I'm not saying they should stop releasing mid tier games. But that's what secondary teams like Monolith and Nd Cube or outsourcing to devs like Namco Bandai are for. A flagship EPD team like Mario Kart crew are too important to waste on games that don't push hardware or bring in the big bucks.

Nintendo only turns to outsourcing if their internal teams can't come up with new ideas for a series, or in the case of the later Yamauchi days, when the don't have dev kits for another Nintendo platform. That's a major reason why F-Zero shifted to NdCube for Maximum Velocity, EAD was silosed away from GBA development. Unless they end up in that creative block, ARMS 2 has no reason to be outsourced. Nintendo doesn't care if the Producer of the Mario Kart series didn't make the next Mario Kart-like 10m+ seller. He's a man who made a successful new IP, that's good enough for them. 

Nintendo has increasingly turned to outsourcing in recent years because EPD can't make HD games fast enough to provide a steady stream of content. Starfox Zero was outsourced to Platinum, Metroid to MercuryStream and reportedly Namco, etc.

It comes back to it simply making no business sense to commit a flagship team to make a game that will be lucky to reach 3 million lifetime when that same team could make the next breakout new hit or 10 million plus seller. ARMS was not a breakout success, it didn't push hardware and it fizzled out and was forgotten inside a year.

Star Fox Zero wasn't actually outsourced to Platinum. The game was developed and designed in house by EAD (it was one of the last games they were working on before the merger). Platinum was brought in to provide production assistance so that the game could meet it's intended Holiday 2015 release, which never happened. Outsourcing would be more like a Yoshi's Woolly World scenario, where an external developer is tasked to design a game, and the only involvement Nintendo has, is a lowly producer overseeing the project. Metroid was mostly outsourced (EPD was still heavily involved BTW) because development started pre-merger which meant that SPD didn't have the same level of staff and talent that EAD had. 

Besides, that was back when the Wii U was struggling and Nintendo was understaffed for AAA HD games. I'd say Switch era EPD has so far relied far less on outsourcing, nearly all of their titles were wholly designed and developed in-house. The most they might do these days, is farm out some asset work to an external company like Monolith Kyoto or Bandai Namco. Nintendo has completely changed it's R&D management from top to bottom, and how staff is allocated to another project. That does mean some games need to take priority over others, but it never means the game will never get made. ARMS 2 isn't going to get outsourced unless either A.) Yabuki and the team have no ideas for a sequel, or B.) Nintendo wants the game out ASAP. Nintendo doesn't really put any of EPD's teams on a pedestal, especially since each team is actually little more than a few producers in an office, the actual development comes from a single large talent pool that all these software groups draw from. Point is, if ARMS was a success, which it is, then Nintendo should have no qualms against letting Yabuki and his team produce a sequel. 

SFZ was still made in conjunction with Platinum, Metroid 2 3DS with Mercury Stream, Fire Emblem Warriors with Omega Force and Team Ninja, even this year games like Kirby Star Allies and Mario Tennis Aces were made by external teams Camelot and HAL. EPD haven't put out a major game since Mario Odyssey 10 months ago.

ARMS 2 would simply be a poor use of finite resources. It has limited commercial potential and there isn't any real demand for it. Nintendo fans aren't clamouring for a sequel, they've almost all moved on and forgotten about the IP.

Kirby and Mario Tennis were created by HAL and Camelot respectively so you can't outsource something that was never made in-house to begin with, and Fire Emblem Warriors was a crossover spin-off. Those aren't very good examples really. EPD's last release wasn't Mario Odyssey, ignoring WarioWare Gold (which was a collab with IS as always), their next title is Nintendo Labo: Toy-Con 3 - Vehicle Kit. It's funny how we're not talking about Labo here, because that's the biggest thing EPD has this year. True it's not selling like Mario Odyseey, but it's got modest sales under its belt, and Nintendo is willing to keep it going. It goes back to what I said earlier. It's not that EPD doesn't have enough resources, it's that they focused almost entirely on the Switch's first year, and didn't start working on future games until after the console was an official success. Anything EPD has in the works now, is a year away at this point, but it's likely to be even more prolific than last year's output. 2017 had 6 games from them on Switch. With the 3DS staff now freed up, their output could be increased by one or two games. 

Also, I don't really buy that Nintendo fans don't want ARMS 2. It still enjoys a healthy following with a decent competitive scene and regular fan-art, among other things. It's definitely enough for Nintendo to consider a sequel. 

Labo isn't a major project, it's a low budget venture. If EPD had sufficient resources we'd be seeing major projects from them on a regular basis, but we're not, because they still have not demonstrated they can provide a consistent supply of HD games; hence why they've been outsourcing for years and will continue to do so. There's nothing wrong with outsourcing, plenty of fine games have come of it.

And no, ARMS does not have a healthy following. Nobody outside a tiny minority even talk about ARMS any more, and its sales are not showing the legs that indicate a healthy franchise.

I wouldn't call Labo a low-budget project at all. While it's true it's not something with a AAA level budget, it's still a product that had a lot of R&D money poured into it. To Nintendo, a Labo kit is considered a major release. EPD has plenty of resources, they've shown they're capable of providing a lot of titles in one year with the Switch's 2017. It's just that as I said, they didn't really start work on anything beyond year one until after the Switch became a success, which is why this year seems a little bare. But even still, Wii U ports and games from development partners ensure that Wii U esque software droughts are a thing of the past. That's not a lack of resources, that's called prioritizing your schedule. Nintendo prioritized 2017 to a large degree, and those who were working on Switch titles prior to the Switch's launch were simply working on those that were releasing in 2017 and early 2018 in Labo's case. 

ARMS fanbase may not be on the level of a Mario Kart or Smash Bros. but it's still got a loyal fairly large following, sales stopped because the game no longer gets updates and as a first entry it feels somewhat lacking in content. Still, 2 million sold is enough for Nintendo to allow for a sequel. 

They were only able to deliver a strong 2017 at the cost of lulls in 2016 and 2018. That's indicative of how limited their resources are.

ARMS sold just 160k in its 4th quarter on the market, that's not healthy at all. Even on Nintendo sites, almost nobody even talks about ARMS any more.

That's not an indicative of limited resources at all. Nintendo ceased development of new Wii U titles in 2015, and most of their teams moved on to the Switch, prepping titles that would release for the first year. They prioritized the 2017 because the Switch needed to be as successful as possible, as fast as possible. They didn't start on future projects until after the console became a known success. Considering games generally take 2-3 years to make, next year should have more EPD projects ready including ARMS 2, Animal Crossing, WarioWare, perhaps even few new IP. HD development is only a problem with AAA games, as they need high budgets to keep up with audience expectations, thus need more staff to compensate. Outside of BotW, Nintendo games are typically made on very modest budgets, and have small teams and short development cycles. Splatoon was made in just a year and a half for example. BotW caliber games from Nintendo are more the exception to the rule, even Shinya Takahashi admits Zelda games are typically Nintendo's biggest productions. 

ARMS may not have been a breakout Splatoon-like megahit, but there are still people talking about it, and as a new IP, it was a solid start for Nintendo to persue more of it. I mean, we have a Dark Horse comic book coming next year, just in time for that potential sequel, and I'd be interested in seeing your reactions if it does turn out to be real and developed in-house.