U.S. small caps and international stocks are leading the performance race so far in 2026. In the U.S. market, large cap value is outperforming large cap growth. Growth stocks are struggling – down 3% this year and down 8.6% since the Nasdaq peak on October 29th of last year.
The top sectors this year are energy, materials, consumer staples and real estate – all laggards in 2025. And last year’s leaders – tech, communication services, consumer discretionary and financials are all in negative territory this year. Is this a sign of the market broadening? Or sector rotation? It seems to be more sector rotation as last year’s leaders are down this year.
The AI boom has recently turned into AI doom. There has been a steady rotation of companies being hit with fears of AI replacing or curtailing demand for their products or services. First it was software firms, then financials including wealth management, law, trucking, and real estate. What’s next? This assumption of one sector after another being disenfranchised by AI seems to be an exaggeration by investors. Investors are reacting to headlines which is a foolish strategy, in our view. As we see it, more sectors will be helped than hurt by AI.
In macro-economic news last week, job growth in January was solid but the 2025 total was revised down to only 181,000 new jobs being created. The CPI in January was a pleasant surprise with inflation cooling down to the mid-2s. Rent inflation, which has been a problem, is now under 3% year-over-year.
Many good stocks, especially in tech and AI, are now in bear market territory (down at least 20% from their highs) since last fall. Many of these stocks have excellent fundamentals so we don’t expect these lower prices to stick. It is not “silly season” yet for tech and AI, but we are close. These are some of the best companies in the U.S. with excellent growth prospects. The AI theme of this bull market is not dead. Many tech and AI companies are completely oversold and prices should rebound.
Earnings season so far has been strong as expected. Earnings and sales beat rates have been solid along with guidance raises at 11% of reports. Where earnings season looks weak is in stock responses to the reports. EPS misses are being punished with a stock price drop of about 5% on average (source: Bespoke Investment Group). Even triple plays (beat on earnings and sales, and raised guidance) are sometimes met with a downward move in the share price. Historically this doesn’t happen often.
OPTIMISTIC INVESTORS V. PESSIMISTS
Do you ever think about which type of investor you are? We do because it shades our outlook about the economy and individual stocks. Maybe it is correlated to how all of us view life – are you a glass half-full or half-empty person? This can certainly bleed into your investing style.
Equity investors can be either optimists or pessimists but bond investors tend to be pessimists. Why? Bond investors are focused on receiving their interest payments and return of principal at maturity. They are focused on what could go wrong. Bond investors see risk as the driving force in their analysis. Don’t get us wrong, there is nothing wrong with analyzing risk with any kind of investment, but there is another way.
Optimists are more focused on what can go right both with regard to macro-variables (the economy, aggregate earnings, inflation, interest rates, etc.) and also individual stocks (earnings, cashflow, margins, dividends, …).
We are optimists. Why? More things typically go right than wrong. The U.S. economy and earnings grow over time. We recognize cyclicality for what it is – part of capitalism. We live in an economic system of growth based on demographics, technology, entrepreneurial spirit and productivity.
Of course we pay close attention to risk, too. Every prudent investor should do so but we wait for good things to happen. It is easier to do that as a long-term investor. Sometimes it takes a while for the positives to unfold. Patience helps.