Heading into 2026, investors are grappling with a market environment that is as perplexing as any we’ve seen in recent history. Both risk assets (stocks) and traditional safe haven assets (bonds and gold) have performed well this past year. At the same time, we’re seeing divergences in both financial markets and the real economy that could potentially create some turbulence ahead.
On the positive side, economic growth and corporate earnings remain healthy, with the important caveat that the surge in output is largely underpinned by massive spending on AI and digital infrastructure. Wealthy Americans have more than picked up the slack for lower earners, continuing their spending on goods and experiences.
“Economic growth and corporate earnings remain healthy, with the important caveat that the surge in output is largely underpinned by massive spending on AI and digital infrastructure.”
On the negative side, there are indicators from both Wall Street and Main Street that may imply trouble around the corner. Asset prices are high, most visibly with any business connected to the artificial intelligence trade. Big bets on the largest technology companies have driven stock market concentration to levels previously unseen in the modern era. Meanwhile, in the real economy, consumer confidence has declined, labor markets are weakening, and public finances are deteriorating with the federal government borrowing heavily to fund its commitments.
Let’s further break down these moving parts.
The K-Shaped Economy
Today’s economy has been described as “K-shaped.” Imagine the letter K, with its two arms diverging in opposing directions. This imagery captures a divided situation where certain segments of the economy flourish while others falter.
High-income earners have seen their wealth grow, largely from rising stock markets and appreciating home values. Meanwhile lower- and middle-income earners face increasing financial strain from inflation and unaffordable housing. A generational divide is evident, too. Older, wealthier consumers enjoy greater financial stability from decades of asset accumulation. In contrast, younger generations are grappling with mounting debts, slower wage growth, and aspirations for home ownership that are increasingly out of reach.
“…industries catering to lower- and middle-income consumers have struggled, including value retail, budget airlines, and auto financing.”
This divide extends to the corporate world. Many technology and AI-related industries have thrived, along with certain premium and luxury brands. Meanwhile, industries catering to lower- and middle-income consumers have struggled, including value retail, budget airlines, and auto financing. In short, while the economy has remained resilient overall, the supporting pillars of growth are both narrow and interdependent, creating vulnerabilities if one or more of the pillars comes under pressure.
“This economic divide is also mirrored in the stock market.”
Quality vs. Momentum Stocks
This economic divide is also mirrored in the stock market. This year, we’ve observed a wide performance gap between momentum stocks (those riding upward price trajectories and investor enthusiasm) and quality stocks (those with durable earnings, strong balance sheets, and high returns on their internal investments).
“In 2025, unprofitable small- and mid-sized companies significantly outperformed profitable ones, indicating investor preference for companies promising future growth.”
In 2025, unprofitable small- and mid-sized companies significantly outperformed profitable ones, indicating investor preference for companies promising future growth over those delivering profits today. This risk-on pattern often emerges late in bull markets when exuberance is high.
We aren’t concerned by the temporary underperformance of quality stocks. A focus on quality has demonstrated its value over the course of many decades. Cash-generative, proven businesses provide resilience during downturns and in more normalized environments.
Why Quality Matters Now
History shows that periods of underperformance from quality stocks have typically been followed by strong relative returns. In other words, drawdowns have tended to be good times to buy rather than to sell. Said another way, the optimal time to build portfolio resilience is during good times, when optimism is high and the outlook is upbeat. Subsequently, in more uncertain, slower-growth environments, the durable earnings from higher quality companies should reward investors.
“We’re finding the most compelling opportunities in relatively mundane areas of the market that often lack the sparkle of AI yet hold tremendous promise on their own merits.”
Many of the high-quality companies we focus on are industry leaders with strong secular tailwinds, capitalizing on long-term structural shifts in the economy. In our view, quality investing simply comes down to allocating capital to businesses with real substance: established business models, adaptable management teams, growing cash flows and sustainable moats.
Where We See Opportunity
In today’s market environment, we’re finding the most compelling opportunities in relatively mundane areas of the market that often lack the sparkle of AI yet hold tremendous promise on their own merits. These include quality stocks both in the U.S. and internationally, companies with growing dividends, and select opportunities in healthcare, business services, and logistics and infrastructure. These are largely essential businesses benefitting from innovation in their ecosystems that are unlikely to be disrupted by regulation or technological leapfrogging. For example, we own several supplier and logistics businesses operating at critical junctures in the economy in areas such as semiconductors, life sciences, food services and industrial parts.
These often aren’t the exciting, world-changing investments making headlines. But with patience, endurance, and the willingness to invest in less popular areas of the market, we believe investors can enhance diversification and long-term, risk-adjusted returns. In a divergent economy and richly valued market, focusing on quality businesses and cash fundamentals remains our core conviction.
The above information is for educational purposes and should not be considered a recommendation or investment advice. Investing in securities can result in loss of capital. Past performance is no guarantee of future performance.
