Market Commentary Q1 2026

Capital Intensity

Markets entered 2026 on solid footing, buoyed by accelerating earnings growth and fresh all-time highs in the S&P 500. What followed was a familiar pattern: geopolitical disruption, rising uncertainty, and a swift repricing of risk. The intensification of conflict in the Middle East has shifted near-term investor focus, but earnings growth remains positive, and S&P 500 estimates have increased since the start of the year. This is a meaningful contrast to prior energy shocks, when earnings were already contracting or decelerating and recession risks were rising.

Geopolitical-driven volatility has often been short-lived historically, with markets ultimately refocusing on underlying earnings trends. Last year’s volatility surrounding tariffs was the most recent example of how quickly sentiment can change, and the market can recover.  

The inflation picture has, however, grown more complicated. Persistent underlying inflation and higher near-term commodity prices have led the market to reduce rate cut expectations for 2026, with the Federal Reserve adopting a notably more hawkish tone in recent commentary. Interest rates act as a governor on asset prices, which partly explains why equity sentiment deteriorated during the first quarter, despite strong underlying fundamentals.

The global impact of energy-driven disruptions is also uneven. Europe and parts of Asia remain more reliant on imported energy, making them more sensitive to sustained increases in oil and natural gas prices. In that context, a prolonged disruption could weigh more heavily on international growth and earnings expectations, where recent equity market strength has been supported by currency movements and valuation expansion.

Periods of elevated inflation also tend to expose differences in business quality. Companies with pricing power are often better positioned to protect margins, while those without face pressure from rising input costs. Despite this, capital-intensive businesses have meaningfully outperformed over the past year, a dynamic we would attribute to the market’s near-term focus on AI disruption uncertainty.

For much of the past decade, businesses that required relatively little capital to grow were rewarded with premium valuations. So-called “asset-light” business models, particularly in software and technology-enabled sectors, benefited from scalable economics, high margins, and durable growth. And when growth is scarce, investors tend to pay up for it.

The potential for AI to disrupt many software and data-based businesses has raised concerns around long-term obsolescence risk, leading to meaningful valuation compression, even where underlying fundamentals remain intact.

Capital intensity is increasingly being used as a proxy for durability in the wake of AI uncertainty. We would caution against drawing that conclusion over the long term. Capital-intensive businesses frequently face rising costs that require additional investment merely to sustain earnings, eroding the very durability the market is currently attributing to them. Over the long term, businesses that can generate high returns on capital without requiring significant incremental investment should create more value for shareholders, and inflationary environments can often reinforce that distinction.

The key factor, in our view, is not whether a business is asset-light or asset-intensive, but how effectively it converts invested capital into sustainable earnings and free cash flow. Businesses with durable competitive advantages, derived from scale, switching costs, or intellectual property, are often better positioned across a wide range of economic conditions.

In the current environment, we believe the market may be underestimating the durability of certain asset-light businesses, particularly those embedded within enterprise workflows and customer ecosystems. Many of these businesses continue to play mission-critical roles, supported by high switching costs and recurring revenue models. That said, not all asset-light businesses will successfully navigate the transitions that may ultimately be required, and selectivity matters more today than it has in years.

Rising capital intensity is, however, receiving less benefit of the doubt when it comes to the major hyperscalers. Alphabet, Amazon, Meta, Microsoft, and Oracle are expected to spend $677 billion on capital expenditures in 2026 and $761 billion in 2027, up from $241 billion in 2024 and $416 billion in 2025. Increases in capex guidance are now being met with skepticism as the market weighs the uncertainty of future returns on these investments.

We believe it is too early to draw conclusions on these hyperscaler investments, but the outcome will likely influence the performance of these businesses and, to an extent, the broader market in the coming years. What we do know is that compute remains very constrained, so the demand remains supportive, for now. We also believe the incumbents retain significant advantages based on their scale and entrenchment, though that assumes capital is deployed effectively in the years to come.

From a valuation perspective, the picture has improved. The S&P 500 forward price-to-earnings ratio has fallen approximately 18% since October, reflecting significant multiple compression in areas most exposed to shifting perceptions around growth durability. The valuation premium for growth versus value stocks is near its lowest level in eight years, now in line with its long-term average.

Periods of dislocation can create opportunities to invest in high-quality businesses at more attractive prices. While uncertainty has increased, we believe opportunities are emerging for long-term, patient investors. The narrative around capital intensity will continue to evolve, and identifying the long-term winners of the AI era remains inherently difficult at this stage, given the pace and breadth of change. We remain focused on what we believe has consistently driven long-term value creation: businesses that can grow efficiently, allocate capital effectively, and sustain their competitive advantages.

Authored by: Jack Holmes, Chief Investment Officer

This is a marketing communication and is not personal advice. We do not take account of your individual circumstances. You should consider whether any investment is suitable for you and seek professional advice if needed. The views, opinions, and commentary expressed herein are for informational purposes only and do not constitute investment advice or a recommendation, offer, or solicitation to buy or sell any security or investment strategy. Such views are subject to change without notice, and no representation is made as to their accuracy or completeness. Investing involves risk, including possible loss of principal. Estimates, forecasts, and forward-looking statements are not guarantees of future results.

Disclosures: Thought Leadership Disclosures