For Terry Smith, 2025 was not an isolated anomaly but rather the culmination of an exceptionally concentrated market regime. Global equity performance was dominated by an extremely small number of mega-cap technology stocks, led by names linked to artificial intelligence. That concentration has, in his view, reached historic levels comparable to those seen in the United States in 1930. In such an environment, it becomes almost impossible for a diversified portfolio built around quality and valuation criteria to keep pace with an index that increasingly resembles a massive sector bet. For 2026, Terry Smith sees no clear sign of a rapid normalization of this situation, especially as the dynamic is self-reinforcing through flows.
At the heart of his diagnosis is the central role of index funds. The shift of more than 50% of US equity assets into passive management has profoundly changed the way markets function. Far from being neutral, this indexation behaves like a mechanical momentum strategy, systematically reinforcing already-dominant stocks regardless of valuation or the quality of their future cash flows. Terry Smith stresses a key point for the years ahead: as long as these flows persist, the outperformance of the index's biggest names can extend far beyond what fundamentals would justify. Looking ahead, he admits he has no visibility on when this mechanism will reverse, beyond a belief that it will end badly, like all periods of extreme capital distortion.
His view of artificial intelligence is deliberately separated from the market's prevailing enthusiasm. Terry Smith does not dispute either the technological scale or the potential societal impact of AI. He does, however, directly challenge the future profitability of the colossal sums being invested by hyperscalers. The surge in capital expenditure in 2025 and 2026 is, in his eyes, a major test of capital discipline. The decline in free-cash-flow generation at several tech giants, for now absorbed by rising share prices, will ultimately become an issue, he argues. The example of Apple, which has chosen not to enter this infrastructure arms race, illustrates his belief that value creation does not necessarily require direct ownership of the most capital-intensive assets.
For 2026, Terry Smith expects a market still marked by widening valuation gaps. Fundsmith finds itself in a paradoxical position: a portfolio posting returns on capital, margins and cash-flow growth well above those of the major indices, yet valued at multiples that are now below those of the US market. This decoupling between economic quality and stock-market valuation is, in his view, an anomaly that will eventually correct, even if the timing remains unpredictable. His core conviction is unchanged: over a multi-year horizon, prices always end up reflecting fundamentals, not the other way around.
Against this set of forces, the strategic response going forward is almost provocatively consistent. Terry Smith explicitly refuses to adapt his process to chase indices or adopt a momentum-driven approach. He reiterates the three pillars of his management: buy high-quality companies, do not overpay for them and, above all, do nothing unnecessarily. That discipline is nevertheless accompanied by a targeted reassessment, notably of the role of management, after the painful experience of Novo Nordisk (a -3% contribution to his fund). In the years ahead, he intends to be more demanding about management teams' ability to execute, even if that means selling more quickly when they fail.
In the background, Terry Smith's 2026 outlook is that of an investor who knows he is operating in a market he considers deeply unbalanced, yet remains resolutely patient. He neither anticipates an imminent crash nor a swift return to normal, but rather the continuation of an irrational regime fueled by indexation and the AI narrative. His conviction is that this phase, however long and spectacular it may be, will leave heavy disappointments for investors who have confused technological innovation with durable value creation. By contrast, he is betting that fundamental discipline, even if temporarily penalized, will ultimately be rewarded when the cycle turns.
