

This market dynamic brings to mind Aesop’s fable of The Tortoise and the Hare. The Hare, confident in his speed, sprints ahead and builds a commanding lead. But his erratic nature and overconfidence prove his undoing. He stops to rest and never recovers. He doesn’t cross the finish line. The Tortoise, meanwhile, maintains a steady, disciplined pace. Unbothered by his flashier competitor racing ahead, he stays the course, doesn’t waver from the plan, and ultimately wins the race.

Up until recently, the market was betting on the Hare. The recent speculative rally was that seductive sprint. It might be fast and exciting, and it seems hard to beat. It makes a disciplined strategy look relatively boring. But the Hare lacks stamina. Low quality companies cannot sprint forever, as we’ve seen in November. Many of them are getting wrecked. Eventually, overvaluation or lack of sound fundamentals causes them to collapse.

The Tortoise is lagging at the moment, but he is methodically trucking along and is on track for an eventual comeback. Diversify’s investment philosophy is centered around owning high quality, competitively advantaged companies with durable long-term earnings growth, while maintaining disciplined valuation criteria. These characteristics may lag in short bursts of speculative strength, but we believe they remain the foundation of reliable long-term compounding. We continue to find some very interesting stocks that fit our criteria.  

Summary:

At Diversify, we are comfortable being the Tortoise. We believe steady, long-term progress ultimately beats short-term flashes. Owing to our unrelenting discipline, we refuse to get caught up in the frantic sprint of the speculative trade du jour, nor will we chase the Hare into overvalued/redline territory.

Our philosophy remains rooted in the belief that while speed is attention grabbing, investing with discipline and employing the power of diversification and quality investing can more durably build and protect wealth. History shows that the steady compounding of high-quality businesses has been the most reliable way to reach the financial finish line. Don’t forget: the Tortoise wins the race.  

We at Diversify feel immense gratitude for the trust you place in us to help you reach your financial goals. Thank you for your partnership. Happy Thanksgiving to you and yours! We are here to help or answer any questions. 

David Wrigley

Chief Investment Officer

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1. 3Fourteen Research, as of November 12, 2025

2. The London Company, What Have I Become, as of October 31, 2025

3. Alpine Marco, Forecast, Tactics and Risk Management, as of November 24, 2025

4. Refinitiv, as of October 31, 2025

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The information contained herein is the opinion of the author as of the date the market update was written and is subject to change without notice as markets change, and new information is available. While Diversify utilizes sources deemed to be reliable, we have not independently verified the content. Investors should carefully consider any changes based on this market commentary and discuss their individual circumstances with their trusted advisors. Past performance is not indicative of future results. This communication is for informational purposes only and should not be construed as investment advice or a recommendation.