Has the catalyst for stock diversification arrived?

But there’s far less discussion about the possibility that a healthier US macroeconomic environment could provide the backdrop for a strong rotation into parts of the market beyond mega-cap technology. That possibility is a key theme in our 2026 annual investment outlook: Resilience and rebalancing.

Case for diversification intensifies

When it comes to the artificial intelligence (AI) trade, many investors fear missing out on the market advance, but also worry about staying in too long. But, diversifying into lower valuation areas, such as smaller capitalization or value stocks, or adopting alternative weighting methodologies has largely gone unheeded. For months, there hasn’t been a catalyst to spark such a rotation. Global growth was slowing, and concerns lingered that inflation could re-emerge. In the aftermath of “Liberation Day,” uncertainty weighed on growth, while the risk of tariff-induced inflation kept the Federal Reserve (Fed) from acting as aggressively as it might otherwise have. Investors were left wondering if diversification was simply an antiquated theory, not a practical strategy.

But market activity last week seems to have affirmed our view that the picture is changing. Leading indicators globally have improved.³ The Fed acknowledged that growth had been improving and, at last week’s Federal Open Market Committee (FOMC) meeting, outlined expectations for even stronger growth in 2026, supported in part by productivity gains from AI.⁴ The Fed reduced rates by 25 basis points last week and signaled at least one more rate cut in 2026.⁵ In our view, improving growth combined with lower US interest rates likely creates a more constructive backdrop for stocks beyond the largest names.

Has a catalyst arrived?

The mega-cap technology trade has lost some momentum, even as the broad S&P 500 Index advanced to a new all-time high on December 11.⁶ For example, last week Oracle sold off on weaker-than-expected earnings, raising concerns about the debt it’s taking on to fund capital expenditures.⁷ Importantly, many of the other hyperscalers have significantly lower debt ratios.⁸ We’re not suggesting the AI trade is over. Rather, we believe the environment is becoming conducive to further diversification. Again, the S&P 500 Index traded this week at an all-time high, notwithstanding the fact that five of the Magnificent 7 stocks (Apple, Amazon, Meta, Microsoft, and Tesla) have underperformed the market this year.⁹ Small-cap indexes, like the Russell 2000 Index, and the S&P 500 Equal Weight Index, also closed at record highs last week.¹⁰

In short, improved growth and Fed easing are meaningful developments. For investors who’ve been waiting for a reason to look beyond mega-cap technology, the catalysts may finally be here.