2026 PE Outlook: AI, Capital Cycles, and the Return of Deal Flow

December 2025

In a few weeks, we will be entering 2026 with a global economy that is structurally resilient. It will be volatile but growth will be positive, inflation will be moderating and the cost of capital will be declining. And AI will be rewriting the operating assumptions for nearly every asset class.

Deal activity will likely accelerate. The deal dam may finally break with strong momentum exiting 2025. But the environment will be bifurcated: the gap between the best-positioned firms and the median will widen, and the primary return driver will shift decisively from multiple expansion to operational improvement.

Here is my framework for the year ahead.

Macro Backdrop

The dominant forces shaping markets in 2026 will be AI-driven capital expenditure, positive but decelerating GDP growth, cooling labor markets, and a likely reduction in interest rates.

Cooling inflation and easing labor markets will improve cash flow predictability across PE portfolios
Shelter inflation will be running well below official CPI measures, implying headline CPI will be closer to 2%. This will create a credible path for two to three 25bp rate cuts over the course of the year
Lower rates will materially improve deal feasibility, equity returns, and the economics of refinancing stressed capital structures
Key risks will remain concentrated in geopolitics (trade policy, regional conflicts), energy prices (AI-driven power demand vs. generation capacity), and fiscal deficits (US debt trajectory remains unsustainable long-term)
Uneven consumer demand will reinforce the need for customer segmentation and pricing discipline at the portfolio company level

Volatility without structural impairment will create opportunity. Investors who mistake noise for signal will underperform. Investors who use dislocations to deploy capital into durable businesses at reasonable prices will generate outsized returns.

AI: The Big Secular Driver

AI will be the single most consequential economic force in 2026. The speed of adoption will be unprecedented in 2026, and the capex cycle required to support it will be massive and multi-year in duration.

What will make this cycle structurally different from past technology booms:

Hyperscalers will continue funding data center buildouts, chip procurement, power infrastructure, and connectivity upgrades largely from operating cash flows rather than leverage. This will not be the fiber-optic buildout of 1999-2001. The balance sheet risk profile will be fundamentally different.
AI spending will drive a multi-year capex cycle across data centers, power, chips, and connectivity with no signs of deceleration
Productivity and margin impact on the broader economy will still be early. The real economic impact that shows up in productivity statistics and corporate earnings will be a 2027-2030 story. In 2026, the primary beneficiaries will remain the infrastructure layer.

For PE-backed companies, the implications will be immediate:

Focus will shift from AI enablement to actual application within portfolio companies
Productivity and margin gains from AI will remain underpenetrated at the operating company level
ROI visibility on AI investments will be uneven, making diligence capability and operational expertise critical
PE firms will be able to arbitrage public market hype by applying AI pragmatically in private companies
AI will change how buyers evaluate and purchase technology. Validation cycles will become more rigorous as procurement teams use AI tools to mechanically assess vendor claims. Traditional relationship-based selling will lose effectiveness.
Portfolio companies that have not adapted their GTM motions to account for AI-informed buying processes will face longer sales cycles and higher customer acquisition costs

PE Valuations and Deal Environment

The S&P 500 returned approximately 16% in 2025 and trades at 22x forward earnings, well above the 15-year average of 17x. Historically, PE has outperformed when public valuations were at these levels. The widening gap between public and private valuations will present opportunity.

Valuations:

Buyout valuations will remain elevated but not disconnected from earnings growth, with dispersion widening across asset quality
Holding values will appear slightly overstated at the median, with GPs increasingly willing to accept 11-20% discounts to drive liquidity
There will be no clear macro catalyst for broad multiple compression, meaning value creation (not multiple expansion) will be the primary return driver
Earnings growth at exit will matter more than it has in a decade

Deal activity:

Global M&A will rebound as cost of capital drops and pent-up demand releases
Sponsor-to-sponsor and public-to-private deals will accelerate as exit markets reopen
Smaller and mid-market companies will be increasingly targeted for add-ons and consolidation
Complexity will remain an attractive entry point. Complexity creates mispricing.
IPO windows will improve, supporting realizations and NAV momentum

Financing:

Credit markets will reopen with better liquidity, but underwriting discipline will matter more than ever
Leverage appetite will shift toward resilient capital structures and covenant protection
Private credit demand will rise alongside PE volume, including mezzanine and structured solutions
Vintage risk from 2021-2022 deals will surface, creating refinancing and rescue opportunities

The Fundraising Challenge and Exit Imperative

PE fundraising will remain a challenge. GP demand will continue to exceed LP supply, particularly in the middle market. That imbalance will be reinforced by a growing DPI gap.

After several years of limited realizations and hold periods expanding to 7+ years from approximately 5, LPs will be increasingly focused on distributions to rebalance portfolios, address liquidity needs, and support commitments to new vintages. This dynamic will push PE managers to accelerate value realization, often through tighter sale processes or less traditional exit paths.

Exit environment:

IPO and secondary exit pipelines will improve versus 2022-2024, with the strongest pipeline since 2021
Strategic buyers will return as balance sheets strengthen
Exit differentiation will be driven by operational maturity, AI readiness, and margin durability
The resulting timing gaps and liquidity pressures will create a cohort of motivated (and in some cases compelled) sellers
LP appetite for new commitments will be directly tied to the pace of distributions. A meaningful uptick in exits will begin to restore the capital recycling dynamic that sustains the PE ecosystem.

Labor and Inflation

The labor market will continue cooling, and AI will accelerate the trend. Not through mass displacement (that narrative is premature), but through attrition management, task automation, and the deferral of incremental hiring decisions. Employers will find that existing headcount, augmented by AI tools, can absorb workloads that previously required new hires.

Workforce productivity and redesign will become central to EBITDA growth
Cooling labor costs will improve margin predictability, particularly for services-heavy portfolio companies
The combination of labor market slack and declining shelter inflation will give the Fed room to cut without reigniting inflationary pressure

Value Creation Playbooks: Operating Alpha

Operational improvement will be the primary return driver. Not multiple expansion. Not financial engineering. The era of loading portfolio companies with 7-8x debt to juice equity returns will be over for the foreseeable future.

What will differentiate top-performing firms:

Capital-heavy to capital-light transformations as a core value creation lever
Margin expansion through automation, digitalization, and AI adoption
Active ownership and hands-on execution at the portfolio company level
Revenue growth, pricing power, and balance sheet durability as the key differentiators
Sales force effectiveness, pricing optimization, and revenue operations as the operational levers that drive terminal value

For the top decile of PE funds, the story will be constructive: US portfolio companies will exhibit healthy revenue growth, continued EBITDA margin expansion, and strong balance sheets with historically low interest expense. These firms will have learned from the 2022-2023 rate shock and will continue exercising discipline on leverage.

The less favorable story will apply to the long tail of PE-backed businesses, particularly those in cyclically exposed sectors or acquired at peak multiples in 2021 with aggressive capital structures. Dispersion in fund-level returns will reflect this divergence.

Sector and Thematic Priorities

Digital infrastructure and power: Structural demand from AI will create a generational investment cycle in data centers, power generation, transmission, and cooling
Defense, infrastructure, and security: Will benefit from geopolitical realignment and economic security priorities
Services over goods: Will be favored for capital efficiency and pricing resilience
Real assets and infrastructure: Will offer inflation linkage and long-duration cash flows
Select healthcare, pharma, and financials: Will be positioned to benefit from potential deregulation
Real estate: Cyclical recovery will be underway with reset valuations, falling financing costs, and collapsing new supply

The Case for Private Markets

The structural case for private market allocations will strengthen in this environment.

Concentration risk: The top 10 S&P 500 stocks will account for an unprecedented share of index market cap. Passive equity allocations will increasingly be a concentrated bet on a handful of mega-cap tech companies.
Weakened diversification: The negative stock-bond correlation that supported 60/40 portfolios for two decades will no longer be reliable
Shrinking public universe: The number of US public companies has declined roughly 40% since 1996. The majority of large, profitable companies will remain private. Investors limited to public markets will be systematically excluding a large and growing portion of corporate value creation.
Private credit: Will offer structural excess returns above public fixed income, with defensive characteristics. Focus will be on larger EBITDA companies with predictable cash flow profiles.
Infrastructure: Multi-decade runway will be driven by AI power demand, electrification, and decades of underinvestment in physical assets

Portfolio construction priorities:

Quality, resilience, and downside protection
High-grading portfolios: better counterparties, assets, and capital structures
Less reliance on multiple expansion, more on operational and strategic levers
Increased focus on relative value across asset classes and geographies
Asia and Europe will remain under-allocated with improving fundamentals

Bottom Line

2026 will be defined by three forces: accelerating AI adoption, increasing return dispersion across managers and asset classes, and a reopening of transaction and exit markets.

The advantage will accrue to scaled, data-driven investment platforms with long-duration capital and proprietary operational capabilities. Financial engineering alone will not generate alpha when entry multiples remain elevated and leverage is constrained. The firms that can drive genuine business improvement at the portfolio company level, particularly in revenue growth, pricing, and go-to-market effectiveness, will separate from the pack.

The gap between the best and the rest will be wider than it has been in over a decade. Selectivity, operational capability, and disciplined capital deployment will be the differentiators that matter.