Balancing Elevated Risks with Opportunities –
As markets continue to push higher, it’s important to step back and assess both what is working well and where risks may be building. While recent performance—particularly within the Technology sector and AI themed investments—has been impressive, history reminds us that sustained market leadership often brings imbalances that eventually correct through rotation and reversion rather than collapse.
On the concern side, the Technology sector has experienced an extraordinary run and is trading at elevated valuations. In fact, when combined, Technology and Communication Services sectors represent market weights comparable to the 1999–2000 period. While Artificial Intelligence remains a powerful long-term theme, the current level of AI-related capital expenditures has yet to produce enough income to fully justify the scale of the investments being made. This environment is somewhat reminiscent of the fiber-optic buildout of the 1990s, when companies were compelled to build infrastructure to remain competitive and relevant, ultimately leading to overcapacity and years of underutilized assets.
We are watching notable rotations beneath the surface that are largely hidden from plain sight. Capital has been flowing out of the traditionally defensive sector of Consumer Staples and into momentum-driven areas like Technology. The valuation gap between these groups has reached historical extremes, which often precedes a period of reversion. Some additional economically important sectors, including Energy, Health Care, and Materials—are also experiencing traditionally extreme underperformance relative to the S&P 500 and Technology, further reinforcing the idea that leadership has become unusually narrow. Similarly, the performance disparity between small- and mid-cap stocks versus large-cap stocks is also near record levels. At the same time, average household exposure to equities is elevated by historical standards, a condition that can amplify volatility during periods of market stress.
That said, there are also several constructive factors supporting the broader market outlook. Unlike prior periods of speculative excess, the companies driving the majority of AI-related capital spending today are generally highly profitable, well-capitalized, and operating with strong balance sheets. Energy prices have remained remarkably stable and are trending lower, which is supportive of consumer spending and helps ease inflationary pressures. From a technical perspective, the S&P 500 continues to trade above key upward-sloping trend lines, indicating that the broader market trend remains intact.
In addition, credit markets are not signaling meaningful concern. High-yield bond spreads remain well-behaved, suggesting that financial stress is not building beneath the surface. Liquidity conditions are also improving, as money supply growth has resumed, adding support to economic activity. A business-friendly and deregulatory policy environment continues to provide a tailwind for corporate investment and long-term growth. Finally, the Federal Reserve continues to lower rates at a moderate pace which signals confidence.
So, what does this mean for investors? We believe this is an environment where discipline and balance matter more than recent history. Maintaining exposure to defensive, dividend-paying stocks help reduce portfolio volatility, particularly if market leadership broadens or favorability rotates. Importantly, there are plenty of attractive opportunities outside of the Technology sector that have been overlooked amid the narrow focus on growth and momentum.
If the revenue created from these massive AI capital expenditures stay modest as they have so far shown, we would not be surprised to see Technology underperform for some period of time as companies digest the massive AI investments currently underway and fall short of revenue expectations. At the same time, small- and mid-cap stocks—after years of flat or muted performance—may finally begin to participate more meaningfully as valuations normalize and capital rotates.
Overall, we do not view the current environment as a large speculative bubble. Rather, we see this next year as the possible period of rotation away from concentrated growth and technology exposure toward more stable, undervalued sectors, creating opportunities for patient, long-term investors. As always, our focus remains on building resilient portfolios designed to navigate changing market leadership while staying aligned with long-term objectives.
| Thomas A. Toth, Senior Chairman | Kenneth Bowen, II President & CEO |