This Bull Enters Middle-Age – Fit & Rested | Strategy Update

We know from the history of economics that business cycles typically last seven to nine years. These extended periods of economic growth – if not derailed – are accompanied by varying degrees of stock market strength, often referred to as “bull markets.” These episodes of stock market strength and prosperity are just long enough to make investors forgetful about the bear markets that precede them, and which always follow. It is with this in mind that we thought we would share some thoughts about this bull market’s health and potential lifespan.

A Bull Market Entering Middle Age

As we enter the fourth year of this bull market, it is important to take into account that it coincides with a powerful technological revolution – artificial intelligence (AI). Business cycles that run parallel to technological innovations – think the internet during the 90s – have a tendency to run on the long end of the historical seven-to-nine-year average. Viewed in these terms, this cycle is entering middle age, and if it is not derailed, could extend to 2030 or 2031.

Economies in mid-cycle have familiar traits and this one is no exception. Economic momentum and demand begins to build in earnest at this stage, and we see this today around the globe with increased demand for services and products, as well as mildly increasing inflation – a result of the demand. After about two decades of tepid 1% to 2% growth, we see the potential for US growth to pick up meaningfully in 2027 to 4-6%, driven in large part by AI-powered productivity gains. Essentially, businesses are doing more with the same people and infrastructure. That is a real tailwind for future economic growth.

Interest Rates – The Invisible Hand of the Bond Market

Faster growth lifts demand, and rising demand creates pricing pressure across the economy – inflation. Astute bond investors saw this coming and have already priced rates higher (the invisible hand), even with the Federal Reserve doing very little. The 10-year Treasury yield, which was once below 1%, now sits near 5.1%. In effect, the Federal Reserve is allowing the bond market to price yields upward to temper growth and inflation, so the cycle can last longer.

History offers perspective, and it’s important to reflect on periods similar to this cycle. During the 1990s technology boom, a period similar to this one, the 10-year yield hovered near 6% and inflation ran around 4%, yet the bull market carried on. Rates can rise, and stocks can still advance…what changes is where you want to be invested.

The List of What Could Derail the Cycle

Several risks are on our radar which could stop this business cycle and bull market in its tracks. Oil prices are a concern: brent crude above $95 can strain the global economy, and a sustained move to $110 or $120 could threaten the cycle itself. US and foreign government debt is also a concern. As rates rise, servicing debt becomes more difficult for governments, and a credit downgrade of the US or another major country could significantly weigh on markets. If one of these other risks doesn’t interrupt this cycle, eventually AI stock valuations will. Technology-driven business cycles and revolutions can end with overpriced stocks, as the bursting of the internet bubble exemplified in 2000. We do not see this yet today, but we are monitoring it very closely. Monetary policy is also a risk as we enter the second half of the business cycle. A Fed or central bank misstep, whether raising rates too much or leaving them too low, could hurt growth or fuel inflation. Lastly, there are always risks that are unknowable. Investing is a balancing act between risk and return, and our team brings a thoughtful, disciplined approach to both.

What to Own, and What to Avoid

A mid-cycle economy with rising rates rewards selectivity. Rate-sensitive areas tend to struggle. Utilities have already weakened; real estate investment trusts (REITs) have significant headwinds; and some banks face pressure as rates climb. We favor companies with the tailwind of stronger growth. Higher rates also reach households. With mortgage rates above 7% and potentially staying elevated into 2027 and 2028, refinancing may be less attractive than it was, while loans for homes and autos become relatively more expensive to service.

In the back half of this bull market, we want to embrace companies that benefit form AI and its productivity growth. This would include technology and telecommunication companies, but also most other sectors of the economy. We are particularly interested in how AI will reshape healthcare over the next few years. As we continue to explore these opportunities, our investment team will continue to stick to our tried-and-true process of understanding the fundamentals of the companies with a focus on high quality.

Bull Markets Climb Walls of Worry

Investors are nervous, and stocks continue to climb higher, which is the classic “wall of worry.” Yet valuations have become more reasonable. The S&P 500 now trades below 20 times earnings, down from 24x at one point, while earnings and the economy look stronger than a year or two ago. We believe that this is supportive of owning stocks, so long as we are selective.

The picture looks even more compelling overseas. After years of neglect, foreign stocks trade near 14 times earnings versus about 19x in the US. Foreign stocks have been outperforming, and they benefit from the same AI productivity trends…the rationale behind 30% to 40% of your portfolio being in non-US companies.

AI: A Pause, Not the End

Concerns about AI safety are legitimate, and we share them. The largest companies leading this technology have strong incentives to avoid releasing something harmful, from both a reputational and a liability standpoint. We believe that self-discipline is likely to continue.

AI-related stocks have mostly traded sideways for about six months, held back by data center pushback and a lack of fresh earnings. We view this as a pause within a longer-term trend. Share prices relative to growth are among the most attractive we have seen in years. Earnings season begins next week, and Micron Technology’s (a tech bellwether) recent report was well above expectations, with orders that cannot be filled for at least a couple of years. Strong reports from technology companies will likely restore investor confidence – pushing these stocks higher.

Individual Bonds Versus Bond Funds

Higher rates make new bonds more attractive, but they also push existing bond prices down like a seesaw. A bond fund has no maturity date, so its price can keep sliding as long as rates stay high. An individual bond matures at face value, assuming the issuer meets its obligations. It is for this reason that we prefer individual high-quality bonds with laddered maturities. With yields in the bond market near 5.5% today, bonds play a valuable role for your portfolio, particularly if your wealth plan calls for a 5% to 7% return. Knowing your maturity dates is key.

Managing the Downside

Our goal is to grow your wealth for your lifetime, for the next generation, and for any philanthropic work you support, without letting significant declines do lasting harm. In past recessions, markets have fallen 38% to 60% and recovering from that takes time – something none of us have in unlimited supply.

Our active risk management rests on three tools. First, stock exposure: in a bull market, hold the exposure you need, and if conditions deteriorate on clear macroeconomic signals, reduce it. Second, sector positioning: even with less stock exposure, defensive sectors such as consumer staples, utilities, and healthcare have historically held up better in tough markets. Third, stop loss orders: they are placed with a wide bandwidth intentionally, to guard against significant declines in a single stock or an entire sector, only beyond normal volatility. They cannot eliminate losses, but they are designed to limit losses from being catastrophic. Eventually, a bear market will arrive, and history suggests those that follow big technology bull markets can be severe. We believe that this bull market has years ahead of it, but our risk management process is in place if it comes to an unexpected early end.

From all of us at Main Street Research, thank you for your continued trust and confidence. If you have questions about your portfolio or would like to discuss any of the themes covered here, please don’t hesitate to reach out. And if you have a family member, friend, or colleague who might benefit from a conversation, we’d be glad to connect with them.

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