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The New AI Trades
- Software sector valuation collapse: Software stocks have declined approximately 25% in early 2026, with some falling over 30% from October highs.
- Forward earnings multiples have compressed from 35x to 20x in a matter of weeks.
- The valuation premium over the broader market narrowed from >100% to 20%, approaching levels seen during the global financial crisis.
- Market pricing suggests a fundamental re-rating of expected growth rates from 15–20% to 5–10%.
- AI-driven disruption risk: Selling pressure extends beyond software to publishing, advertising, media, legal services, IT consulting, and insurance.
- Specific catalysts include the release of Google's Genie 3 gaming tool, Claude's co-work plugins affecting legal services, and insurance quote-comparison products.
- Investors are questioning the long-term sustainability of business models susceptible to large language model automation.
- Historical market parallels: Research identifies analogs in 2000s newspaper disruptions (internet rise) and 1990s tobacco industry (legislation).
- In both historical cases, stock prices bottomed only after earnings estimates stabilized following multi-year declines.
- Current market recovery is expected to be contingent on earnings stabilization rather than just price bottoms.
- AI capital expenditure (CapEx) surge: Five major U.S. hyperscalers spent $400 billion on CapEx in 2025.
- 2026 CapEx forecasts have risen sharply from an initial $540 billion expectation to $660 billion following recent earnings.
- The implied growth rate for 2026 CapEx has jumped to 60% from 35% at the start of the year.
- Analysts suggest CapEx figures could rise further due to strong balance sheets and persistent supply constraints.
- AI monetization and funding concerns: Market reaction to CapEx increases varies significantly based on perceived monetization pathways.
- Stock performance diverged post-announcement based on confidence in cloud and advertising revenue generation.
- 2026 CapEx estimates are projected to consume approximately 90% of these companies' operating cash flows.
- Heavy capital deployment is forcing a reduction in share buybacks and increased reliance on debt issuance.
- Market rotation and broadening: The S&P 500 is experiencing a rotation from AI-centric leaders toward cyclical sectors.
- Non-U.S. equities, small-caps, and defensive sectors are underperforming relative to cyclicals, consumer discretionary, and industrials.
- Macroeconomic drivers include fading tariff headwinds and tailwinds from financial conditions and fiscal policy, forecasting accelerating growth in early 2026.
- Goldman Sachs S&P 500 outlook: The firm forecasts continued index upside, though at a slower pace than previous years.
- High valuation multiples are expected to remain flat, with earnings growth serving as the primary driver of returns.
- Fourth-quarter earnings are projected to grow 12% for the index, with the median company growing at 9%.
- The strategy relies on earnings strength, particularly outside the largest AI-centric names, to support market gains despite high concentration risks.
- Market dynamism: The index is expected to exhibit increased dispersion, with companies entering and exiting the top tier based on fundamental execution.
- The bar for significant gains is higher due to elevated starting valuations, requiring sustained earnings delivery.