Focus on the ‘Picks and Shovels’

The idea:
If you look at the Russell value index versus the Russell growth index, value is outperforming growth right now. The Russell growth index has a lot of firms that are being disrupted by AI — software, media and others. Meanwhile, the value index has only 15% AI-distruptive exposure. This index is made up of the “picks and shovels” of the economy: utilities, electric, machinery, transportation, auto. We believe these areas are not only AI-insulated, but are AI beneficiaries.

Agriculture is a good example. The agricultural cycle, and productivity around it, is an attractive investment. The agricultural land under cultivation isn’t growing in acreage, but the population is growing and what we need to eat requires more input.

The strategy:
Agricultural machinery is key to getting more productivity within the acreage. Seeds, fertilizer, machinery are all important to boosting production. The companies operating in this space tend to be large, well-established players with strong execution capabilities. Over time, they have demonstrated sustained pricing power, driven by innovation. Although the agricultural cycle is currently in a downturn and crop prices are low, these supporting businesses are well-positioned and we believe have the potential to benefit when the cycle eventually recovers.

The big picture:
There is ongoing debate about AI’s downstream impact and the level of capital expenditure it will drive across the economy. For investors seeking exposure that is less dependent on these outcomes, materials and industrial manufacturing offer compelling opportunities. These are structural winners that are not directly tied to AI and can perform well across a range of scenarios, regardless of how AI-related debates unfold.

However, there are risks. The current geopolitical environment could keep oil prices elevated, which would increase fertilizer costs and potentially delay a recovery in the agricultural cycle. Crop prices are already low and their trajectory remains uncertain given recent global shocks.

If farmer profitability is further pressured by higher input costs (such as fertilizer) and weak crop prices, the current down cycle could persist longer than expected.

Small Industrials Are the Big Play

The idea:
The story is straightforward: The US economy remains heavily dependent on the rest of the world for a wide range of goods — just look at the trade deficit. That dependence becomes especially problematic during periods of contracting globalization.

As a result, there is a growing need for the US to rebuild its domestic manufacturing base. And small- and mid-cap industrial stocks have outperformed the market. We believe there’s an American industrial renaissance underway that started more than a decade ago.

The strategy:
Small-industrial stocks are notoriously cyclical and expensive, which tends to keep investors away. While valuations are not meaningfully discounted, you are getting stocks with significant secular earnings potential. Failing to invest in industrials, but discussing the risks for the US of being dependent on other countries for goods, is akin to saying “we want to transport more goods but are unwilling to build more roads.”

One particularly attractive industrial subsector is energy distribution. Modernizing the electric grid is essential to economic growth and reindustrialization. Today, much of the US grid still relies on decades-old aluminum and copper technology. By upgrading to carbon-based conductors, the country could increase grid capacity by an estimated 20% to 30%. This subsector is both capital-starved and structurally important. There are relatively few companies operating in this space, yet the need for investment is significant and growing. Demand is only increasing as energy-intensive industries — particularly data centers — continue to expand. It will be virtually impossible to reindustrialize the US economy and regain some element of economic independence without modernizing US industrial infrastructure.

The big picture:
Long-term investment opportunities are often driven by the scarcity of capital. Ideally, you want to be the only banker in a town full of borrowers — that’s where the strongest long-term returns are generated. In contrast, when capital is abundant, borrowers tend to receive free capital and investors are often short-changed. While AI is a compelling economic narrative, it is less attractive from a long-term investment perspective due to its significant overcapitalization. In contrast, many parts of the old economy remain underinvested and overlooked, creating more attractive opportunities for patient capital.

Slow and Steady Wins the Race

The idea:
The AI boom has created a small group of winners that have experienced enormous growth and valuations, widening the gap and making everyone else seem like they’re losing. However, many companies are performing well in their own right.

Take credit card and payment companies, for example. These firms have been growing at a normal pace — or even faster than their historical averages — but that growth appears modest compared to AI-driven companies. This has created a disconnect between stock price performance and underlying business fundamentals.

It’s a classic tortoise-versus-the-hare dynamic. These consumer-focused businesses tend to grow slowly and steadily over time.

The strategy:
While there are always risks in the consumer finance sector, incumbents — particularly in credit cards and payments — benefit from strong network effects. Their extensive partnerships with businesses make them difficult to disrupt, even with technological advances.

Companies with broad exposure to both high- and low-end consumers tend to perform well, even when the broader economy is shaky. While lower-end consumers have been relatively neutral for payments businesses in recent years, strength from higher-end consumers has persisted.

There’s no sweeping narrative or clear catalyst here — just steady, incremental growth year over year. Some payments stocks have declined, moving from premium valuations to more reasonable levels, which may present attractive opportunities for investors.

The big picture:
Looking at historical analogs of economic disruption, like railroads, stocks in those sectors often experienced their strongest growth and highest market capitalizations early in their adoption cycles. While AI is booming today, history suggests that dynamic will eventually shift. And when it falls from its peak, the market will come back to these companies that are grinding along.

Foundations of the AI Buildout

The idea:
Value is outperforming growth year-to-date, echoing the dynamic in early 2025 amid tariff-driven volatility. Certain value sectors, in particular, have remained resilient despite geopolitical uncertainty – most notably, energy. The sector has been a standout performer this year. However, sentiment may shift again at some point, so investors should anchor their investments in the value sectors that are underpinned by strong earnings growth and secular tailwinds. Materials and utilities stand out here.

The strategy:
The sector dispersion this year has been striking: Although the S&P 500 is down year-to-date, six of the 11 S&P 500 sectors are still positive. Many are the traditional value sectors: energy, industrials, consumer staples, utilities, real estate and materials. Looking underneath the hood, 65% to 95% of stocks within each of these sectors are beating the S&P 500 year-to-date, creating a breadth of opportunities. This creates an opportune environment for stock picking within these sectors.

Materials and utilities are both set to grow their earnings by double digits in 2026. From a secular standpoint, these sectors, along with industrials, are key contributors to the AI buildout, as AI winners shift from capital-expenditure spenders to recipients.

The big picture:
The new economy depends on the old economy, it’s no longer an either-or dynamic. Advances in technology are driving increased capital expenditures in traditional sectors, meaning investments in the old economy can complement AI-driven growth.

Strong earnings, relative outperformance, underlying quality and attractive valuations have drawn investors back to these sectors. What will make this especially compelling going forward is how the old economy increasingly intersects with, and supports, the new one.