As a result, returns have diverged and AI-related stocks are no longer moving in tandem, with performance increasingly reflecting views on who will ultimately win.

Arnold said the shift marks a turning point for investors.

“AI has entered a new phase, where broad exposure is no longer enough and returns are becoming far more selective,” said Arnold.

“Markets are now moving to a stock-by-stock assessment of who is best positioned to deliver sustainable returns, rather than rewarding the theme as a whole.”

Arnold identifies three critical factors shaping the next stage of the AI investment cycle; deployment of capital, debt, and demand, which together determine where value will emerge.

On capital deployment, Arnold noted that while technology companies continue to invest heavily in AI infrastructure, investors are becoming more discerning about how effectively that capital is being used.

“A year ago, rising capital expenditure was seen as a sign of confidence and leadership,” said Arnold.

“Tech businesses are committing vast sums to AI infrastructure; across chips, networking, data centres and cloud capacity. However, the market is increasingly questioning whether all this investment will generate sufficient returns.”

At the same time, increased use of debt across the AI ecosystem is adding complexity and risk, with markets beginning to differentiate between companies based on their balance sheet strength and ability to sustain investment.

“Take Oracle, issuing almost as much debt since January 2025 than in the previous seven years combined in a bid to accelerate its data centre build out. The perceived risk of its debt rose quickly in Q4 2025, signalling investor scepticism around its ability to catch up in the race for AI leadership and generate sufficient returns to justify both the investment, and the leverage used to fund it.

“The growing use of leverage is amplifying both opportunities and risks. But not all leverage is being treated equally, with markets more comfortable with the credit profiles and capital structures of other hyperscalers.”

Demand remains the most difficult factor to assess, with strong AI adoption not always translating into immediate revenue, particularly as companies balance short-term monetisation with long-term strategic investment.

“Understanding where real, durable demand sits requires much deeper analysis, as usage, pricing power and revenue can diverge significantly across the AI value chain,” Arnold said.

“Even at the individual company level, the link between demand and revenue can be unclear. This was evident in the market’s reaction to Microsoft’s recent earnings. Slower-than-expected growth in its cloud computing platform was initially seen as a leading indicator of weakening demand. However, management clarified this reflected a deliberate decision to redirect capacity towards internal AI development (such as Copilot), aimed at driving long-term monetisation.”

Schroders believes the next phase of the AI cycle is underway, with markets now treating companies in the space very differently.

“Broad exposure to the theme has worked up until recently, but it’s becoming clear that stock selection, not general thematic exposure, will drive the next leg of returns,” said Arnold.

“Diversification remains critical, but the focus now is on identifying the companies that can execute and deliver sustainable returns through the cycle,” he added.

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Arnold says the past year has seen enormous sums being poured into technology as major tech players race to build the infrastructure needed to support artificial intelligence, and investors are questioning whether that will translate into real revenue and justify the scale of spending.

“The first question is about deployment of capital. If you’ve owned stock in any AI business over the past two or three years, it’s likely you’ve done very well. But the level of capex upgrades we have seen during reporting season has been huge,” Arnold says.

“Technology giants have committed hundreds of billions of dollars to data centres, chips and computing power to build the backbone of the AI economy. But as spending rises, so too does the pressure to generate returns.

“Now, the market is starting to take a different view on how sustainable these projections really are, and what we saw toward the back end of 2025 was different companies being rewarded or punished in very different ways.

“We’ve seen a sell off across several major tech companies in recent months. As a result, investors are being punished, software companies are being punished, and the hyperscalers are being looked at very differently to how they were only twelve months ago.”

Arnold says debt is the second pressure point emerging in the sector.

“The combination of increased levels of debt and an inability to catch up on revenue expectations can become a real problem,” Arnold says.

“Share prices went up when the story around the growth potential of AI was positive. Now, as valuations have soared, we’re starting to see that optimism temper.”

The third and perhaps most important factor impacting investment is demand.

“As innovation occurs at a rapid rate, demand is becoming harder to track, but it remains the most influential factor. We spend a lot of time going through the AI tech stack asking whether demand is actually justifying the capex we see today,” Arnold says.

“Companies building AI infrastructure argue the spending is necessary because they are seeing the demand. Markets, however, are looking at these numbers and becoming more sceptical.”

Arnold says this has been most clear in software companies. The recent sell-off reflects a growing concern that some software companies may struggle to defend their business models in a world dominated by large language models.

However, Arnold believes some areas of the market will prove more resilient than others. Businesses that operate in environments where accuracy is critical, where switching systems is difficult, or where regulation creates barriers to entry are likely to maintain stronger competitive positions.

“If a company’s value is based purely on a publicly available data set, then a large language model is going to commoditise that,” Arnold says.

“Areas where there isn’t a tolerance for errors will likely be more protected.

“Similarly, companies that control proprietary data or have high switching costs embedded in their products may be better placed to defend their margins.”

As the AI investment cycle continues to accelerate, Arnold says investors will increasingly focus on these fundamentals rather than broad narratives about technological disruption.

“The market is moving beyond the excitement of the disruption theme, and for stock pickers it means there are opportunities to outperform. But it also comes with a higher level of risk,” Arnold says.

“What if AI turns out to be less ‘bubble versus boom’ and more a stress test for who can actually turn US$660 billion of capital expenditure into revenue?

“What matters now is whether the spending we’re seeing today can actually turn into sustainable revenue tomorrow.”

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Sebastian Mullins

Investors are facing a fundamentally different market environment in 2026, with structurally higher volatility, greater government intervention and a need for more selective asset allocation, according to investment experts at Schroders.

Sebastian Mullins, head of multi-asset and fixed income, and Ben Arnold, investment director, global equity, say the post-GFC era of low inflation, low volatility and passive returns has given way to a new regime that demands a more active approach.

Mullins says that markets have transitioned into a period that more closely resembles historical norms than the unusually benign conditions of the past decade.

“We’ve moved into a new investing regime, one with higher inflation, more government intervention and greater volatility. That’s not a short-term phenomenon, it’s structural.”

Mullins notes that fiscal policy has become a central driver of liquidity and market outcomes, overtaking the role traditionally played by monetary policy. Defence spending, energy security, supply chain resilience and AI infrastructure investment are all contributing to sustained government intervention and higher debt levels globally.

“The invisible hand of free markets has been replaced by a very visible hand of government. That has far-reaching consequences for asset allocation. In this environment, inflation is likely to remain higher for longer, as governments seek to manage rising debt burdens through economic growth rather than fiscal restraint.”

While equities remain attractive relative to bonds, Mullins cautions that traditional diversification assumptions can no longer be relied upon.

“Investors should think of fixed income as an income strategy rather than a source of portfolio protection in an inflationary environment. Bonds now pay you income, but they no longer provide the protection investors once relied on.

“Asset allocation needs to be far more dynamic,” he says.

Arnold says artificial intelligence continues to be a powerful driver of earnings growth, but investors must be increasingly selective.

He points to rising leverage and unprecedented capital expenditure among some technology companies as early warning signs, noting that long-term winners will be determined by real-world adoption and sustainable margins rather than headline investment announcements.

“The key question isn’t how much companies are spending on AI, it’s whether adoption and returns justify that investment. Adoption will ultimately determine which companies succeed and which fall behind.”

He says the dominance of US mega-cap technology stocks is starting to unwind, with performance diverging significantly within the group commonly referred to as the “Magnificent Seven (Mag 7)”.

“Lumping all mega-cap tech stocks together is risky. These are very different businesses with very different outcomes, and the market is becoming more discerning. Five of the seven Mag 7 stocks underperformed the broader US market last year, highlighting the growing dispersion within mega-cap technology.

“Lower correlations within mega-cap tech signal a healthier equity market and reinforce the case for active stock selection,” he says.

Both Mullins and Arnold highlight improving opportunities outside the US, particularly in parts of Europe and select emerging markets, where valuations remain more attractive and earnings upgrades are emerging.

“You don’t have to own US mega-cap tech to access growth,” Arnold says. “There are compelling opportunities across Europe and other regions that investors have overlooked in recent years.”

Arnold says select European financials are examples of businesses benefiting from structural reform and earnings upgrades. He points to Italy’s Intesa Sanpaolo for its transformation into a stronger asset management-led business, and Austria-listed Erste Bank as a market leader across parts of Eastern Europe benefitting from earnings upgrades not yet fully reflected in market valuations.

Mullins notes that peripheral markets such as Italy and Spain delivered strong returns, challenging outdated perceptions of the region.

“The PIGS are now flying. These markets were up 60 per cent last year. There are compelling opportunities across Europe for investors willing to look beyond the obvious.”

Turning to domestic markets, Mullins says Australia stands out among developed economies for persistently high inflation, increasing the likelihood of further interest rate hikes, the opposite of that of the United States, where rate cuts are increasingly expected.

“Australia’s inflation challenge sets it apart from global peers. That has important implications for local interest rates and asset allocation decisions.

“With inflation still above target and employment running strong, the RBA has limited room to ease, making the outlook for Australian rates very different from the US.”

He adds that while global opportunities are broadening, Australian investors must remain focused on balancing income, inflation protection and risk as markets move further into a new cycle.

“Investors can’t rely on old playbooks in this environment. With inflation higher for longer and correlations changing, portfolio construction needs to be more deliberate and more dynamic.”

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