5 Reasons Why This Bull Market Looks To Be Promising

By Brian Nelson, CFA

We’ve just hit new all-time highs on the market-cap weighted S&P 500 (SPY), and we think this is the beginning of what could be one of the biggest bull market runs in stock-market history. In particular, we’re pointing to the area of artificial intelligence [AI] as the key catalyst to drive stocks higher, and if we had to point to a historic analog, we’d say we’re just like we were in the mid-1990s, ready to make a huge multi-year run similar to the dot-com boom. Back then, investors were just getting a taste of the Internet, and today, investors are just finding out what a game-changer AI will be. We think investors should continue to stay aggressive in the current market environment.

We’ve been bullish on equities for a long time now, perhaps best punctuated by our early November article, “The Crash Higher Is Coming,” and our sentiment today is as enthusiastic as it was then. Household net worth continues to soar thanks to booming housing and equity prices, and consumers continue to spend at a rapid and aggressive pace, as evidenced by the strong holiday selling season. We think the U.S. economy will not experience the recession that “everybody” seems to be expecting, at least not anytime soon, and the step-up in product and service prices should continue to pad earnings growth at many a company in the S&P 500.

Here are 5 of the top reasons that we think stocks will continue to reward investors, as we wrote in a recent article on our website:

1. The Fed has signaled that rate cuts could start with inflation at a 2 handle (2 point something) and not at exactly 2.0%. That means that the Fed may become anticipatory to prevent overshooting to the downside with inflation. We see this as positive for long-duration equities, particularly those whose free cash flow generation is robust in the out-years, inclusive of big cap tech (XLK) and the stylistic area of large cap growth (SCHG).

2. Unemployment is at structural lows of 3.7%. Employers are working hard to keep talent on board, and with each paycheck, employees are pumping more and more money into the stock market via retirement accounts. This tailwind remains a stiff one and will likely continue to be a strong foundation for the markets.

3. Employee wage gains have been phenomenal in recent years. Not only are employers starving for more help, but they are paying their workers considerably more. Wage hikes achieved through annual raises, worker strikes and ongoing hourly increases at the low end of the market should continue to propel consumer spending. Many have been talking about a soft landing in the U.S. economy, but there may be no landing at all as nominal GDP growth remains robust.

4. The huge step change in inflation will likely lead to a huge step change in market prices. If you’ve gone to a restaurant lately, you’ve probably noticed that menu prices are up significantly the past few years. Many households that have experienced huge wage gains are not balking at the higher prices, however, and we think higher prices are sticky across most areas of the economy, save for food-at-home goods, which may start to experience deflation. As the rising tide of prices flows across the economy, we expect a benign multiplier effect to continue to broaden out, paving the way for what could be a similar increase in nominal equity prices. Stocks doubling in the next few years would not surprise us.

5. Artificial intelligence [AI] remains a huge source of upside potential. The release of ChatGPT turned our heads in a big way when it was launched, and we expect continued advancements in AI in the coming years. Microsoft (MSFT) has already started to monetize AI in Copilot, and while Nvidia (NVDA) and AMD (AMD) will benefit by providing the computing power behind the AI revolution, we’re expecting many more companies to announce how they will tangibly monetize AI in 2024 and beyond, both with respect to expense management and revenue upside potential. We like the promise that AI holds.

2022 was a terrible year for many strategies, while many dividend growth and high yielding strategies surprisingly held up during that year. We didn’t think that made much sense as 2022 was a year of significant monetary tightening where the risk-free rate exploded higher due to Fed policy. We should have seen a rotation out of many dividend paying strategies that year. However, 2023 helped to rectify much of that anomaly as investors started to move away from dividend investing, perhaps into fixed income, with many dividend growth stocks not faring as well as even the underperforming equal-weight S&P 500 (RSP) during the year.

We think investors that are heavily weighted in dividend growth stocks may not participate in what could be the next boom in stock prices, unless of course, they are already heavily weighted toward some of the free-cash-flow generating powerhouses of Apple (AAPL), Microsoft, Oracle (ORCL) and Cisco (CSCO), among other tech giants. 2023 was an excellent year for big cap tech, but the group still has a long way to run, in our view, with little to no overhead supply (a technical term meaning resistance has yet to be formed from investors eager to sell to breakeven).

Nvidia, for example, has made a huge move, but we still see upside to more than $800 per share on the basis of the high end of our fair value estimate range for shares. We last wrote about Nvidia on Seeking Alpha in the following article, “Nvidia’s Shares Look Cheap.” Just because a stock has advanced considerably of late doesn’t mean it still can’t run more. Nvidia will have to continue to innovate to keep other chip makers from taking share, but the market for AI will be absolutely huge, and the tangible free cash flow generation made during this super cycle will be enormous. This is a far cry from the dot-com bust, where companies were far away from generating GAAP earnings, let alone positive free cash flow.

What are some of the risks to our uber-bullish thesis? Well, we think we’re just starting the part of the economic cycle where the fear of missing out is starting to form. Investors that are looking for low-multiple, poorly-performing stocks will likely continue to find themselves holding low-multiple, poorly-performing stocks, as we wrote in our book Value Trap: Theory of Universal Valuation. However, if the speculative fervor fails to rise up as we think it will to appropriately price AI-driven stocks on the basis of their burgeoning future free cash flow expectations, then we could see a market that stagnates somewhat as it digests the big gains of 2023.

We can point to the Federal Reserve as another big risk if inflation starts to rear its ugly head again, which may cause the market to price in fewer rate cuts during 2024. If that happens, the market-derived spot discount rate to future expected free cash flows may increase, and we could see some sort of market pullback during the back half of 2024. However, we think the underlying economic factors in the U.S. coupled with the promise of AI may be just strong enough for even a potentially more hawkish Fed to offset. After all, the Fed has done its best to drive the U.S. economy into a slowdown and pressure the U.S. job market, and thus far, it has failed — instead succeeding at orchestrating arguably the best outcome possible for workers and investors alike.

Concluding Thoughts

All told, we think investors should continue to be aggressive in the current market environment that could very well be compared to the mid-1990s given how AI may change the economic game, much like the Internet did back then. We expect the areas of big cap tech and large cap growth to continue to lead, with many dividend-heavy sectors trailing behind in a material way. AI will be a huge catalyst that drives considerable free cash flow generation at the strongest of tech giants, and the U.S. economy remains on solid ground thanks to a low unemployment rate and the huge wage gains experienced over the past few years. Though there are some risks, we remain bullish as this bull market looks to be awesome!