Editor’s Note: The DeepSeek debacle that gave Nvidia (NSDQ: NVDA) and the NASDAQ a collective heart attack last week? Yeah, that was just the coming attraction.

Wall Street has strapped itself to overvalued mega-cap tech stocks, speeding toward a precipice like the ending to Thelma & Louise.

Throw in the chaos of Donald Trump’s policies, lingering inflation, and a newly skittish Federal Reserve, and you’ve got the roadmap for a correction…or worse.

However, there are ways to keep your portfolio from crashing without giving up on growth. I go into detail, below.

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A looming precipice?

Several metrics suggest that the stock market is currently overvalued. Here’s a look at the most salient warning signs.

• Buffett Indicator. Named after billionaire super-investor Warren Buffett, this ratio compares total market capitalization to a country’s gross domestic product (GDP). A reading above 100% indicates overvaluation. The Buffett Indicator for the U.S. currently hovers at approximately 207%, signaling significant overvaluation.
• CAPE Ratio. The cyclically adjusted P/E ratio (CAPE), which accounts for inflation-adjusted earnings over a 10-year period, is currently well above its historical average, further indicating overvaluation.
• Market Concentration. The market’s performance has become increasingly reliant on a handful of technology giants. This lack of diversification can lead to heightened volatility, as evidenced by the recent market reaction to DeepSeek’s artificial intelligence (AI) advancements.

The introduction of DeepSeek’s AI model by a Chinese startup has had a profound impact on the market. DeepSeek apparently produces superb results while using cheaper chips than those made my giants such as Nvidia, a fact that spooked Silicon Valley and Wall Street.

Nvidia shares plunged 17% on January 27, resulting in a market cap loss of $589 billion, the biggest single-day drop ever for a U.S. company (see chart).

This event has prompted a reevaluation of valuations within the AI and technology sectors, highlighting the market’s sensitivity to developments affecting major tech companies.

Mixed economic news…

The latest economic data presents a good news/bad news scenario.

U.S. economic growth decelerated but remained steady in late 2024, positioning the economy on firm ground as it enters a new year—and a new presidential administration.

According to the U.S. Bureau of Economic Analysis (BEA), in a report released January 30, inflation-adjusted U.S. gross domestic product (GDP) expanded at an annualized rate of 2.3% in the fourth quarter, a slowdown from the 3.1% pace in the prior quarter. Nevertheless, the economy continued to outperform expectations, ending the year on a solid note.

Overall, GDP grew by 2.5% from the end of 2023 to the end of 2024, surpassing the predictions of many economists at the year’s outset. Strong consumer spending, driven by a robust labor market and rising wages, helped sustain momentum despite elevated interest rates and persistent inflation.

The latest news on inflation, however, was less encouraging. The Federal Reserve’s preferred price gauge rose in December, in a sign that the inflation beast hasn’t been vanquished. The Personal Consumption and Expenditures (PCE) index increased an annual 2.6%, up from 2.4% in November, the BEA reported January 31. Excluding volatile items, the “core” index was unchanged, rising an annual 2.8%.

These PCE numbers roughly met expectations but they’re nonetheless adverse enough to generate anxiety on Wall Street. Future inflation readings are expected to be worse.

Policy-driven turmoil…

Trump’s policies are contributing to economic uncertainty. Triggers abound for a market sell-off.

The administration’s imposition of tariffs on imports from Canada, Mexico, and China is expected to increase consumer costs and stoke inflation.

Efforts to tighten immigration and conduct mass deportations already are causing labor shortages, which are likely to drive up wages and contribute to inflationary pressures.

What’s more, proposed tax cuts could exacerbate the federal deficit, leading to higher interest rates and further inflation. Inflation this year is projected to remain above the Fed’s 2% target.

The Fed has taken notice, signaling greater worry over inflation. The central bank on January 29 announced interest rates will remain steady at between 4.25% and 4.50%, marking the central bank’s first rate decision of Trump’s second term.

The Fed noted it had no immediate plans to lower rates further, amid increased economic uncertainty arising from Trump’s “America First” agenda.

“In considering the extent and timing of additional adjustments to the target range for the federal funds rate, the (Fed) will carefully assess incoming data, the evolving outlook, and the balance of risks,” the central bank said in a statement.

Fed Chair Jerome Powell warned: “In the current condition, there’s probably some elevated uncertainty because of significant policy shifts.”

Strategies for defensive growth…

Given these risks, individual investors should consider strategies to protect their portfolios while still pursuing growth:

Diversification. Reduce exposure to overvalued sectors, particularly mega-cap technology stocks, and diversify into sectors with more reasonable valuations, such as healthcare, consumer staples, and utilities.

Quality Investments. Focus on companies with strong balance sheets, consistent earnings, and a history of dividend growth. These companies are generally better positioned to withstand economic downturns.

International Exposure. Investing in international markets can provide exposure to economies with different growth drivers and potentially more attractive valuations.

Alternative Assets. Consider allocating a portion of your portfolio to alternative assets such as real estate, commodities, or infrastructure investments, which can offer diversification benefits and potential inflation protection.

Fixed Income Securities. Incorporate high-quality bonds to provide income and reduce portfolio volatility. Inflation-protected securities can also help guard against rising inflation.

Regular Portfolio Rebalancing. Regularly review and adjust your portfolio to maintain the desired asset allocation, taking profits from overperforming assets and reinvesting in underperforming ones.

By implementing these strategies, investors can position their portfolios to achieve defensive growth, balancing the pursuit of returns with prudent risk management in an uncertain economic environment.

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John Persinos is the editorial director of Investing Daily.

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