'This is a place where you have to differentiate the high-quality names': Girard on AI winners

Key Concepts

• Market Volatility: Fluctuations in stock prices, driven by investor sentiment, economic indicators, and geopolitical events.
• Valuation: The process of determining the economic worth of an asset or company. High valuations can indicate potential for correction.
• Capex (Capital Expenditure): Funds used by a company to acquire, upgrade, and maintain physical assets such as property, plants, buildings, and equipment.
• PMI (Purchasing Managers' Index): An economic indicator derived from monthly surveys of private sector companies, indicating business conditions.
• GDP (Gross Domestic Product): The total monetary or market value of all final goods and services produced within a country’s borders in a specific time period.
• Multiples: Financial ratios used to value a company relative to its peers or historical performance (e.g., Price-to-Earnings ratio).
• Geopolitics: The influence of geography on politics and international relations.
• Tariffs: Taxes imposed on imported or exported goods.
• K-shaped Economy: A type of economic recovery where different segments of the population experience vastly different outcomes – some thrive while others struggle.
• Consumer Staples: Essential products that consumers purchase regardless of economic conditions (e.g., food, household goods).
• Consumer Discretionary: Non-essential products and services that consumers purchase when they have disposable income (e.g., entertainment, luxury goods).

Market Volatility and 2026 Outlook

Yuko Gerard, Vice President and Portfolio Manager at Scotia Bank, attributes recent stock market volatility to a combination of factors. Primarily, investors are expressing concern over high valuations of companies that performed exceptionally well in the previous year, questioning the sustainability of their growth and seeking alternative investment opportunities. Specifically, there’s scrutiny on capital expenditure (capex) and whether these investments will translate into increased revenue and profit margins. A second source of volatility stems from the potential impact of Artificial Intelligence (AI) on businesses, extending beyond the technology sector itself. Investors are assessing which companies might be negatively affected by AI disruption.

Despite current volatility, Gerard anticipates a positive market outlook for 2026, grounded in improving economic indicators. She notes that leading indicators like the PMI and GDP growth, alongside inflation and labor market data, are currently stronger than they were a few years ago. This suggests a lower recession risk and the potential for solid earnings growth. However, she cautions that investor sentiment and resulting market multiples remain uncertain, and have already impacted prices year-to-date.

Risks to Growth in 2026

Several risks could derail the positive outlook for 2026. Gerard highlights that a deterioration in US job data and inflation numbers, leading to altered monetary policy decisions, represents a significant threat. Geopolitical risks remain a constant concern, and ongoing trade negotiations, particularly regarding tariffs, could introduce further volatility. She specifically mentions that tariff discussions from the previous year are still relevant and could impact the market depending on implementation.

“Geopolitics is always going to be another… risk and also we have these trade… it’s still not done yet right like tariff was a big… talk last year we still see that coming… here and there and so anytime those those kind of a news comes up. I think it’s going to add volatility.” – Yuko Gerard

Sector Preferences and AI Exposure

Regarding sector preferences, Gerard acknowledges the strong performance of materials and energy within the TSX (Toronto Stock Exchange) due to geopolitical uncertainties and demand for precious metals. However, she doesn’t necessarily view these as ideal long-term holdings, noting that active managers tend to be underweight in these areas.

When discussing AI’s impact, Gerard emphasizes the importance of differentiating between high-quality companies with strong balance sheets and those that are more vulnerable. She cites Microsoft as an example of a company that experienced a negative reaction to its capex spending announcement but represents a potential buying opportunity in the long run due to its overall strength.

“This is a place where you really have to differentiate the high quality names and… versus the… you know more the… if you look at the balance sheet you know weak balance sheet and you need to really kind of look at you know why they're impacting why they're being impacted and why the price is going down.” – Yuko Gerard

Diversification Strategies and Overlooked Opportunities

Gerard advocates for diversification, noting that portfolios with broader exposure, particularly equal-weighted portfolios in the US, have outperformed market-cap weighted indexes. This suggests that leadership is broadening beyond a few mega-cap stocks.

She identifies the industrials sector as an area where opportunities may be overlooked. These companies were penalized last year due to multiple resets but represent good quality businesses now trading at more reasonable valuations.

Regarding diversification within the US, Gerard suggests exploring opportunities in industrials. She cautions against overexposure to consumer discretionary spending due to the K-shaped economic recovery, where lower-income consumers are struggling despite moderating inflation. However, she views consumer staples as a relatively safe haven in the current volatile market.

“There's a lot of names in the industrials that really got punished last year because of the multiple reset but they're really a good quality companies and I think once they realize that you know now that it's it's actually in a reasonable valuation that those are the areas that uh can benefit from this broadening of the leadership.” – Yuko Gerard

Conclusion

The current market volatility is driven by concerns about high valuations, the impact of AI, and broader economic uncertainties. However, improving economic indicators suggest a positive outlook for 2026, contingent on factors like stable inflation, geopolitical stability, and favorable trade policies. Diversification, particularly away from concentrated mega-cap holdings and towards sectors like industrials and defensive consumer staples, is a key strategy for navigating the current environment and capitalizing on potential opportunities. A focus on quality companies with strong balance sheets, like Microsoft, is crucial when assessing AI’s impact.