Expect AI to Stumble and Grow

In talking with our clients over the past few weeks, one question that continues to come up over and over again is, after three consecutive years of double digit returns in the equity markets, specifically within the U.S. S&P 500 Index, can we actually expect another good year in the S&P 500? When you look at the technology sector, for example, one of the main drivers of earnings growth and returns over the last couple of years, there's been a healthy discussion around valuation.

In fact, when you take a look at the tech sector's valuation relative to history, it does appear to be stretched. What I encourage our clients to do, however, is think about the underlying companies, the fundamentals, the earnings and the growth that those companies are actually delivering today. Another way to look at this is by evaluating the market from the perspective of a PEG ratio: price to earnings divided by growth.

In doing so, you'll see that the PEG ratio of the technology sector, for example, is slightly elevated at about 2.2 times today. But when you compare it to what it was back in the tech bubble of the late 90s, 2.5, suddenly it makes a little bit more sense.

The underlying fundamentals are there; earnings are expected to grow, but as earnings continue to grow and as the market evolves, we also have to recognize just how disruptive AI is today.

Is AI a Risk or Opportunity for Software Companies?

What we saw over the last couple of weeks with major disruption within software stocks is a perfect example of that. Software stocks exhibited carnage. And the fear was that artificial intelligence itself was going to displace the need for many of these software companies to exist. We think that fear is largely overblown. To be very clear, depending on how narrow in scope these businesses are, some of them are going to be replaced. However, when you think about enterprise-wide usage of software systems, it's more likely than not you're going to see these companies' integrating technology and AI within their tech such that they can offer their clients a better service, perhaps even for a premium.

One thing has been made clear: AI is a disruptor.

When you look at the hyperscalers, for example, over 2026, they are expected to spend upwards of $600 billion in capital expenditures on these data centers. Along with these investments being made, there are so many questions around whether there is actually going to be a return on investment from these hyperscalers for all of this money going in.

Careful Security Selection Is Key to Navigating Uncertainty

There are many more questions than there are answers. But one thing we know is certain: AI today is still in its early innings. It is reshaping how we operate. It is reshaping how we work. Yet at the same time, we know there are going to be a number of missteps across both public and private markets. From our vantage point, when we think about investing in technology and these hyperscalers, software companies, etc., we have to start leaning more on security selection and thinking about the companies that we want to have exposure to rather than just buying broad market beta.