The current market has rewarded momentum and mega-cap tech. If investors turn their attention to the rising concentration and valuation risks present in the market and the AI theme becomes less dominant, we expect the resilient quality attributes of select stocks to come back into favour.
Clyde Rossouw, Head of Quality: “History shows that when cyclicals are priced as defensives and defensives as cyclicals, a great rotation tends not to be too far away. True defence is not found in chasing momentum but in identifying companies with resilient cash flows, strong balance sheets and the ability to compound through different economic and market environments.”
Market leadership rotated sharply during 2025. Early in the year, political uncertainty and the ‘Liberation Day’ tariff shock weighed heavily on the Magnificent 7 and on momentum and growth factors. Passive quality, tilted toward these exposures, followed the market lower. In contrast, our fundamental quality approach, with its focus on resilient fundamentals, fared better, offering robust defence in the face of the sharp selloff.
“These kinds of dislocations are precisely where a fundamental quality approach can show its defensive characteristics,” Rossouw said. “Our purist approach is built around companies that can weather earnings shocks.” Later in the year, rising valuation concerns within AI triggered renewed risk-off sentiment. Our Quality approach once again delivered smaller drawdowns.
While the AI revolution is undeniably real and the underlying technology is potentially more transformative than the early internet years, the current level of spending may have pulled forward years of future earnings and demand for infrastructure suppliers.
“There will inevitably be digestion periods, inventory corrections, and a temporary halt or slowdown in the pace of the buildout. Businesses that rely on massive, coordinated capex plans from a handful of the world’s largest companies are, by definition, cyclical,” Rossouw said.
The market largely shrugged off this cyclicality in 2025, pushing valuations of AI-exposed companies to extremes. Investors should be mindful of this concentration risk. Rossouw warned: “History shows that capex cycles can reverse quickly, and a level of caution is warranted. If sentiment changes, the fallout could be significant. This is a moment for valuation discipline and fundamental analysis, not blind faith in a single narrative or factor exposure.”
High-quality businesses in software, IT services and information services were caught in the cross-currents of 2025, punished by fears that AI would erode their pricing power or displace their products. Many now trade at or below market-level valuations despite recurring revenues, high switching costs and asset-light business models.
“The irony is stark. Only a few years ago, these companies were expected to be the primary monetisers of AI. Fundamentals haven’t changed; sentiment has. For long-term investors, this creates the potential for attractive compounding from businesses that can grow earnings steadily, without relying on aggressive assumptions about the pace of AI adoption,” Rossouw said. One area that the market may be underestimating is AI’s potential impact on pharmaceutical innovation. If AI improves R&D productivity and accelerates drug discovery, major pharmaceutical companies could generate far better outcomes for every dollar of spend. Yet this opportunity is not captured in the valuation of many of these stocks, which have been out of favour based on the view that they are not technologically driven.
Traditional defensives may also return to favour. “In 2025, they were caught between a rock and a hard place in a momentum-driven market, lacking the excitement of AI exposure and suffering from dependence on squeezed consumers. But in a more uncertain macro environment with a less dominant AI-theme, their defensive attributes should come back into favour,” Rossouw said.
The investment landscape entering 2026 is marked by contradictions. Weak consumer data coexists with the market bidding up highly cyclical AI infrastructure suppliers to defensive status, while some of the most reliable recurring-revenue businesses in corporate history sit discounted. Rossouw noted: “The great risk lies in the crowded trade: the conviction that the AI infrastructure wave will never crest. When the inevitable air pocket in capex arrives, the market will abruptly remember the cyclical nature of these businesses and high starting multiples will offer little protection.”
Opportunity lies in mispriced resilience, not momentum. Rossouw concluded: “True defence is not found in chasing momentum into cyclical extremes but in identifying where resilient cash flows are being offered at a discount because they lack a positive AI narrative. When the market re-focuses on fundamentals, we would expect some of the perceived ‘AI losers’ to come to the fore.