Market Insights: Price (Valuation) Still Matters as a Margin of Safety
Source: FactSet. Data from 4/30/2011-11/20/2025. Dates for drawdown episodes are as follows: 2011 Eurozone Crisis 4/30/2011-9/30/2011. 2015 Flash Crash 8/1/2015-9/30/2015. 2018 Global Growth Scare/China 1/1/2018-12/31/2018. 2020 Covid 1/1/2020-3/31/2020. 2022 Hard Landing that Wasn’t 1/1/2022-12/31/2022. Feb-Apr 2025 Tariff Scare 2/19/2025-4/8/2025. Nov 2025 AI reset 10/28/2025-11/20/2025.
A Shift in Defensive Characteristics
Amidst three consecutive years of double-digit U.S. large cap returns, a subtle but significant shift has occurred in how the Information Technology sector behaves during market stress. This change may have important implications for portfolio construction and risk management as we move forward.
For years, technology stocks were viewed not just as growth engines but also as relatively defensive holdings during market turbulence. However, recent market behavior suggests this dynamic may be changing, and valuation levels appear to be playing an increasingly important role.
The Historical Context: Tech as a Safe Haven
Looking back over the past 15 years, the Information Technology sector within the Russell 1000 Index demonstrated remarkable resilience during several notable market drawdowns. During the 2011 Eurozone Crisis, when concerns about sovereign debt roiled global markets, tech stocks outperformed the broader index. Similarly, during the 2015 Flash Crash and subsequent volatility, the technology sector provided a buffer for investors seeking stability.
This pattern reinforced a narrative that had taken hold: quality technology businesses, with their strong balance sheets, recurring revenue models, and secular growth tailwinds, could serve as both offensive and defensive holdings. Many investors came to view tech concentration not as a risk, but as a feature of prudent portfolio construction.
A Different Story in Recent Downturns
More recently, however, this historical pattern has not held. During recent market selloffs, the Information Technology sector has struggled relative to the broader market, underperforming during periods of stress rather than providing the defensive characteristics investors had come to expect.
What changed? While multiple factors influence market behavior during any given period, one stands out prominently: valuation. Technology stocks have reached elevated valuation levels relative to the broader market, and this valuation premium appears to be affecting how the sector performs during downturns.
When valuations are stretched, even high-quality businesses can face meaningful declines during market stress as investors reassess what they’re willing to pay for future growth. The margin of safety that reasonable valuations traditionally provide becomes compressed, leaving less room for error when market sentiment shifts.
Concentration Meets Vulnerability
This shift in defensive characteristics occurs at a particularly notable moment. The Information Technology sector has reached record levels of concentration within both the S&P 500 and Russell 1000 indexes. Simultaneously, active share for many active large cap managers relative to these benchmarks sits at multi-year lows.
This combination creates a challenging dynamic for investors. Not only are portfolios increasingly concentrated in technology stocks through their benchmark exposures, but the traditional assumption that this concentration provides defensive benefits during market stress may no longer hold to the degree it once did.
For portfolios constructed with both passive and active exposures that closely track major indexes, the risk is compounded. What appears to be diversification across multiple managers may actually represent concentrated exposure to the same underlying holdings—holdings that have demonstrated increased vulnerability during recent market downturns.
The Risk Management Challenge
The question facing investors is not whether technology companies are high-quality businesses—many demonstrably are. Rather, the question is whether current valuations provide adequate margin of safety, and whether portfolio construction appropriately accounts for the concentration that exists in major benchmarks.
Market leadership and defensive characteristics both evolve over time. Sectors and strategies that provided stability in one market environment may not provide the same characteristics in another, particularly when valuations reach elevated levels relative to historical norms and relative to other market segments.
This reality underscores a fundamental principle of investing: price matters. Quality businesses purchased at elevated valuations face different risk dynamics than quality businesses purchased at more reasonable prices. The margin of safety that valuation discipline provides becomes especially important during periods of market stress.
The Case for Differentiation
Given these dynamics, investors may want to evaluate whether their portfolio construction reflects the current market environment. This evaluation might include:
- Assessing the actual concentration levels within their equity allocations, accounting for the overlap between different strategies and managers.
- Examining how their portfolios have performed during recent periods of market stress.
- Considering whether their managers maintain sufficient differentiation from increasingly concentrated benchmarks.
- Evaluating whether valuation discipline plays a meaningful role in their investment approach.
At The London Company, our investment philosophy emphasizes both business quality and valuation discipline. We believe that having the courage to maintain high active share—to look different from the herd—becomes particularly valuable when consensus positioning favors “quality at any price.”
Our approach seeks to identify quality businesses trading at reasonable valuations, providing what we believe is a more sustainable margin of safety. While we cannot predict short-term market movements, we believe this discipline positions portfolios to potentially weather various market environments, including periods when elevated valuations come under pressure.
In a market environment characterized by record concentration and compressed active share across the industry, differentiation itself becomes a form of risk management. By constructing portfolios that look meaningfully different from tech-heavy, growth-oriented benchmarks, we aim to provide diversification benefits that may prove valuable as market dynamics continue to evolve.
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