Key Points Summary

1. AI and Tariffs Define 2026-More So Than 2025
2. AI/IT to Drive Economic Growth–More Than Past “Outsized Role”
3. Specific Small Language Models Returns Could Outperform LLMs
4. AI Reshapes Society and Politics—New “AI MAGA”
5. “New” Fed Rapid Rate Cuts—Steepens Curve—Fiscal Needs Dominate
6. Investors Prefer Split Congress in Midterms
7. Domestic Equities—A World of Change-Diversify-Quality Firms Precious Metals- Target AI-Beyond “Mag7”
8. International Equities—Tariff Regime–Look to Non-U.S. investment Opportunities—Asia/Pac—Selectively Europe
9. Fixed Income—Narrow Spreads–Not Rewarded for Assuming Credit Risk—Treasury Notes-Agency Paper—Select Private Credit

AI and Tariffs Define 2026-More So than 2025—Aggressive Rate Cuts Lift Equities—Investors Pefer Split Congress in Midterms

The new American Revolution—AI and tariffs–will shape 2026 more dramatically than 2025. AI accelerates its transformative impact, boosting economic productivity and growth through decade’s end. The tariff regime alters global trade patterns pushing economies toward intra-regional models increasing international investment opportunities. A new Fed Chair will drive more aggressive rate cuts, lifting equity markets. Mid-term elections will likely flip House control, widening the partisan divide. Investors typically prefer a split Congress.

AI/IT to Drive Economic Growth—More Than Past “Outsized Role”

A recent Chicago Fed Letter highlights IT’s “outsized role” in U.S. economic growth over forty years. The study measures total factor productivity (TFP), which evaluates economic efficiency by excluding labor and capital growth. TFP serves as a proxy for technological advancement. IT accounted for 45% of productivity (TFP) growth over forty years (see Figure 1.) AI and IT advancements will drive significant future economic growth, despite limited workforce growth and inflated costs, to a greater degree than in the past, through productivity improvements.

Figure 1
Cumulative Total Factor Productivity (TFP) Growth in Information Technology and Non-IT Sectors—1988-2023

Sources: Chicago Fed, U.S. Bureau of Labor Statistics, U.S. Bureau of Economic Analysis,

Specific Small Language Models Could Outperform Big InvestorsBroadening Sources of Productivity

IT sector productivity growth outpaced non-IT growth, extending beyond the dot-com period for forty years (see Figure 2.) Future economic growth will concentrate on AI/IT, contrasting with past growth that spreads more widely across the economy. AI will broaden the productivity sources that power the U.S. economy. With this outlook, investors must identify companies that generate sufficient returns, which justify their massive capital spending. Companies that develop and train small language models (SLMs)for specific tasks, such as by financial firms or government agencies, may provide better returns than those that deploy large language models (LLMs).   

Figure 2
Average Total Factor Productivity (TFP) Growth in IT and non-ITSectors by half-decade, 1988-2023.

Sources: Chicago Fed, U.S. Bureau of Labor Statistics, U.S. Bureau of Economic Analysis

AI Reshapes Society and Politics—New “AI MAGA”–Increased Demands for Federal Social Programs

Generative AI boosts the U.S. economy while reshaping society and politics affecting financial markets and investment returns. Automation and China trade reduced blue collar jobs, sparking populism and MAGA which led to Trump’s election. In contrast, AI will likely diminish white collar jobs, becoming more evident in 2026 (see Figure 3.) College graduates, facing unmet career expectations from the “overproduction of elites” and sizeable student loans may rally around new populist movements. This shift could further divide the country by income groups. This populism might escalate demands on social programs, straining the federal budget. Treasury markets could face additional pressure from these demands.

Figure 3
Gap Between Actual and Expected AI Usage by MajorOccupation

Sources: BLS, Etoundou et al, Anthropic, The Budget Lab

“New” Fed Rapid Rate Cuts—Steepens Curve—Fiscal Needs Dominate

The transition into 2026 begins with nominating a new Fed Chair for the 14-year Board seat opening in January. Jay Powell steps down on May 15th, ending his term early. The new Fed chair then begins a four-year term. Two Trump appointees in 2026 increase the dovish faction, widening the existing FOMC split (see Figure 4.) The “new” Fed will likely prioritize employment over inflation. Expect faster, larger rate cuts to moderate the budget’s rising interest costs. Growing inflation and Treasury supply concerns will likely steepen the curve benefitting financial and levered mid-caps. The Treasury may coordinate more closely with the Fed to manage its borrowing mix amid growing deficits. The government will rely more on short-term paper to finance deficits, leveraging lower short-term rates to reduce the budget’s interest burden (see Figure 5.) The “new” Fed board will likely raise independence concerns as fiscal demands predominate over monetary policy.

Figure 4
Federal Reserve Open Market Committee Dove-Hawk*

*Regional Presidents Voting on the FOMC: Collins, Goolsbee, Musalem, and Schmid Source: BofA Global Research

Figure 5
Gross Issuance of U.S. Treasuries

Sources: Securities Industry & Financial Markets Association, Macrobond, Apollo Chief Economist

Investment Conclusions—Uncertain AI Winners: Over the next 5-10 years, the “New American Revolution”—driven by AI and tariffs– and its global impact will force investors to reassess their investment focus. Massive AI infrastructure spending and strategic tariff use to rejigger material sources and supply chains will influence this shift. A previous Commentary (10/10/2025) enumerated trillions in global data center capital expenditures that will continue to stimulate the economy. Each company assumes its massive data center investments will achieve full utilization. The question remains whether the revenue curve will support these assumptions (see Figure 6.) History suggests that returns will more likely favor companies–both private and public–that provide alternative products and services. These companies will leverage data center capacity to develop and train small language-specific models that enhance productivity.

Figure 6
Relative Performance of Top Decile in LTM Capex YoY vs. theEqual Weighted S&P 500 (1986-9/25)

Sources: BofA Equity & Quant Strategy, FactSet

Domestic Equities—A World of Change-Diversify-Quality Firms-Precious Metals— : Massive AI spending injects economic stimulus, overcoming uncertain employment, inflation, and tariff outlooks. At the same time, markets narrow and trade at elevated valuations (see Figure 7.) Diversify strategically. Select quality firms that demonstrate sustained earnings growth, maintain strong balance sheets, and reward shareholders through increased dividends and buybacks. Add precious metals and selected digital assets for diversification amid lower rates and rising global uncertainties.

Figure 7
S&P 500 Sector Forward P/E

Source: The Daily Shot

Domestic Equities–Target AI-Beyond “Mag7”: Target companies beyond the “Mag 7” that build specialized language models to boost productivity and create competitive advantages. Stagnant workforce growth will likely accelerate adoption of AIpowered automation and robotics.

International Equities—Tariff Regime–Look to Non-U.S. Investment

Opportunities—Asia/Pac—Selectively Europe: Post “Liberation Day,” even if the Supreme Court overturns IEEPA, shifting geopolitical and economic relationships accelerate a refocus on trading among countries and regions, diminishing U.S. importance in globalization. Diversify into non-U.S. markets using actively managed funds led by experienced global managers who invest selectively in Europe and more broadly across Asia/Pacific.

Fixed Income—Narrow Spreads–Not Rewarded for Assuming Credit

Risk—Treasury Notes-Agency Paper—Select Private Credit:  Narrow spreads

between corporate and Treasury yields compress returns for assuming credit risk, prompting a focus on intermediate Treasury notes and Agency paper. Tight public spreads and lower interest rates create selective opportunities in private credit, which accesses growing U.S. industry segments unavailable publicly, delivers more attractive yields, and increases diversification during “The New American Revolution.”