A Bull Market with Volatility Ahead | Strategy Update

A Resilient Bull Market – Still in its Early Innings

It has been a volatile year, but our view of global equities and fixed income remains constructive. Global equity markets have recently reached new highs, and from our perspective we remain in the earlier-to-middle stages of the business cycle — something like the fourth inning of a game that could run considerably longer. As we have mentioned, business cycles typically last seven to nine years, and this one is being driven by the same kind of powerful force that powered the internet-led expansion of the 1990s. Like the evolution of the internet, artificial intelligence (“AI”) is generating significant productivity gains, along with above average economic and corporate profit growth.

The most recent evidence continues to support this view. Corporate earnings have been notably stronger than expected this quarter, with a large majority of reporting companies beating consensus estimates by a wide margin. Nvidia’s recent earnings release is a case in point. Earnings, revenue, and forward guidance all surpassed expectations, while the price to earnings ratio (20x) remains well below the company’s growth rate (+60%). Moreover, gross domestic product (GDP) growth is accelerating. And importantly, this is not a US-only story — foreign markets are experiencing similar AI-driven productivity tailwinds, which is part of why your international holdings, roughly 40% of our equity portfolios, have contributed meaningfully to performance. Assuming this business cycle doesn’t get derailed, stocks could move higher into 2030 or beyond…hence our Dow Jones Industrial Average target of 100K.

Determining Normal Turbulence from Something Worse

This is really the heart of today’s update. Every business cycle eventually ends, often because valuations get pushed further than fundamentals can support. We don’t believe we’re at that point with AI-related stocks — valuations relative to growth rates are actually more reasonable today than they’ve been since 2023, as earnings have accelerated alongside prices. We are watching for signs of the cycle maturing, such as vendor financing arrangements among AI companies, but we do not see this as a warning sign quite yet.

The more useful exercise is distinguishing short-term volatility — the kind investors simply have to live with — from the early stages of a more serious downturn. The last two meaningful drawdowns, in 2022 and 2008, saw major indexes fall 30–55%. Our active risk management process, including sector positioning and stop-loss discipline, is designed to help limit damage if conditions genuinely deteriorate. The three areas below are where we see the most potential for volatility between now and year-end — and where we’re watching for the difference between “normal” and “something worse.”

Oil Prices and the Strait of Hormuz

Oil has been volatile this year, trading anywhere from the $70s to above $100 a barrel amid the ongoing conflict in the Middle East and uncertainty around the Strait of Hormuz. Elevated oil prices flow through the entire economy, and a sustained price meaningfully above $100 a barrel for a couple of quarters could weigh on global growth and potentially tip the economy into contraction. So far this year, oil-driven volatility has been short-lived, and markets have recovered to new highs each time. That is the pattern we’d want to see continue. A sustained move well above $100, paired with market declines larger than what we’d consider typical, is what would prompt us to lean more heavily on active risk management tools.

Midterm Elections: Sector Noise, Not a Market Problem

Midterm election years tend to generate anxiety, and this one will likely be no exception. Historically, however, broad market direction has been driven far more by economic growth than by which party controls Congress. Should control of the House or Senate shift, we would expect any impact to show up at the sector level rather than across the market as a whole — potential pressure on healthcare, energy, or financial stocks, for example, depending on the outcome, rather than a broad market selloff. We expect the elections may contribute to short-term volatility, but we do not see them as a likely catalyst for a more serious downturn.

A New Fed Chair, the US Treasury, and the Path of Interest Rates

New Fed Chair Kevin Warsh represents a meaningful shift in tone from his predecessor, favoring a more tight-lipped approach to public communication about future policy. He is also widely viewed as inflation-focused, and with inflation running closer to 3% than the Fed’s 2% target, we would expect the Fed to lean toward gradual rate increases — potentially as soon as September — as the economy’s underlying strength continues to generate demand and price pressure. Rate increases tend to unsettle markets in the short run, but it’s worth remembering that markets can perform well even in a gradual rising-rate environment, as they did through much of the 1990s cycle. We see this as a likely source of near-term volatility, not evidence of a larger problem.

The Real Concern: US Debt

Of the risks on our radar, US debt levels concern us the most. Total federal debt now exceeds $40 trillion, with annual interest payments of around $1 trillion. At current interest rate levels, that burden is manageable but tight. If rates on the 10-year Treasury were to rise meaningfully from here, debt service costs would climb further, at a time when the debt level itself is already elevated. Treasury Secretary Scott Bessent’s recent announcement of purchasing 10–30-year Treasurys is a sign that Treasury officials share our concern. We believe this is a genuine risk that could evolve from short-term volatility into something more serious over time, and it is the area where we are watching most closely and are most prepared to act through active risk management if conditions warrant.

Staying Prepared, Not Alarmed

Our approach throughout periods like this is the same: distinguish ordinary volatility from the early signs of a more serious downturn, and be ready to reduce equity exposure or lean on stop-loss discipline if conditions genuinely warrant it. We remain optimistic about the cycle ahead of us, supported by strong corporate earnings, resilient economic growth, and the ongoing productivity gains from artificial intelligence. But staying prepared for a normal correction to become something more, whether triggered by oil, debt, elections, or something unforeseen, is part of how we protect your long-term financial plan.

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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