AI & Earnings Fuel Bull Case, but Beware Valuations and Geopolitics in 2026

As we enter 2026, the investment landscape is characterized by two dominant forces: powerful tailwinds from AI-driven capital expenditure and corporate earnings growth, and countervailing risks stemming from stretched valuations, geopolitical uncertainty, and potential policy missteps. Key institutions like J.P. Morgan, Natixis, Bank of America, and others are aligning around this duality in their outlooks.

AI investment remains central. Goldman Sachs estimates hyperscaler capital expenditures will reach over $533 billion in 2026 (up ~34% YoY), signaling continued demand for infrastructure, semiconductors, cloud, and data center operators. This is reinforced by J.P. Morgan’s global research which sees AI expansion as a primary growth driver.

On the earnings side, projections anticipate mid‐teens growth — 14–15% year-over-year — for U.S. corporate profits in 2026. S&P 500 gains are forecast in a wide range depending on strength of economic growth and monetary policy outcomes: gains between +6% and +17% are plausible under a constructive scenario, with more aggressive growth or bubble bursts pushing variation.

The policy backdrop is critical: rate cuts remain expected but only conditionally. Inflation pressures, wage dynamics, and geopolitical trade disruptions may force the Fed to navigate a narrow path to avoid derailing momentum.

Valuations are particularly stretched in U.S. large-cap growth, especially the so-called “Magnificent Seven” tech stocks. The Shiller CAPE ratio has climbed to near its highest historical levels, raising concerns of multiple compression. Moreover, bond yields and credit spreads are at levels that could amplify downside in fixed income and risk assets if inflation rebounds or Fed action diverges from expectations.

Strategically, diversification is being reframed: instead of simply tilting between growth vs. value or U.S. vs non-U.S., portfolio construction is leaning toward sectoral exposure (especially in AI), geography (favoring emerging and ex-U.S. markets), and asset classes (commodities, high-yield, inflation-linked, alternatives). Traditional defensive allocations like long-duration Treasuries are seen as offering less protection in this regime.

Open questions centre on how resilient earnings can be if growth (especially consumer demand) softens, whether inflation can be kept under control without sacrificing growth, and whether AI investment delivers sufficient returns to justify lofty valuations, especially if broadening out beyond the flagship companies proves difficult.