AI optimism is still there but last week brought more questions about timing and RoI: Buchanan

Key Concepts

• AI Investment Differentiation: The market is distinguishing between companies providing the foundational infrastructure for AI (“picks and shovels”) and those expecting long-term payoffs from AI-driven data applications.
• Earnings Quality & Cash Flow: A shift in investor focus from solely revenue growth to sustainable cash flow generation, margin resilience, and overall quality metrics.
• Cyclical Shift: The market is potentially moving later in the economic cycle, demanding greater evidence of profitability and sustainability.
• Valuation Concerns in AI Deals: Circular funding mechanisms and overlapping optimism in AI-related deals create valuation risks.
• Turnaround Stories: Identifying undervalued companies undergoing successful operational improvements (e.g., GAP).
• Capital Markets Play: Focusing on companies directly benefiting from capital market activity, less reliant on broader economic conditions (e.g., Goldman Sachs).

Market Commentary & Investor Sentiment (February 2026 Outlook)

The North American markets experienced mixed performance today, with the NASDAQ leading declines due to tech-related selling. Keith Buchanan, Senior Portfolio Manager at Globalt Investments, discussed key concerns driving this sentiment and outlined investment strategies for navigating the evolving market landscape. A primary driver of the current market hesitation is the increasing bar for earnings growth. While Q4 earnings growth is currently tracking at over 12%, exceeding initial expectations of 8%, the market now demands “great” results, not just “good” ones. This expectation is projected to accelerate throughout 2026. Buchanan emphasized that revenue growth alone is no longer sufficient; investors are now prioritizing cash flow generation, margin resilience, and other quality metrics indicative of a mature stage in the economic cycle.

AI Investment Landscape & Funding Mechanisms

Buchanan highlighted concerns surrounding the interconnectedness of funding mechanisms within the AI space. He described these deals as having a “circular nature,” creating a risk that the market hadn’t fully appreciated 12-18 months ago. This interconnectedness means that the success (or failure) of one deal can have a cascading effect on valuations across multiple companies. He noted that this concern persists despite Nvidia CEO assurances of a positive relationship with OpenAI.

The market is now actively “dissecting and discerning” between AI companies based on their funding mechanisms. Companies with cheaper, more immediate funding sources are favored over those reliant on long-term data payoffs. This represents a “healthy exercise” as the market assesses the sustainability of valuations baked into AI-related names. The focus is shifting from the initial “infrastructure buildout” phase of AI to evaluating the potential for realizing gains in later phases.

Buchanan stated, “The key factor in how the market has shifted over the past month or so is understanding the funding mechanisms that takes you from one point to the next along that spectrum.”

Shifting Storylines & Capital Allocation

The market storyline is shifting away from a broad enthusiasm for all things AI towards a preference for companies demonstrating “quality cash generation and margin stability.” If companies, particularly those with overlapping funding structures and optimistic revenue projections, fail to demonstrate these qualities, their valuations may decline. This could lead to capital flowing into “old economy names” that can demonstrate these characteristics.

Buchanan observed a movement of investor attention outside of the tech sector, which presents challenges for the tech story and necessitates consistent execution on a quarterly basis. He noted this shift isn’t necessarily “disorderly or unhealthy,” but requires tech companies to deliver tangible results.

Stock Specific Recommendations & Rationale

Buchanan presented two specific stock recommendations:

1. GAP (GPS): He believes GAP is undergoing a significant turnaround, with improvements in merchandising and a greater focus on cost controls. Q1 results demonstrated this progress, and he anticipates further upside in 2026. He believes the stock is currently mispriced, reflecting a perception of GAP as a “broken retailer” rather than a company executing a successful turnaround. He sees an opportunity to buy shares at current levels.

2. Goldman Sachs (GS): He views Goldman Sachs as a “pure play cap markets story,” benefiting from robust earnings power demonstrated in Q1 and strong performance in its ancillary businesses. He anticipates valuation growth in 2026, driven by its revenue streams, which are less vulnerable to the pace of Federal Reserve rate cuts compared to other financial institutions. He praised Goldman Sachs’s “quality management team and opportunity set.”

Data & Statistics Mentioned

• Q4 Earnings Growth: Initial expectations were 8%, currently tracking above 12%.
• 2026 Earnings Expectations: The market expects accelerating earnings growth throughout 2026.

Conclusion

The market is undergoing a recalibration, shifting from a focus on top-line revenue growth in AI-related companies to a more discerning evaluation of cash flow, margin resilience, and sustainable business models. This shift presents both challenges and opportunities for investors. Buchanan’s recommendations highlight the importance of identifying undervalued turnaround stories (GAP) and capitalizing on companies benefiting from specific market dynamics (Goldman Sachs) rather than relying solely on broad sector trends. The emphasis on quality metrics and sustainable profitability suggests a move towards a more mature phase of the economic cycle, demanding greater accountability from companies seeking to maintain or increase their valuations.