Jeffrey Schulze
Strong market entry points are rarely found during moments of comfort or clarity. Instead, the most attractive buying opportunities are typically associated with periods of market stress. From there, equities tend to climb a “wall of worry,” advancing in the face of issues such as recessions, inflation spikes, geopolitical tensions, policy errors and lofty valuations, according to ClearBridge Investments.
“This dynamic exists because what matters most for financial markets is if reality turns out better or worse than what has already been priced in. As a result, when expectations are low—as they are today—stocks can push higher if subsequent events turn out better than feared. From this perspective, scepticism is not a barrier to a bull market but rather part of its foundation. Doubts will eventually be assuaged and sentiment will improve, which should lead to hedges being unwound and cash moving off the sidelines,” says Jeff Schulze, head of market and economic strategy at ClearBridge Investments.
At present, the biggest “bricks” in the wall of worry include stagflation, private credit risks, job losses due to artificial intelligence (AI) and market concentration.
“The first is directly related to oil prices. How long these stay higher appears to be the most significant worry for investors at present. While current conditions invite comparisons to the 1970s, the US economy is structurally different today—with energy independence achieved and energy intensity lower—suggesting the transmission from higher oil prices into growth and inflation should be more muted than the past.”
The most recent oil shock in 2022, sparked by the Russian invasion of Ukraine, did not drive a US recession as the aforementioned structural changes were already in place.
“The second brick in the wall of worry has been private credit. The opaque nature of the asset class has led some to conclude that it is ripe to be the next shadow-banking accident. However, deeper analysis shows that while risks certainly exist, they are unlikely to generate substantial enough macroeconomic spillovers to cause a recession.”
At its core, private credit uses long-term funding that is gated, which limits the risk of a problematic “run on the bank” dynamic where investors all look to exit at once. Use of leverage in the asset class is moderate, with IMF research suggesting that aggregate bank exposure to the industry amounts to $300 billion, or less than 2% of overall loan books. Although private credit has witnessed an uptick in defaults recently, its overall size amounts to a fraction of what mortgage-backed securities (MBS) were heading into the Global Financial Crisis (GFC). Private credit today is equivalent to 6% of gross domestic product (GDP); MBS in 2007 was approximately 30%.
The third brick in the wall of worry has been fear of an AI-induced layoff cycle or “job apocalypse.”
“This fear is understandable. If AI displaces workers faster than it creates new jobs, overall household income would fall, demand would weaken and corporate profits would deteriorate. Although February’s soft jobs report supported this recessionary narrative, a closer examination of the data suggests that other factors are playing a larger role than AI in slowing the pace of US job creation. These include changes in immigration and trade policy, alongside the continued aging of the US population and DOGE-related efforts to shrink the federal workforce,” he notes.
“One overlooked component of the debate around an AI-induced layoff cycle, in our view, is the fact that throughout history, major technological advances have led to job creation alongside job destruction. This creative destruction process means that significant value and jobs are created by new businesses, offsetting some of the losses from the disruption of legacy firms,” he adds.
“Already, AI has created jobs building infrastructure (such as data centers), and we believe these opportunities will broaden in the years to come. The pace of job creation relative to destruction will be crucial in determining the path of the labor market and by extension the US economy, but history shows that the overall effect is usually a positive one. Only 40% of today’s jobs existed 85 years ago, suggesting investors and workers alike should embrace the opportunities presented by AI.
“Similar fears regarding a “job apocalypse” were present during the late 1990s internet revolution. However, the economy benefited as new occupations were created in areas that were previously unimaginable, such as e-commerce, video games and content creators—yes, “influencers.”
“History shows that when we look back on 2026 in a decade or two, the likelihood is high that a substantial number of jobs will exist in areas we can’t even dream of today, built on the back of advances made possible by AI. Put differently, creative destruction is a feature rather than a bug of technological change and a positive force for economic growth. In fact, this very idea was awarded the Nobel Prize in economics last year.”
The fourth and final brick is elevated US equity market concentration. The 10 largest companies in the S&P 500 currently account for 38% of the benchmark and trade at a 5.4x multiple-point premium based on expected next-12-month earnings. Given this backdrop, passive large cap benchmarking no longer offers a broadly diversified and balanced portfolio, but rather an increasingly concentrated exposure to the most richly valued part of the index.
Admittedly, it is hard to imagine a world where today’s largest companies are not dominant forces over the next decade. However, a myriad of factors may alter the earnings trajectory of the current leaders as AI matures and the competitive landscape changes. The aftermath of the tech bubble may serve as a good case study, particularly as it coincides with the last period of elevated S&P 500 concentration.
The prospects of the 10 largest S&P 500 constituents at the peak of the tech bubble (March 2000) have varied widely over the subsequent 26 years. Four have had negative price returns, and only three have outperformed the benchmark. Notably, none of the 10 have outpaced the equal-weight S&P 500. While the current environment is certainly different than the dot-com era, this case study is a helpful reminder of the dynamic that may play out in the coming years. Importantly, it also illustrates the opportunity for active managers that can accurately assess the changing competitive landscape and embedded valuations of today’s leaders.
“With multiple bricks making up the wall of worry today, investors can be tempted to treat each unsettling headline as the tipping point for the next crisis. Comparisons abound between higher oil and stagflation in the 1970s, and between current private credit risks and MBS ahead of the GFC, for example. However, many of these issues are more nuanced than is typically understood.
“We conclude that these worries are likely forming the foundation for a renewed rally as fears subside, a typical feature of bull markets. Given our constructive economic and market outlook, we believe the market will ultimately climb today’s wall of worry as investors’ leading fears are assuaged. As a result, we view the current pullback as an opportunity to deploy capital for long-term investors,” notes Schulze.
