You’ve heard of the Summer of Love and the Summer of George. Now, at least for the stock market, it looks to be the Summer of AI.
Stocks have been on a tear, with the S&P 500 up 14% this year. While there are reasons to exercise caution—or expect at least a pause in the market rally, given double-digit annual gains for the
are unlikely to go on forever—that doesn’t mean a reckoning is imminent.
Trivariate Research Founder Adam Parker sees three reasons the gains can keep coming.
To begin, financial conditions are relatively easy. Yes, banks aren’t lending as much and regional banks have been sore spots, but Parker notes that this is offset by plenty of private credit. In fact, in the past three and a half decades, the Bloomberg Financial Conditions Index has only been easier 8% of the time.
Expanding margins are another point in the rally’s favor. Analysts expect that nearly three-quarters of the top 500 U.S. stocks will see margins grow thanks to factors including labor productivity, lower input costs, and prices remaining elevated.
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This played out in the first quarter when net margins improved for eight of the S&P 500’s 11 sectors year over year. As DataTrek’s Nicholas Colas notes: “it isn’t just Tech’s profitability boosting index fundamentals. Better margins are a macro theme.”
Of course, no discussion of the rally would be complete without mentioning Big Tech and artificial intelligence. Trivariate’s Parker credits “the dream of AI” as the third pillar supporting more gains.
At this stage, it can still be difficult to pinpoint AI winners or understand the true scope of how it will change corporate productivity. Yet the dream of “revenue growth without any net hiring, is so powerful, that the market continues to rally through news that might have previously been worrisome,” Parker says. “Investors are assigning a higher probability to long-term earnings growth, fueled by AI, than they were at the beginning of the year.”
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The promise of AI alone would be enough to keep pushing the stock market higher. Taken with the first two factors, Parker says he believes the market’s gains aren’t in danger. That could change if there was a catalyst like tighter financial conditions, a deterioration in the U.S. economy, or if the July jobs report and coming second-quarter earnings season show concerns.
Parker says he believes the more likely scenario is that the “market will be in ‘innocent until proven guilty’ mode when it comes to AI potential in the near-term.”
Therefore investors shouldn’t shy away from the AI trade, he says even if it’s a bit pricey. Avoid
Nvidia
,
and
—the three largest components of the S&P 500 that have grown so rapidly—at your peril, too, as worries about market concentration are misguided. “Who wants to run a fund for the next few years and say they didn’t have exposure to such a crucial trend because they couldn’t make the valuation work? Not us.”
DataTrek’s Colas highlights the S&P 500 as a less volatile way to play potential winners and losers in AI than other more tech-heavy bets. While he’s a believer in Big Tech—“Gen AI is a powerful new technology, and the biggest players have the best chance of developing and monetizing it”—he says there is validity to the counterargument that “new technology tends to create new winners and losers.”
If that is true, the S&P 500 is a less volatile investment than something like
that tracks the
where the Magnificent Seven—Google parent
Alphabet
,
Apple,
parent Meta Platforms, Microsoft, Nvidia, and
—plus
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account for just under half of the exchange-traded fund.
By investing in the S&P 500, investors will be joining those who are continuing to support the index’s rise, which will likely keep attracting more funds via passive investing
Ultimately, investors don’t have to believe the party will keep going forever to see that it isn’t quite over yet.
Write to Teresa Rivas at teresa.rivas@barrons.com
