The AI Story Is Intact, But Sentiment Got Ahead of It
The recent sharp pullback in the technology sector, particularly among the key artificial intelligence names, should be understood as a healthy reset rather than a sign that the underlying thesis has broken. The AI story itself remains fully intact. There is no reason to discount how revolutionary this technology will ultimately become, nor how real the capital spending behind it is. Enormous sums are being deployed to build out the infrastructure needed to support this new mode of productivity and a fundamentally new way for the economy to run. None of that has changed.
What did change—and what triggered the pullback—is that market sentiment ran ahead of the actual story. For some time there has been a concern that the concentration of gains in the stock market was growing in an unhealthy way. That concentration is itself a source of risk. The market had reached a point where it was pricing in a level of perfection that is, frankly, unreasonable. That is precisely why the names that drove the bulk of the market's gains over the past year carried real downside risk, and why that dynamic can continue to play out into the second half of the year.
Distinguishing Growth Expectations From Valuation
It is important to separate two different things: the expectations for growth and spending, and the valuation the market places on those expectations. The data does not show that the growth and spending expectations for the largest technology companies—sometimes nicknamed the "lag seven" rather than the "mag seven" given their relative underperformance this year—are out of kilter. The expectations themselves are reasonable.
The risk lies instead in the valuation being assigned to those expectations. The market is currently pricing in a near-perfect path from where these companies are today to where they could be three to five years from now. In reality, there is far less certainty about how all of this ultimately shakes out. Some corporations that command very high prices today will not be valued as highly three years from now. The market will eventually sort out the winners and the losers. The core concern is that, right now, the market is counting on far more winners than will actually exist four or five years out. As a result, overall valuations are at risk as the transition moves into the phase where returns must genuinely materialize for investors.
The pivotal question the market will soon begin asking is: what are the returns on invested capital? As those questions start to get answered, several current valuations look vulnerable.
The Spending Conundrum
This points directly to the conundrum these companies face regarding their heavy capital spending and the move into the debt markets to fund it. On one hand, these companies have no real choice—they have to spend at these elevated levels, and fund that spending, because investors expect it given the sheer size of the opportunity. On the other hand, some of that capital spending simply will not earn the returns investors demand when judged in hindsight three years from now.
So the companies are caught: they must do the spending, they must try to make it work, and they must push returns as high as possible. But the efficiency and accountability that the market will eventually demand on that invested capital will threaten some of these valuations. The capital has to be deployed in a way that genuinely justifies the opportunity. The underlying reality is that there will be winners and losers, and the market is currently pricing in far too many winners to be justified when we look back three years from now. The spending is necessary, but the returns are unlikely to be there for everyone, leaving a set of winners and losers that today's prices do not account for.
Outlook for the Second Half: Diversification Is Key
It is essential to frame all of this carefully: this is not a bearish view on the US stock market overall. Rather, the moment clearly calls for diversification. Several axes of diversification make sense at once:
- From large-cap to small-cap.
- From growth to value.
- Adding some international exposure.
Simply riding the existing winners and betting more heavily on the stocks that have already risen the most is a recipe for a very rough ride in the second half of the year. Diversification is therefore a central key to success in the back half of 2026. In practice, that means owning spaces that are not directly tied to—or even adjacent to—the AI infrastructure push. There are names and industries outside that orbit offering returns and valuations that are genuinely attractive and worth allocating client assets toward.
Specific Names and Sectors
When it comes to concrete ideas, industrials are a natural area to consider, with Caterpillar as a prominent example given its strong performance this year. There is exposure to Caterpillar, but it is worth noting that the name has itself been adjacent to the AI build-out, so it counts as somewhat related to that theme rather than fully independent of it.
A more distinctly separate idea is Delta Airlines. The company is now positioned favorably because jet fuel costs have come back down, which has unlocked value upside in the name. Delta stands out as a best-of-breed operator pushing both international and domestic travel in a way that matches what the global consumer now wants. Compared with 10 or 20 years ago, consumers today place far greater value on travel experiences, and Delta's valuation is attractive on that basis. The company is also returning capital to shareholders in a way that is not typical of other parts of the market. It is a compelling example of digging into names that are not even adjacently related to the AI build-out, where attractive opportunities and promising industries can still be found for the second half.
The Near-Term Catalyst: The Labor Market
Looking at the week immediately ahead—a compressed, holiday-shortened week—the critical variable is the labor market, which serves as the bridge between inflation and growth. The upcoming jobs report is walking a very fine line: it will help determine whether the Fed becomes more involved or less involved, and whether recession fears begin to surface.
Because the report has to walk such a thin line, there is significant potential for volatility as it comes in. The data could either confirm or deny the most recent fears—both of recession on one side, and of higher rates going forward on the other. That second concern, the prospect of rate hikes or persistently higher rates, is something the market is also beginning to grapple with. The jobs report is therefore the key event to watch, with real capacity to move sentiment in either direction.
