On the one side is the extraordinary promise of artificial intelligence (AI). The AI theme, together with the massive buildout of data centres, specialised chips and energy infrastructure, has dominated equity returns over the past three years. A small cohort of companies has delivered exceptional gains for investors and is increasingly being viewed as defensive in nature, despite being inherently cyclical.
On the other side is the less glamorous reality of the underlying economy. Aggregate GDP figures and index-level performance appear supportive, but beneath the surface, they mask a weakening consumer environment. Resilient spending by the wealthiest households and heavy investment by AI hyperscalers contrast with the growing financial strain on middle- and lower-income consumers.
This imbalance leaves markets resting on a fragile equilibrium. Traditional defensive areas, such as consumer staples and healthcare, are no longer seen as being able to provide the ballast typically expected during periods of economic stress or elevated valuation dispersion. Their weaker pricing power and challenged end-markets have pushed them out of favour with investors.
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Meanwhile, the very companies whose fortunes depend on large, synchronised capex cycles are viewed as ‘safe bets’ simply because their near-term growth outlook appears unstoppable. The current narrative is based on a fundamental contradiction. Companies powering the AI boom, such as semiconductor producers, networking suppliers, and power-infrastructure providers, trade at valuations that imply utility-like stability.
The belief is that generative AI represents such a profound secular shift that it overrides normal cyclical dynamics. The demand for advanced computing remains structurally above supply, and hyperscalers must invest aggressively to maintain their leadership, regardless of macroeconomic conditions. But how durable is this narrative?
History provides perspective. In the late 1990s and early 2000s, telecom carriers invested vast sums in fibre-optic networks, expecting unending bandwidth demand. Equipment manufacturers saw explosive earnings and soaring share prices until overcapacity, falling valuations and a pullback in spending triggered a rapid and severe correction.
Order books that once looked unshakeable vanished almost instantly. While AI is unquestionably transformative, arguably more so than early internet technologies, the scale and speed of current spending may have brought forward multiple years of future demand. Periods of digestion, inventory adjustments and pauses in deployment are inevitable.
Companies dependent on concentrated capex from a handful of large customers are, by definition, cyclical. Unlike fibre-optic cables, which last decades, GPUs have a short operational life, amplifying the impact of overinvestment. Yet markets continue to treat the most momentum-driven parts of the AI ecosystem as defensive.
Investors appear to be seeking safety in growth, convinced, somehow, that AI can overpower normal business cycles. A second factor behind the market’s current imbalance is the increasingly stressed consumer landscape. Headline retail figures mask a widening divide.
The highest-income households, who hold the bulk of asset wealth, have benefitted from strong housing and equity markets, with spending on luxury goods, travel and premium services remaining robust. In many cases, the wealth effect created by AI-driven equity gains is reinforcing this strength. In contrast, middle- and lower-income households are facing intensifying pressure.
Inflation in essential categories, such as housing, food, and energy, combined with the depletion of pandemic-era savings and support measures, has left budgets strained. Rising delinquencies in credit cards and auto loans, along with widespread trading down at retailers, confirm the strain. Although consumer staples should theoretically fare well in such periods, their weaker growth and contracting multiples leave them out of favour in a momentum-driven market that prizes AI-related narratives.
Ironically, the most compelling defensive opportunities may sit among the market’s perceived ‘AI losers.’ Many high-quality businesses in software, IT services and information services have been indiscriminately de-rated. Investors worry that AI will automate their workforces, replace their products or erode their data advantages. Just a few years ago, these same companies were expected to be the biggest beneficiaries of AI adoption.
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