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Expect AI to Stumble and Grow
AI is transforming tech and driving volatility. Valuations look high, but earnings growth matter. Missteps are inevitable, reinforcing the need to move beyond broad beta.
- Portfolio Construction
- Markets & Economy
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- Equity Insights
Key Points
Tech valuations look elevated, but strong earnings growth helps explain today’s pricing and differentiates this cycle from past bubbles.
AI is highly disruptive and still early, driving volatility as some business models falter while others adapt and strengthen.
As AI reshapes business models, returns will hinge on choosing the right stocks — not owning the whole market.
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. , 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 .
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.
The index, a gauge of the large-cap U.S. equity market, includes 500 companies that represent approximately 80% of the market capitalization of publicly traded U.S. equities.
The process of determining the value of an asset based on the analysis of variables related to investment returns or comparisons with similar assets.
Main Point
AI’s Early Stages: Volatility and Growth
AI is reshaping tech business models and driving market volatility. While valuations appear elevated, earnings of growth and fundamentals still matter. With disruption and missteps ahead, outcomes are likely to diverge — shifting attention away from broad exposure and toward individual stocks.
Joseph Tanious
Chief Investment Strategist, North America
Joseph Tanious is chief investment strategist, North America for Northern Trust Asset Management. He is responsible for developing and communicating the firm’s investment outlook across asset classes as well as producing investment analysis and thought leadership for the broader marketplace globally. To build out economic and market views, Joe regularly collaborates with the firm’s investment teams in equities, fixed income, multi-asset and alternatives.
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