The day of reckoning could be coming closer for US stock markets and companies with high valuations that are closely tied to artificial intelligence (AI), if corporate earnings do not fulfil investors’ lofty expectations in 2026, Chad Padowitz, co-chief investment officer at Talaria Capital says.
While US equity markets have risen strongly in 2025 on the back of the AI boom and lower interest rates, US valuations have run ahead of earnings.
“It’s not so obvious that capital expenditure being spent on AI, which is a substantial amount, is going to deliver the revenue that the share prices are broadly anticipating, so I think we are in a period where investors might start asking, ‘show me why you are spending the money.’ This does create more risk if companies don’t deliver given the level of valuations that are currently priced into the US stock market,” Mr Padowitz says.
“A lot of data is telling you that the US economy is not firing on all cylinders. A jump in layoffs in the US in October was the biggest for 20 years, while overall the US has a shrinking working-age population. Typically, this would make immigration a priority. However, with the current stance on immigration, the opposite is happening.”
“So, while the equity market hitting all-time highs this year would suggest that the US economy is firing on all cylinders, there is meaningful data telling you that that is not the case, and the economy is a lot more muddled out there than share market valuations would suggest.”
In light of such economic uncertainty, some sectors such as insurance could help investors protect against a US share market downturn.
“We do think there are opportunities for equity investing the further away you go away from the growth-AI theme. For instance, we think insurance is a good sector,” Mr Padowitz says.
“Insurance has been pretty much out of favour, and while it isn’t the most exciting sector, it is very profitable and defensive, so it is not overly sensitive to inflation.
“The expectations for corporate earnings next year are very aggressive for the S&P 500, with consensus at 13 per cent EPS in 2026. As we get into new year, if the market starts to think that that level of optimism won’t be met, that could certainly be a catalyst for a weaker stock market.”
