Clyde Rossouw: Head of Quality, Ninety One. 
History shows that when cyclicals are priced as defensives and defensives as cyclicals, a great rotation is rarely far away.
Market leadership rotated sharply during 2025. Early in the year, political uncertainty and heightened growth concerns following the ‘Liberation Day’ tariff shock weighed heavily on the Magnificent 7, as well as on momentum and growth factors more broadly. Passive quality strategies, tilted towards these exposures, followed the market lower. In contrast, a fundamental quality approach, with its focus on resilient fundamentals, fared better, offering robust defence in the face of the sharp sell-off.
Later in the year, after the implementation of tariffs was postponed and then substantially eased, momentum once again led markets higher and tech mega-caps reasserted their dominance. Towards the end of the year, rising valuation concerns within AI led to an uptick in risk-off sentiment. Once again, quality – particularly a purist quality approach – delivered smaller drawdowns than the broader market.
While the AI revolution is undeniably real and the underlying technology is potentially more transformative than the early internet years, the current level of spending may have pulled forward years of future earnings and demand for infrastructure suppliers. There will inevitably be digestion periods, inventory corrections and temporary slowdowns in the pace of the buildout. Businesses that rely on massive, coordinated capex plans from a handful of the world’s largest companies are, by definition, cyclical.
For much of 2025, the market largely shrugged off this cyclicality. Investors chased safety in growth, convinced that the irresistible force of AI could defy global business cycles. History suggests otherwise. Capex cycles can reverse quickly, and if sentiment changes, the fallout could be significant. High starting multiples offer little protection when the market abruptly remembers the cyclical nature of these businesses.
Looking ahead, market leadership may begin to broaden. A wide swathe of high-quality businesses across software, IT services and information services has been indiscriminately de-rated. The market’s fear is simple: AI will automate their workers, disintermediate their products or undermine their data moats. Ironically, only a few years ago, these businesses were expected to be the primary monetisers of AI.
Many now trade at or below market-level valuations, despite recurring revenues, high switching costs and asset-light business models. Their high subscription retention rates may ultimately prove more defensive and durable than the long-range forecasts underpinning much of the AI infrastructure trade. Fundamentals have not changed; sentiment has.
Another area the market may be underestimating is AI’s potential impact on pharmaceutical innovation. Large pharmaceutical companies spend heavily on research and development each year. If AI can improve pipeline quality, accelerate drug discovery and reduce uncertainty, these businesses could deliver far better outcomes for the same dollar of spend. Yet this opportunity is not reflected in the valuation of many of these stocks, which have fallen out of favour based on the view that they are not technologically driven.
Traditional defensives may also return to favour. In 2025, they were caught between a rock and a hard place in a momentum-driven market, lacking the excitement of AI exposure while remaining dependent on squeezed consumers. In a more uncertain macroeconomic environment, and with a less dominant AI narrative, their defensive quality attributes should once again prove valuable.
The investment landscape entering 2026 is therefore marked by cognitive dissonance. Weak consumer conditions coexist with markets bidding up highly cyclical AI infrastructure suppliers to defensive status, while some of the most predictable recurring-revenue businesses in corporate history are priced for failure.
True defence is not found in chasing momentum into cyclical extremes, but in identifying resilient cash flows being offered at a discount because they lack a positive AI narrative. When the market refocuses on fundamentals, some of the perceived ‘AI losers’ may yet come to the fore.
DM
Author: Clyde Rossouw, Head of Quality at Ninety One