Key Insights
- A more challenging period seems likely for equity markets. Geopolitics, sticky inflation, and potentially peaking earnings growth are likely to generate some volatility.
- A small cohort of companies have dominated market performance this year, but the period ahead may be more complex and near‑term earnings will likely drive sentiment.
- A more balanced portfolio with exposure to the best secular themes, coupled with areas that offer more defensive characteristics, will be important.
Equity markets have performed well this year, but returns have been concentrated in a narrow subset of the market, namely artificial intelligence (AI) and artificial incretins (GLP‑1s). However, we are entering a key earnings season in which many of the significant outperformers year‑to‑date may begin to see a slowing rate of returns improvement. In our experience, fundamental momentum tends to matter more in the short term for relative performance and valuation, and therefore the margin for error is smaller.
Two seismic developments: balancing exposure to artificial intelligence and artificial incretins (AI2)
Corporate earnings for many large technology and health care companies have been strong over the past 18 months. However, in terms of the AI infrastructure buildout, we believe we are clearly past the early phase of adoption and most meaningful inflection in spending. It is wise at this point to question whether the current pace of capital expenditure growth can be sustained at these levels. The risk of an unexpected surprise in terms of earnings guidance could prompt a rotation out of AI names. That needs to be managed in a strategic manner, especially from a factor risk perspective.
GLP‑1 impacts beyond diabetes and obesity
While GLP‑1 receptors are concentrated in the pancreas, they are spread throughout the body—and evidence is growing that GLP‑1 drugs can interact directly with GLP‑1 receptors found in other organs.
We have for some time treated our exposure to the so‑called Magnificent Seven (Apple, Microsoft, Alphabet, Amazon, NVIDIA, Meta Platforms, and Tesla) as a separately defined sector. That allows more potential to govern the impact on portfolio returns versus the benchmark, particularly given the unusually high concentration of these stocks in market indices. The bar is now set extremely high for these companies in terms of earnings delivery—a risk that warrants due consideration.
While the initial infrastructure cycle for AI may be peaking, we are, however, only just beginning to see the potential benefits of AI in other areas. In the next few years, we expect to see an acceleration in terms of speed, productivity, and innovation as companies employ their AI capabilities. The potential is not limited to technology—it traverses nearly every sector and industry, some that may not be immediately obvious. Energy, industrials, and even real estate are all potential beneficiaries of the AI cycle.
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