Key takeaways:
- We believe the artificial intelligence (AI) story will remain central to midcaps in 2026, but success could depend on identifying which AI-exposed companies will be winners versus losers, rather than just considering general exposure.
- Economic acceleration could help broaden market performance beyond the AI theme. We see compelling opportunities in electrical utilities and cyclical areas like industrials and transports, where supply constraints and new growth drivers offer potential.
- Index-level industry concentration and elevated valuations pose a risk if key themes stumble and companies fail to grow into their multiples. As such, we view diversification and business-model quality as essential.
IMPORTANT INFORMATION
Actively managed portfolios may fail to produce the intended results. No investment strategy can ensure a profit or eliminate the risk of loss.
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.
Diversification neither assures a profit nor eliminates the risk of experiencing investment losses.
Energy industries can be significantly affected by fluctuations in energy prices and supply and demand of fuels, conservation, the success of exploration projects, and tax and other government regulations.
Equity securities are subject to risks including market risk. Returns will fluctuate in response to issuer, political and economic developments.
Smaller capitalization securities may be less stable and more susceptible to adverse developments, and may be more volatile and less liquid than larger capitalization securities.
Definitions
Cyclical stocks: Companies that sell discretionary consumer items (such as cars), or industries highly sensitive to changes in the economy (e.g., mining).
Price-to-Earnings (P/E) Ratio measures share price compared to earnings per share for a stock or stocks in a portfolio.
S&P 500® Index reflects U.S. large-cap equity performance and represents broad U.S. equity market performance.
Volatility is the rate and extent at which the price of a portfolio, security or index, moves up and down. If the price swings up and down with large movements, it has high volatility. If the price moves more slowly and to a lesser extent, it has lower volatility. The higher the volatility the higher the risk of the investment.
View transcript
Brian Demain: When we think about what’s going to impact mid-cap stocks in 2026, I’d talk about a couple of different issues. You know, the first is that the AI narrative is so central to everything that’s happening in the U.S. equity markets today, and midcaps are no exception. And I think the important point is that it’s not a simple narrative. What I think will be important in 2026 is not just AI or not AI, but which companies in AI that are exposed to AI are winners?; Which are losers? What does this mean for hardware? What does this mean for software? There’s going to be a lot of nuance, but it’s going to remain a really central theme.
I think the second big question is the broader macro economy and what that means for the broad swath of companies that are not necessarily directly exposed to the AI theme, and with those companies, you know, an economic acceleration could be a powerful tailwind in the mid-cap space because it would really lead to a broadening out of what’s been a very concentrated equity market over the last 12 to 24 months.
We think we can find opportunities in a number of different sectors and industries into 2026. Again, the AI theme has been really important, and it’s something we spend a lot of time thinking about, but it’s certainly not the only area where we’re looking. We also see opportunity in certain cyclical areas of industrials; for example, transports, where we think we could see a recovery in the next year, with that recovery being amplified by certain supply constraints in that market. We’re excited about what’s happening in the electrical utility space, and there’s a number of different ways to express the growth that has emerged in that sector. So, what’s really powerful is that there are a number of different growth drivers that we think can lead to performance from different areas of the equity market in 2026.
There are really a couple of underappreciated risks in the mid-cap space. One is some of the extreme valuations we see for certain companies in the index. We really have an exceptional percentage of midcaps trading at above 10 times sales, which we would kind of consider a cutoff between a more prosaic valuation and a pretty extreme valuation. Some companies, you can justify those types of multiples, but that generally tends to be the exception more than the rule. So, with so much of the benchmark trading at a valuation that we think only certain companies will grow into that, that presents a risk.
I think the other potential big risk is, were the AI story to slow down, there’s a decent amount of exposure in the mid-cap space, and it’s not as well maybe understood as the Mag 7 in the large-cap space, where it’s very clear. So, you know, were the AI growth dynamic to slow, you know, that would definitely impact large caps, but it would impact a fair number of midcaps as well.
I think the most important takeaway for an investor considering midcaps, or considering the broader equity market for that matter, in 2026 is the importance of staying focused on diversification and business-model quality. When we think about diversification, the equity indices are more concentrated than they’ve been historically. That’s true both in terms of number of holdings and industry concentration around those holdings. And, you know, that concentration can be a good thing if the key themes driving those holdings do well, but it can be a risk if there’s any trip-up in those themes or drivers. So, you know, when considering active management, the value of that diversification as kind of the last free lunch I think is an important thing for investors to think about.
On top of that, you know, it’s important for an investor to think about the quality of a business model. We’ve had a very strong equity market here in 2025 and really for the last few years. And that often, a rising tide can lift all boats. We may have a rising tide in 2026; we may not. And if not, owning businesses with higher quality could lead to better relative performance.
