The Performance Chasm: Is the AI Rally Over or Just Shifting Gears?

The 2026 rotation: Temporary blip or new regime?

The first weeks of 2026 have been characterized by what analysts are calling ‘the Great Rotation.’

As of January 14, the Russell 2000 Index (INDEXRUSSELL:RUT) had outperformed the Nasdaq Composite (INDEXNASDAQ:.IXIC) for 10 consecutive sessions, the longest streak since 1990.

In the first two weeks of 2026, the Russell 2000 surged nearly 7 percent, while the Nasdaq and S&P 500 (INDEXSP:.INX) remained largely rangebound, gaining only around 1 to 2 percent.

When asked if that means the laggards will finally start commanding a larger piece of the pie, Farias was realistic.

“We continue to believe the market will be dominated by a few stocks,” he noted. “It’s the nature of the internet boom moving into the AI boom … the profits will remain in the hands of a small list of companies.’

However, Farias acknowledged that the stock market rally is finally broadening.

While large-cap tech companies remain the engine, he pointed to scattered winners in non-AI sectors such as retail, which have shown resilience even as tech valuations have become stretched.

Has AI rewired capital flows?

The fundamental question for 2026 is whether AI has permanently diverted capital away from traditional sectors like industrials and consumer staples. Farias suggested the shift is practical rather than just speculative.

“A lot of companies are very focused on AI to reduce costs and automate as much as possible,” he said. “If that’s where you’re spending a lot of time, you’re spending less time on other areas. The money goes in the same direction.’

This rewiring is visible in the State Street Utilities Select Sector SPDR ETF (ARCA:XLU). Traditionally a defensive, low-growth play, it soared 21 percent last year, benefiting from the exploding energy appetite needed to run AI models. Despite its recent pullback, structural demand remains.

Measuring AI tilt and managing risk

With the S&P 500 currently trading at a price-to-earnings ratio of 31.37, many investors wonder if they are overexposed to a potential AI bubble. Farias uses a disciplined approach to measure AI tilt within portfolios.

“A simple way to do it is we look at days when AI stocks are down and look at how we’ve done,” he said. To manage concentration risk, his firm typically limits individual stock exposures to between roughly 5 and 6 percent.

The challenge for 2026 is that the top 10 companies now account for over 40 percent of the S&P 500’s total market cap. Farias argued that this concentration is somewhat justified by profitability.

The rebalance: Where is capital moving?

If an investor decides to trim their winners, where is that money likely to go in 2026?

Farias identified several ripple-effect sectors that could benefit from AI indirectly:

Looking for mispriced opportunities

While the AI frenzy has made most of the tech sector expensive, Farias sees a catch-up phase coming in the small-cap space, which has lagged for years, but is finally showing signs of a sustained reversal.

In contrast, he remains cautious on healthcare and energy.

“Healthcare is challenging … if you buy State Street Health Care Select Sector SPDR ETF (ARCA:XLV), you get too much large-cap exposure, which is somewhat stagnant,” he noted.

Instead, he prefers targeted plays like the iShares US Medical Devices ETF (ARCA:IHI). As for energy, while holding positions, he is “not particularly bullish” despite the recent rotation.

Balanced playbook for 2026

For Farias, the AI rally isn’t over, but it is changing shape. The winners-take-all dynamic of 2025 is giving way to a more complex 2026, where market breadth matters more than just momentum.

For investors seeking a balanced path, he and other analysts suggest a mix of AI offense and defensive value. This means staying tethered to the AI growth engine through low-cost ETFs like the Invesco ESG NASDAQ 100 ETF (NASDAQ:QQMG) or State Street SPDR Portfolio S&P 500 ETF (ARCA:SPYM), while capturing the rotation by selectively adding small caps and financials, which Farias said are emerging as an attractive area for 2026.