There’s more to growth than AI

Speculation continues to be the defining attribute of today’s financial markets. As evidence, investors continue to equate the financial markets and the prediction markets despite those markets’ vastly different economic purposes.

The financial markets exist for capital formation and real business investment in plants, equipment, and employment. These markets are the economic link between the classic equivalence of savings and investment.

The prediction markets, however, exist purely to make a bet on any outcome, with virtually no economic value added.

Excess liquidity is the lifeblood of speculation, and the primary custodian of excess liquidity is the Federal Reserve. The Fed potentially needing to raise interest rates to fight inflation could eventually cause the end of the current speculative fervor. As the old saying goes, “the Fed takes the punchbowl away from the party”.

Our view at the beginning of 2026 was that investor expectations were too optimistic regarding how much and how frequently the Fed would cut rates. In other words, liquidity would not be flowing as abundantly as speculators anticipated.

Exhibit 1 demonstrates that investors have reconsidered their year-end 2025 Fed forecasts and have indeed started to price in liquidity drying up.

Without excess liquidity, fundamentals again matter…

Our research over the past 30-plus years has shown that market rotations (i.e., shifts between growth/value, large/small, high quality/low quality) are based on profits cycles and valuation fundamentals. When markets ignore fundamentals, it is typically because excess liquidity drives speculation and momentum and relative strength dominate performance rather than profits and valuation.

Many have commented about the U.S. economy’s “resilience”, and nominal growth has surprised during 2026. However, fewer have noted that the nominal economy’s strength has led to stronger and broader profits growth. More companies are growing both in and outside the U.S.

Exhibit 2 shows our profits cycle forecasts for major regions. U.S. profits growth is not bad, but the cycle does appear to be slowly peaking. However, non-U.S. cycles seem to be accelerating, implying that U.S. and non-U.S. profits growth is starting to converge.

The bull case for non-U.S. stocks was for several years almost purely based on those regions’ undervaluation. The lack of a growth story constrained their outperformance. Today, non-U.S. markets offer growth that is increasingly competitive with the U.S., and their performance so far during 2026 reflects that improved profitability.

One might suggest that the U.S. is the only market offering long-term profits growth, but that isn’t true at all. Exhibit 3 shows the projected long-term growth rates for every stock in the ACWI Index with projected growth greater than 25%.

Probably surprising to most investors, the group includes only one of the so-called Magnificent 7 stocks, and the multi-colored bars demonstrate that long-term growth is available around the world.

…and performance is again beginning to reflect broadly improving profits

Investors scoffed at our suggestion that the stock market could rotate away from the momentum-driven AI and technology theme without a bear market. However, that has indeed been 2026’s story so far.

Exhibit 4 shows the percentage of stocks by year within the S&P 500 that outperformed the index. The years 2023 to 2025 marked the narrowest period for the stock market in the past 35 years, and the recent narrowness persisted for longer than the Technology Bubble in 1998/99.

So far, the market has broadened during 2026, reflecting the reduction in speculative liquidity and improving fundamentals. Although the market has broadened, 2026’s market is still less broad than the long-term median breadth. Because most investors still seem fixated on the momentum stocks of the past several years despite the changing liquidity and profits backdrops, it is possible that we are still in the early stages of a longer-term broad market advance.

Exhibit 5 demonstrates that market performance during the first half of 2026 has been globally broad. The chart compares the total return performance of five broad U.S. and global indices, all of which have meaningfully outperformed the Magnificent 7 stocks.

Boring is beautiful: Follow fundamentals, not the hype

If we are correct and inflation forces the Fed to continue to reduce economic liquidity and profits continue to improve and broaden, then stocks with shorter durations and those with improving and underappreciated fundamentals might continue to outperform.

Our 2026 theme, Boring is Beautiful, focusing primarily on dividends and non-U.S. stocks, still seems prudent.

IMPORTANT INFORMATION

Artificial intelligence (“AI”) focused companies, including those that develop or utilize AI technologies, may face rapid product obsolescence, intense competition, and increased regulatory scrutiny. These companies often rely heavily on intellectual property, invest significantly in research and development, and depend on maintaining and growing consumer demand. Their securities may be more volatile than those of companies offering more established technologies and may be affected by risks tied to the use of AI in business operations, including legal liability or reputational harm.

Equity securities are subject to risks including market risk. Returns will fluctuate in response to issuer, political and economic developments.

Technology industries can be significantly affected by obsolescence of existing technology, short product cycles, falling prices and profits, competition from new market entrants, and general economic conditions. A concentrated investment in a single industry could be more volatile than the performance of less concentrated investments and the market as a whole.