We’re in new territory ― an environment shaped by the unparalleled might of AI ― that market observers are still digesting. This, we believe, is why fundamental research and stock selection are so critical today ― to see around corners and capitalize on the potential that other market participants may be underestimating or missing entirely.
2. A growing opportunity set
Tech and the Mag 7 garner the most headlines, and for good reason. Yet non-Mag 7 earnings power may be underappreciated and represent an opportunity to diversify portfolios. Full-year earnings growth expectations for the “other 493” have been revised from 10% at the start of the year to nearly 18% today, which would represent the highest calendar year earnings growth reported since 2021. The key is to pick your places with an eye toward countering any AI hiccups without sacrificing the potential rewards of this potent mega force.
We’ve previously pointed to industrials as an area of opportunity given the role that some companies, such as those providing electrical equipment or cooling systems, play in the AI infrastructure buildout. Yet other portions of the sector also have our attention. Companies making and supplying to aircrafts are well positioned as aging and undersized commercial fleets are set to grow to meet strong demand for air travel. Defense companies, meanwhile, are benefiting from increased government spending and a larger global focus on safety and security amid geopolitical tensions.
Elsewhere, we see financials quietly building momentum. Our data shows rising earnings expectations for 2026 and 2027, led by banks. While they acknowledged on Q1 earnings calls that geopolitical escalation could exert some downward pressure, banks also noted that consumers remain resilient, capital market outlooks are strong, and credit conditions are stable. As early adopters, banks are seeing AI-related efficiency and productivity gains. In addition, the easiest regulatory regime in the post-GFC era sets up a favorable environment for M&A and IPO activity.
Another potential area of interest: HALO stocks, meaning Heavy Assets Low Obsolescence. These are companies with capital-intensive physical infrastructure that is difficult to digitize, such as a barrel of oil or a power plant. AI can impact these businesses but is more likely to be used for efficiency gains rather than as a replacement for core competencies. HALO stocks have come into focus as investors have started to question the durability of some asset-light business models (e.g., software).
3. Earnings beats and market reaction
We noted last quarter in Strong earnings meet stock market volatility that market pricing does not always reflect current fundamentals. As Q4 earnings came in strong, the market faltered. Such temporary dislocations can be due to macro forces that are detached from company fundamentals. Stripping that dynamic out, anomalies between earnings surprises and market reaction also bear watching and can make earnings seasons an exciting time for stock selection.
At the index level, the one-day reward for double beats (upside surprise on both sales and EPS) was lower in Q1 than the average of the past 20 years. A look to the sector, industry and company level can reveal more interesting insights. Case in point: While software companies are on track to post impressive earnings in Q1 at 23% yoy, AI disruption means future prospects could be challenged for some. Weak industry-level stock price reaction reflected this. Bottom-up stock pickers go deeper to assess whether price reactions are properly calibrated at the individual company level.
Bottom line: Markets have shown us this year that fundamentals can prevail even amid macro and geopolitical uncertainties. Looking ahead, consensus estimates paint a picture of continued earnings strength in 2026. This keeps us optimistic, but certainly not complacent. We believe companies that show durability in their cash flows ― and in their ability to monetize AI investments ― are best placed for the long haul. Active investors have the challenge ― and the great opportunity ― to sniff them out in the untiring pursuit of above-market returns.
