Resources/Weekly Insights

Volume 15, Edition 3 | January 26 - February 1, 2026

Diversification in a Time of Big Market Delusions

Doug Walters, CFA

Early earnings results are strong, but AI‑driven story stocks may be pricing in more than today’s fundamentals can justify. This week’s Insight explores what to consider when narrative may be outrunning reality.

Contributed by Doug Walters, David Lemire, Max Berkovich, Matthew Johnson

A few weeks ago, we explored the market valuation debates and how they hinge less on today’s prices and more on assumptions about tomorrow’s earnings. We are currently in the Q4 2025 earnings season, and with one‑third of S&P 500 companies now having reported results, we look for evidence of earnings catching up to prices.

To date, 167 companies have reported, with 77.25% beating earnings expectations, meaningfully above the historical average that typically falls in the mid‑60% range. The average “surprise” (how much earnings have beaten by) is 9.2% thus far. While companies routinely “beat,” the magnitude matters — and this quarter’s early pattern is encouraging on the face.

The Big Market Delusion

But strong earnings may not be enough to justify the valuations of some companies in the heart of the artificial intelligence (AI) boom. Exceptional earnings are likely required. The so called “Dean of Valuation” Professor Aswath Damodaran recently noted in his blog that we are living in, what he calls, another “Big Market Delusion.” The concept is simple. One could perhaps justify the valuation of AI innovator ChatGPT at $500B if it wins the large language model race. Likewise, the boost that Google’s valuation has received from ownership of Gemini could be justified if they are the winner. The same could be said for Grok, Claude, and the many other businesses vying for supremacy. But they cannot all win. Damodaran notes that their collective valuation of $1.5T can’t be justified by the less than $100B in combined revenue. He sees this segment as suffering from the Big Market Delusion and that ultimately the market only supports one or two big winners.

Markets can support elevated valuations for extended periods of time when companies deliver. But if prices reflect unrealistic expectations of future assumptions, investors risk leaning too far into hope and too away from fundamentals. Damodaran’s central point is not that AI leaders are doomed — rather, that even great companies can be mispriced when enthusiasm outruns cash‑flow reality.

Enter Diversification

This is where well-diversified portfolios enter the conversation. In the simplest terms, they are about not putting all your eggs in one basket (today – particularly the AI basket). They are not immune to the ups and downs of AI but rather seek to avoid over concentration. Should AI drag the market down at some point, the diversified portfolio has rebalancing levers fixed income, gold, and other segments and geographies of equities to call on.

The takeaway – in the near term, continued positive earnings trends have the potential to keep market sentiment buoyant and close some of the valuation gap. But with the excitement that surrounds the promise of AI comes the risk that too much good news is currently priced in. With the economy still relatively strong, and earnings trends still positive, now is a good time to ensure your portfolio is a well-diversified one.

77.25%

Percent of companies positively surprising on earnings

As a former Wall Street research analyst, I can tell you that companies have perfected the art of sandbagging expectations.

Headline of the Week

The Future of the Fed

Markets closed the week grappling with a pivotal shift in U.S. monetary leadership after President Trump formally nominated former Fed Governor Kevin Warsh to succeed Jerome Powell as Chair of the Federal Reserve when Powell’s term ends in May. Powell is expected to remain on the Board of Governors through the end of his term in 2028, rather than stepping down immediately, a departure from the practice followed by many prior Fed Chairs.

Still, the nomination faces a potentially difficult confirmation path. Senator Thom Tillis (R‑NC) publicly stated that he will oppose any Federal Reserve nomination until the Department of Justice resolves its investigation into Chairman Powell, threatening procedural delays despite acknowledging Warsh as “a qualified nominee with a deep understanding of monetary policy.”

For markets, Warsh is largely viewed as a steady and credible choice. Although Warsh has recently aligned with the President’s call for lower short‑term rates, his prior Fed tenure tells a more orthodox story: he was a vocal inflation hawk and a consistent critic of quantitative easing, particularly its role in suppressing long‑term yields. That history was reflected in Friday’s market response, with a modest sell‑off in long‑duration Treasuries and a steepening of the yield curve as investors began to price a Fed more constrained in its use of the balance sheet.

The Week Ahead

A packed week with central bank rate decisions, employment data, economic releases, and earnings.

A Workout

The first week of a new month brings a barrage of employment data.

The most important is, of course, the non-farm payroll (NFP) report on Friday, but we do get an ADP employment report and Job Openings and Labor Turnover survey (JOLTS) earlier in the week.
After NFP indicated 50,000 jobs were created in December, the expectation of 70,000 jobs created in January does indicate improving labor conditions, solidifying the reason the Federal Reserve kept rates unchanged.
The Institute of Supply Management’s Manufacturing and Services Purchasing Managers Index (PMI) will also be released, with manufacturing expected to improve slightly and services decline.

No Change

European Central Bank (ECB) and Bank of England (BoE) face rate decisions during the week. However, neither is expected to make any changes.

The BoE may not cut rates, but is expected to have a close vote, with Governor Bailey breaking the tie in favor of no change, which will keep hopes alive for a cut in upcoming meeting(s).
The ECB meeting is expected to be less exciting with all members content with inflation and growth as it is.
The ECB meeting is expected to have a heavy dose of tariff and Euro strength discussion.

Capital Expense

Several Magnificent 7 members have already reported earnings; now the baton goes to Alphabet and Apple.

Sure Palantir, Disney, Merck, Pfizer, Pepsi, and Eli Lilly are huge important companies reporting earnings next week, but the big two will overshadow them all.
Google and YouTube parent, Alphabet, is expected to report stellar results, but the market will zero-in on spending, with analysts expecting capital expenditures to climb over 70% for 2026 to nearly $90 Billion.
Amazon, is also expected to report great numbers. The focus will be on growth in AWS the cloud computing unit, and it is expected to have capital expenditures guidance of over $144 Billion to keep up with AI innovation in 2026.
Investors will be analyzing where the two giants intend to spend these huge sums in 2026, looking for hints where AI hype goes next.

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