Capture AI upside while managing Tech volatility

After three years of gains fueled by artificial intelligence (AI), US Technology stocks are experiencing rising volatility as investors question stretched valuations, the scale of AI hyperscaler capital spending, the pace of AI monetization, and the ensuing disruption to established profitability models within the software industry.

Despite near‑term choppiness, we continue to believe Technology will remain a long‑term winner in the AI innovation cycle, supported by accelerating AI adoption across a multitude of verticals and sustained demand for greater AI computing power.

But given the inherently higher volatility that accompanies transformational growth themes like AI, balancing Tech exposure with allocations to Communication Services and Utilities may offer a more stable and resilient portfolio construction strategy for investors participating in the AI theme.

AI demand is powering Tech earnings

Accelerating AI technological development and massive AI data center buildouts have driven strong earnings growth in Technology over the past three years. The sector is expected to see higher earnings growth for the third straight year, becoming the dominant growth engine of US equity earnings (Figure 1). This growth trend has supported the sector’s strong performance since the start of 2023; Tech gained 34% on an annualized basis, outpacing the S&P 500 by 12% annualized over the same time frame.¹

While earnings are expected to remain strong, concerns about the scale of AI capital expenditures (CapEx), the pace of AI monetization, and potential disruption to software business models are driving a re-rating of Tech. The broad sector and the software industry are down 9% and 30% from their October peaks, respectively.² AI hyperscalers like Microsoft and Oracle face near‑term pressure from rising AI capital spending and slower-than-expected ROI, while recent product releases from OpenAI, Anthropic, and Google heighten disruption risks for Software as a Service (SaaS) companies through greater competition and pressure on “sticky” revenue models.

However, hyperscalers’ elevated AI CapEx is helping to relieve immediate capacity constraints—reflected in hundreds of billions of order backlogs³ —supporting robust AI demand and laying the groundwork for future growth. Whether today’s dominant SaaS providers will be displaced by new entrants remains an open question, given the incumbents’ deep integration of enterprise data, strong connectivity across enterprise systems, and high security standards.

High volatility and dispersion within Tech are expected to continue as markets speculate on the eventual winners and losers. But we believe the broad Tech sector will remain a long‑term key beneficiary of the AI revolution.

AI monetization fuels Communication Services’ growth

Communication Services has also benefited from AI advancement, consistently exceeding high-growth expectations over the past three years (Figure 2). AI-driven efficiency gains and revenue growth are likely to continue supporting the sector’s growth momentum. With low consensus growth expectations for 2026, Communication Services may deliver positive surprises given strong AI-driven growth momentum and accelerating advertising spending anticipated from major global events like the Winter Olympics, FIFA World Cup, and US midterm elections.

Top companies in the Communication Services sector, particularly those in the interactive media and entertainment space, are showing more progress in AI monetization near term. Social media and digital search platforms are integrating AI across existing products to enhance user experience through personalized content targeting, such as improved search results and content recommendations, that are increasing user engagement and driving digital advertising revenue growth.

For example, Meta used advanced AI models to enhance its advertising rankings—a move that contributed a 3.5% increase in ad clicks on Facebook.⁴ Meanwhile, Google Search saw increased usage in Q4 after integrating the upgraded Gemini 3 AI model into Google Search, contributing to record quarterly revenue growth of $113.8 billion in Q4 2025.⁵

In addition to interactive media, the entertainment industry is increasingly using AI to streamline the content creation process through the automation of video editing and content generation, as well as the enhancement of 3D modeling in films and video games. These AI strategies are likely to lead to significant cost savings and increased productivity for companies in the industry, with estimates projecting that TV and film production costs could fall by as much as 30%.⁶

Despite the sector’s strong performance over the past three years, its relative valuations remain constructive, with the forward-looking price-to-earnings ratio in-line with the market and below the historical median premium of 7%.⁷ Driven by both earnings growth and multiple expansion, Communication Services has the potential to continue delivering strong returns.⁸

Diversifying with Utilities may help smooth AI volatility

Historically, Utilities has been viewed as a defensive sector, valued primarily for stability and income. However, the rapid build-out of power-intensive AI data centers has driven a structural increase in electricity demand, creating secular tailwinds for the sector that have translated into strong relative performance.

Utilities have notably outperformed other defensive sectors, such as Health Care and Consumer Staples, and income-oriented Real Estate since the end of 2022⁹ —suggesting that the sector is increasingly being re-rated based on its secular growth.

Moreover, despite its AI-related growth driver, the correlation of Utilities with other AI beneficiaries, like Tech and Communication Services, remains low (0.40 and 0.44, respectively).¹⁰ Utilities’ less cyclical demand profile— represented by regulated monopolies with stable cash flows—underscores the sector’s defensive characteristics and positions it as a potential diversifier for investors looking to capture AI-driven growth opportunities.

Adding Utilities to growth-oriented AI exposures may help reduce portfolio volatility and mitigate drawdown risk while capturing upside growth potential. Specifically, since the beginning of 2023, an equal-weighted portfolio of Tech, Communication Services, and Utilities rebalanced monthly outperformed the S&P 500 by 9.2% on an annual basis, but with less volatility and lower drawdowns than Tech, Communication Services, and the broader S&P 500 Index (Figure 3).

Three-sector approach to AI growth promotes portfolio resilience

Despite ongoing debate about AI winners, losers, and valuations, we believe the Technology and Communication Services sectors will be the primary beneficiaries of the AI technological revolution. But the path forward is unlikely to be linear; elevated volatility and dispersion will persist.

In this environment, pairing these AI growth sectors with the lower-correlated Utilities sector may enhance a portfolio’s resilience by helping to potentially improve risk-adjusted returns and mitigate drawdown risk.