(tl;dr version at the bottom)
So there's an enormous difference in damage capabilities between 3 Star and 4 Star weapons. Not, "Oh, I get another bar of damage, yay", but, "OH MY GOD MY DAMAGE JUST DOUBLED, SWEET." Of course, this just sets you up for disappointment when you go to get 5 Star weapons- many of them don't seem to be worth the effort. They get a minor boost in damage as compared to the difference between 3 and 4 star weapons. This is mainly seen in swords and guns; you actually have an incentive to upgrade 4 Star bombs into their 5 Star variants because this typically means a bigger range and higher damage- for instance, Ash of Agni has a much larger range than the Fiery Vaporizer Mk. III, despite the fact that its damage increase is negligible.
On the other hand, going back to swords- I decided to go down the Calibur family of swords as soon as I realized that "Hey, I can just buy every recipe here!", as opposed to hunting down the recipes for more obscure weapons. Now sure, Leviathan Blade is not the shiniest or most powerful sword in the game (despite its rather intimidating size), but I would still expect it to be significantly more powerful than the Ascended Calibur, or to at least have some kind of special property- maybe a different charge or a wider swing. Yet my level 8 Ascended deals the same damage as a newly crafted Leviathan Blade. At level 10, the difference will become blatantly obvious. Why on earth would I craft a WEAKER blade from the one that I worked my butt off to level so high? Well, one of my friends in-game informed me that as you level it, the Leviathan Blade can actually max out the Normal Damage bar, but I would still expect a newly crafted Leviathan to be at least as powerful as the Ascended Calibur is at max level.
It's not a problem with 5 Star weapons being weak, it's 4 Star weapons being too strong. I know there's already been some nerfing done on certain weapons (ie all of the quick swords like the Strikers), but I really think this needs to be addressed. Look at the leap between Tempered Calibur and Ascended Calibur, and then at the minuscule difference between Ascended and Leviathan:
http://wiki.spiralknights.com/Tempered_Calibur
http://wiki.spiralknights.com/Ascended_Calibur
http://wiki.spiralknights.com/Leviathan_Blade
Another great example of this: The difference between Sealed Sword and Faust and then the difference between Faust and Gran Faust.
http://wiki.spiralknights.com/Sealed_Sword
http://wiki.spiralknights.com/Faust
http://wiki.spiralknights.com/Gran_Faust
I don't think the Tier difference should make that big of a difference- ie, "Oh look, Knight Example has crafted a new sword and gone from Tier 2 to 3, MASSIVE DAMAGE BONUS IS GO."- but I can kind of understand as that being the reasoning behind 2* and 3* weapons having similar damage, and then 4* and 5* weapons having similar damage. Still though :v
tldr -> I think the 4 Star weapons should be nerfed at least a little. Yea or nay?
Armors suffer from the exact same affliction.
It should be noted that the 3--->4* transition marks the line where real money CE has to be used to craft that item. So the power boost might conceivably be intentional as a way to drive demand for crystal energy- I'm not sure.