After sitting on the launch pad for two years, global equity markets have finally launched into a powerful new bull market. This rocket-like initial rally results from global central banks winning the war against inflation and the promise of what artificial intelligence (AI) might bring to companies and economies. We are in the early phase of this bull market, and investors need to be cognizant of how long stocks can run on this fuel, what sectors will benefit the most, and how to manage risk as stock indexes push higher. So, let's dig in.

Business Cycles & Bull Markets

Once global central banks, including our own Federal Reserve, won the war on inflation, our team forecasted that a new business cycle would be born along with a new bull market in global equities. Bear markets are a result of economies and stock markets suffering from disequilibrium. In the latest bear market, the culprit was unsustainably high inflation paired with stock prices failing to account for the impending rise in interest rates. This disequilibrium has now been resolved as inflation has decelerated from over 9% to just under 3%, and global equities have returned down to earth. Recall that stock indexes were down approximately 30-40% in 2022. When economies and markets come back into equilibrium, — which officially occurred in the fall of 2023, it usually starts a new business cycle as businesses shake off the fear of economic dysfunction and regain the confidence to invest and grow their businesses. Business cycles, also known as economic expansions, are potent drivers of stock prices, and this one is in its early phase. Moreover, consumers reaccelerate spending and confidence as inflationary woes dissipate. In our founder, James Demmert's latest book, Wall Street Lessons, he discusses the power and average lifespan of business cycles and their effect on equity markets. One pertinent data point is that the average business cycle lasts 7-9 years. That's right — a long time!

How Far Can This AI and Tech-Led Bull Market Run

Knowing that the current business cycle may last 7-9 years, we can estimate how far stock indexes can extend based on economic and corporate earnings growth. However, this particular economic cycle has a more powerful twist: the emergence of AI and its ability to transform technology and create remarkable productivity growth for global economies and companies. Enhanced productivity growth is the ability of economies and companies to do more with the same infrastructure. In our view, AI will have a real and lasting effect on many sectors of the economy and lead to higher corporate profit margins and earnings growth. When considering the influence of AI paired with the early phase of the new business cycle, it is not difficult to imagine corporate profits could triple over the next 7-9 years or a Dow Jones Industrial Average of 100,000, S&P 500 of 15,000, and Nasdaq of 50,000.

Sector Exposure & Stock Selection

As this last quarter exemplifies, investors who can tilt their portfolio towards the sectors of the market that will benefit most from this new AI and tech-led bull market can also benefit. Such a bull market would include companies that design essential components for AI (hardware) and technology companies that can leverage AI (software). Think of Nvidia and Microsoft as good examples. However, it's not just tech that will benefit from AI. We believe healthcare, financials, industrials, and communications will also participate. All eleven sectors have the potential to benefit in the long run, and discovering which sectors and companies best represent them will be a crucial component of performance in the coming years. Our team is up to the task!  

Fixed Income Adds Value

For the non-stock portion of your portfolio, we expect a smooth flight in the first-class cabin. In our view, the Federal Reserve is finished raising rates and may soon begin to lower them. Recall bond prices increase when rates lower, which, together with the 4-5% yields, will add great value to your portfolio over this new business cycle.  

Risks in Our Journey

There are always risks that can disrupt a business cycle and bull market. These include central bank policy, fiscal policy, geopolitical turmoil, and stock market bubbles. This singular bull market could also lose steam if AI proves less impactful than imagined or if governments restrict the technology from being truly transformative. For these unpredictable reasons, we must continue employing our unique Active Risk Management process. This process includes our ability to reduce your allocation to stocks, rotate sector exposure, and use carefully placed stop loss orders. Active Risk Management will be with us on our upward venture and is a critical component to the safety of our journey.  

We hope this Strategy Update is helpful, and feel free to share it with your colleagues, family, and friends. Please let us know if you have experienced any changes in your finances or have questions about your portfolio. If you have a friend or family member who would be interested in a no-cost portfolio review, please let us know.

Thanks again for your continued vote of confidence in our work,

Your team at Main Street Research