2026 Outlook Focus on quality in the age of AI

Advisor takeaways for client conversations:

  • AI remains a powerful theme, but the landscape is evolving.
    Artificial intelligence (AI) is still a long-term opportunity, but the first wave was about a few very large mega-cap companies spending heavily. Going forward, the winners may look different, and we believe the initial wave of infrastructure spending will slow. Growth becomes more about how AI is used, not just who builds it.
  • The AI opportunity is expanding beyond a few mega-cap stocks.
    As AI moves into everyday business use, companies across healthcare, industrials, and services may benefit by becoming more efficient and profitable. That's why we're looking beyond just the biggest tech names.
  • Through market cycles, quality endures.
    Periods of innovation can create excitement and volatility, but over time, quality stocks that include companies with strong balance sheets, consistent earnings, and durable business models tend to hold up better with potential for long-term value creation.

It’s no surprise that AI will likely remain the center of investment debate this year – and maybe years to come – bringing both volatility and opportunity. Basic AI functionality has gone mainstream, but the application by companies and the awaited productivity gains remain in their infancy. So far, the AI rally has been driven by spending, not by the commercial success of AI products.

Consider the unprecedented spending: capital expenditures (capex) as a percentage of sales at the four large hyperscalers (Amazon, Microsoft, Meta Platforms, and Alphabet) was an average of 15% in 2019. That has nearly doubled to 27%. The pace of this spending growth is likely to slow down, and so should revenue growth at semiconductor and hardware companies. What’s more, margins are likely to fall when supply catches up to demand. AI is here to stay, but the winners of the next leg of the AI cycle may be different.

The market is broadening

Since 2023, only a handful of stocks have outperformed the large-cap Russell 1000® Growth Index, with the largest eight companies contributing roughly 70% of the index return during the three-year period.

The lopsided return was not entirely supported by fundamentals, but at a macroeconomic level it seemed moderately rational. AI and AI-adjacent industries have been rare areas of strength in the economy. Meanwhile, industrial and consumer goods industries have been in a recession. This can be seen in the Institute for Supply Management (ISM®) Manufacturing Purchasing Managers’ Index (PMI®) and the goods portion of the US Consumer Price Index (CPI) being flat to negative through much of the past three years. This is beginning to shift, however, and there are signs that the industrial economy is returning to growth. This should favor other sectors and support a broadening of stock market returns as investors capitalize on a reacceleration of profits and cash flows in industries that have been stagnant. When AI is no longer the sole economic growth engine, it will also no longer be the sole market driver.

Through cycles, quality endures

With the exception of high-quality AI beneficiaries like NVIDIA and Broadcom, the multiyear stock rally has not favored high-quality businesses. Instead, it has favored high-risk stocks and technicals like momentum. But keep in mind, the market has experienced periods like this before: the internet boom in the late 1990s, for example, and the pandemic in 2020.

During most new technological revolutions, excitement, above all, drives the market. Over the long term, however, fundamentals have shown to prevail. Amid the noise, prudent investors should consider seeking a balanced portfolio leaning into quality companies to help mitigate potential volatility while continuing to participate in new opportunities that may flow from AI.

Quality growth has offered material compounding benefits
Growth of $10,000, quality growth vs. hyper growth (1995–2024)

Growth of $10,000, quality growth vs. hyper growth (1995–2024) chart

Sources: UBS HOLT, Nomura Asset Management. Companies are equally weighted, rebalanced monthly for the top 1,000 US companies by total market cap. The quality growth group is designed to identify firms with competitive advantages, above-average growth characteristics, and valuations that confirm the market’s favorable outlook. The hyper growth group is designed to identify early lifecycle growth companies, committed to high rates of reinvestment but showing limited profitability due to the pursuit of growth. Chart is for illustrative purposes only. Past performance does not guarantee future results.

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