Three investment themes to prepare for in 2026: defense names may continue to lag despite record backlogs and higher military spending because fixed‑price development programs, rising program complexity and governments’ stronger bargaining power are squeezing margins—illustrated by multibillion‑dollar charges at Boeing, Lockheed and RTX—and a de‑escalation of conflicts or fiscal constraints could further dent sentiment; the AI trade should broaden beyond infrastructure winners (Nvidia, Vertiv) toward software firms that embed AI to monetize operational data and drive durable revenue growth (PTC is highlighted as an example) as infrastructure valuations look stretched; and a potential easing of inflation and Fed rate cuts next year could revive housing affordability and create a reflationary tailwind for beaten‑up, interest‑sensitive cyclicals such as Whirlpool and Stanley Black & Decker, prompting a rotation into rate‑sensitive equities if the macro outlook normalizes.
Major defense contractors have underperformed the broader market despite record order backlogs and increased military spending commitments (NATO aim of 5% of GDP by 2035), because fixed-price development programs and rising technical complexity are compressing margins. Boeing, Lockheed Martin and RTX have reported multibillion-dollar losses and charges on programs, illustrating how government monopsony bargaining and cost overruns are translating backlog into uncertain profitability. The AI theme is shifting from infrastructure winners toward companies embedding AI in software to monetize operational data; Nvidia and Vertiv drove outsized returns on the infrastructure side, and even Caterpillar’s rally reflected AI tangential exposure. PTC is highlighted as an example of a software vendor positioned to convert industrial digitalization and AI analytics into steadier sales growth. Macro dynamics suggest a potential rotation to interest-rate-sensitive cyclicals if inflation eases and the Fed can cut rates in 2026: market rates fell in 2025 but housing affordability remained constrained while house-price growth slowed. Companies such as Whirlpool and Stanley Black & Decker would benefit from a genuine improvement in housing affordability, but the trade depends on durable disinflation and policy confirmation.
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