Quarterly Q&A – Q1 2026 | Strategy Update

Thus far, the first quarter of 2026 has been remarkably different than last year in terms of investor psychology and where investors are rotating their attention – and their funds. After two years of unwavering investor attention on Artificial Intelligence (AI) and the “magnificent seven” stocks, investor psychology and interest appear to be redirected to other investment sectors, as well as to other parts of the world. This could have significant positive implications for the long-term health of the global economy, as well as for financial markets. In many disciplines, a few months may not make for a long-term trend, but logic suggests this change in market leadership and investor psychology may last for quite a while – years not months. So, let’s dig in!

What’s changing in markets – and what should investors know?

The year has begun with a noticeable shift of investor attention away from tech and into just about every other sector of the global economy. Much of this change has been predicated by investor opinion and psychology that although AI is powerful, its effect on other sectors aside from tech will also be highly profitable. This type of rotation is typical in the early-to-mid stages of long-term bull markets, particularly those driven by technological innovation. It signals expanding economic participation rather than narrowing speculation and is a sign of health and potential longevity of the cycle. Healthy bull markets do not advance in a straight line. They broaden. They evolve. They become more discerning. And that is precisely what we are witnessing.

In the US markets, this rotation has caused domestic indexes to trade sideways, although beneath the surface there has been meaningful movement. While some areas within the technology sector have corrected significantly, sectors such as industrials and materials have begun to lead. Since AI stocks and the Mag7 represent more than 35% of the S&P 500, the net change has been quite subdued, with the index essentially flat for the year. Given the relative underperformance of tech stocks this year, many investors are worried about the future.

What’s the future for AI technology stocks?

Investors are beginning to realize that not all technology is being or will be treated equally in the AI revolution going forward. As an example, certain software companies have struggled as artificial intelligence reshapes business models. At the same time, semiconductors and select AI infrastructure companies continue to demonstrate strength. The market is rewarding strong business models and penalizing vulnerable ones. As AI matures, investors will need to pay special attention to where AI success can be generated and where it will be destructive, since the “easy money” AI trade is now a thing of the past. This new phase of the tech-led bull market will favor diligent research and active stock selection – our forte! Fortunately, and importantly, we are not seeing indiscriminate buying or irrational exuberance in tech – at least not yet.

Are we in an Artificial Intelligence bubble?

Artificial intelligence remains the defining theme of this cycle. Naturally, investors are asking whether enthusiasm has gone too far. We continuously monitor several key indicators when evaluating potential bubble conditions, including valuation levels, investor sentiment, leverage, monetary policy, earnings growth, and capital spending trends. At present, many of these metrics suggest we are not yet at extreme bubble conditions. In particular, investor sentiment remains cautious rather than euphoric. Historically, true bubbles form during periods of widespread, irrational optimism. Today, skepticism remains prevalent, which has actually released some of this bubble’s “air.” However, this by no means eliminates risk. As we all know, the AI buildout requires substantial capital investment and questions about return on investment are legitimate. That said, history shows that technological super-cycles often produce multi-year periods of elevated productivity growth and corporate profitability. We are in a bubble that so far looks unlikely to “pop” anytime soon, and may significantly award astute and careful investors in coming years.

How long could this business cycle last?

Our research suggests this business cycle is approximately two and a half years old. To put this into context, technology-driven cycles historically have lasted eight to nine years. If that framework holds, we may still be in the early innings. Keep in mind, technological innovation tends to increase productivity growth, expand corporate profit margins, and support stronger earnings growth. During these types of expansions, stock market returns have historically exceeded long-term averages. While long-term equity market returns typically average 9-10% annually, technology-driven expansions have often delivered superlative annualized returns during peak innovation phases.

Of course, risks exist. Unknown shocks, monetary policy errors, excessive leverage, or an overheated AI buildout could interrupt the path. That is why optimism must always be paired with discipline.

Why are international stocks outperforming the United States?

One of the most important developments over the past year has been the outperformance of international equities relative to those domiciled in the United States. As you know, for the past year, we have been strong advocates of investing in foreign equities, and we continue to have this outlook. For decades, U.S. markets dominated global returns. But policy shifts, fiscal changes abroad, and a meaningful decline in the U.S. dollar have altered the landscape. Valuations overseas remain significantly lower than those in the United States. In many cases, price-to-earnings ratios abroad are roughly half of domestic levels. At the same time, fiscal spending initiatives in regions such as Japan and Europe are reshaping economic trajectories. Many investors remain under-allocated internationally after years of U.S. dominance. Capital beginning to flow more meaningfully into foreign markets (trillions of dollars) will be very supportive of continued relative strength in foreign stocks. It’s been a long time, but global diversification is once again being rewarded.

Should investors be concerned about tariffs and policy headlines?

Recent headlines surrounding tariffs have understandably created confusion. However, markets often look through political noise. Thus far, tariff-related inflation has not meaningfully appeared in economic data, and corporate earnings remain broadly resilient. Rather than reacting to headlines, we focus on identifying businesses with durable pricing power, strong balance sheets, and sustainable earnings growth. The market’s reaction to recent policy developments reinforces an important lesson: price action often tells a more different story than daily news coverage.

Is Dow 100,000 by 2030 Realistic?

We have spoken publicly about the possibility of Dow 100,000 by the end of the decade. This view is based on historical business cycle analysis rather than speculation. Technological super-cycles can support higher productivity, faster earnings growth, and elevated market returns. When earnings growth is compounded over several years, the potential index levels become more compelling. We have written a “white paper” which fully discusses the probability and fundamentals of our DOW 100k theory, which is available at jamesdemmert.com. Could this thesis be derailed? Absolutely. Economic cycles are never linear. That is precisely why risk management remains central to our strategy.

How does the conflict with Iran register with your outlook for markets?

This is an important question that has some lessons from the past, but also considerations of what may be different today. Past crises in the Mideast have caused temporary declines in global stock markets and sent oil prices and gold soaring – pretty much what we’ve seen thus far. In the past, none of these conflicts have derailed the global economic cycle and our work suggests the same going forward over the balance of the year. Though the next few weeks may present further stock market volatility, today’s conflict with Iran seems to have the support of most nations – particularly those in the immediate area. This makes the current situation different from those in the past. Additionally, we believe global oil supplies are unlikely to be significantly disrupted since the world has enough “other” supply to make up for any lack of Iranian exports. Of course, these types of conflicts can escalate in unexpected fashion, so we will be watching closely and employing our Active Risk Management process, as always.

How is Main Street Research managing risk in this environment?

Even in a constructive environment, discipline is paramount. Our Active Risk Management framework includes strategic asset allocation adjustments, sector rotation when appropriate, defensive positioning during periods of elevated risk, and the disciplined use of stop loss strategies. Earlier this year, these tools helped limit exposure to certain holdings. This is not about predicting market tops. It is about managing risk in real time. Our objective remains clear: participate meaningfully in the upside of a technological bull market, while preserving the ability to protect capital if conditions deteriorate.

As we all know, markets evolve. Leadership rotates. Headlines distract. Cycles unfold. What matters most is maintaining a disciplined, research-driven process anchored in long-term opportunity and prudent risk management.

From all of us at Main Street Research, thank you for your continued confidence in our work. If you have questions about your portfolio, international positioning, AI exposure, or risk management strategy, please reach out. We look forward to navigating 2026 and beyond together.

If you have a family member, friend, or colleague who may benefit from our work or a no-cost wealth management and portfolio review, please let us know. We are always grateful for your referrals and trust.

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