Taking Stock

The dominant feature of the investment landscape in 2026 remains the remarkable boom in AI investment spending, which has comprehensively trumped both geopolitics and central bank policy as a driver of equity returns. Our analysts see data center investment spending of USD 1.6 trillion this year, more than three times the level of just two years ago. Optimists see as much as 8 trillion 5 years from now. With no letup in enthusiasm for AI investment in sight, we can see the total spend topping USD 3 trillion in 2028. So far, every revision to this forecast has been upwards (Exhibit 1).

As optimism rises, so do the risks. These include: an increasing reliance on debt markets rather than cash flow as funding for all this spending; the significant challenge of physical constraints such as power supply; growing popular opposition to data centers; and (for us the biggest risk) uncertainty over the trajectory of prices for tokens. We will be carefully monitoring all these issues.

But for now, the boom continues, driving huge forecast revisions not just in technology but for many industrial companies too. The AI boom and the associated market gains have also spurred a powerful capital markets cycle. Overall, we see U.S. profits jumping 27% this year and another 22% in 2027. To put that into context, back in January we expected just 14% growth this year. Globally, the picture is even stronger in the emerging markets where earnings will rise a running 65% in 2026 and another 22% next year.

It is hard to recall such a sudden acceleration in overall profitability outside a recovery from recession, and today’s profit story is very different. While we have seen a broadening of growth from the so-called Magnificent Seven, almost 75% of the profits expansion in the U.S. that we expect this year will come from AI spending plus the jump in oil prices. Everything else is growing at about 8% this year. That is solid enough, but hardly exceptional. Markets have quickly recognized much of this now.

The key question is, how long can it last? For the memory semiconductor stocks, for example, we see an inevitable mean reversion and sharp contraction of profits at some point. Thus many of these stocks look quite expensive from a longer-term perspective, even when trading on single digit multiples of near-term earnings. Meanwhile fear over the disruptive and destructive impact of all this new AI capacity on the profitability of existing businesses, especially in software but also across many other industries, has led to some very attractive long-term returns on offer in the so-called “AI losers” cohort (Exhibit 2).

Identifying the genuine opportunities here, and balancing portfolio exposure between short-term winners and potential long-term value are the key dynamics in portfolio construction across many markets.

Regionally, the differences in the opportunity set are less noticeable. It's really all about AI, wherever you look. In our research work, the U.S. market now offers very similar returns to other markets, as our expectation of faster long-term U.S. earnings growth justifies persistently higher valuations in U.S. markets, as we have seen for the last 15 years.

Emerging markets still offer plenty of growth, too, but their valuations no longer look as tempting as they did at the beginning of last year. European companies continue to grow more slowly, but they provide reasonable valuations, higher dividends and a useful diversification from the ever-present AI theme. We advise diversifying by region and by style to balance risks across equity markets that have become remarkably concentrated and in that way risky should the appetite for the AI boom fade.

A momentum market: What’s next?

As market participants have flocked to invest in the AI winners, markets have increasingly been driven by a narrow group of companies. From a factor viewpoint. we have been experiencing one of the strongest momentum markets we have ever seen. Our systematic research puts that into context and gives us important clues about what to expect next. The chart below presents some historical perspective. The size of the momentum boom is among the top four we have seen in the last 40 years, and the speed of the boom is second, only surpassed by the internet boom in 1999 (Exhibit 3).

When we check the health of the high momentum names, we do see some warning signs. Our systematic research team notes that the correlation between momentum and the other factors that we watch (valuation, quality) is now falling. Increasingly, it’s all about chasing higher stock prices. And the sharply rising volatility of the most fashionable stocks (look at the recent wild daily swings in the Korean market, dominated by memory stocks) is another sign that risks are rising.

The warnings are visible in the technology sector, of course, and industrials too, and by region in Japan and emerging markets. All this adds to the argument that investors should diversify by style (value) and geography to protect against the rapid loss of capital that typically follows the end of a momentum boom.

Lessons learned from past periods of market exuberance

Are we in a bubble? At our quarterly meeting in July, we asked our investors, many of whom have three or four decades of market experience, to share their perspectives on how to survive through periods of exuberance. We discussed parallels between today’s markets and past booms…and busts. Most don’t think we are in bubble, yet. The boom is earnings, not valuations. Many of the market leaders are still reasonable priced. But, the strength of AI boom gives us pause for thought. Here are some of the themes;

• Valuation matters. Eventually. Booms tend to create unsustainable valuations and the resulting drawdown can last a decade or more.
• But market timing is nearly impossible. Peak enthusiasm is only obvious in hindsight. In the internet boom of the late 1990’s, for example, the NASDAQ index was widely seen as dangerously overpriced by the summer of 1999, only to double again in the next nine months.
• Strong risk management wins cycles. Successful investing is as much as anything about mastering emotions. Staying focused, objective and looking forward dispassionately for the best opportunities and biggest risks is both essential and very challenging. Many investors become overconfident and too aggressive after strong performance, and then too pessimistic and cautious after the markets have humbled them. A disciplined process helps mitigate these potentially destructive influences. And there is no substitute for experience. Living through a cycle provides great lessons for the future and the confidence to take advantage of the opportunities that market exuberance inevitably creates.

Exhibit 4 shows the views of our team members. Many like industrials, quality stocks and select “AI losers,” while avoiding consumer staples and speculative growth names.

46e52be0-1623-11e7-a6c0-005056960c63