How investors can think about the record market rally's road ahead

Key Concepts

• Government Shutdown: Historical market impact, potential economic effects.
• Market Trend: Upward trend in equity markets, AI-driven momentum, everything rally.
• AI Trade: Momentum behind AI stocks (e.g., Nvidia), power demand for data centers.
• Broadening Trade: Expansion beyond tech into sectors like utilities, healthcare, financials.
• Earnings Season: Anticipation of strong earnings, positioning ahead of financial releases.
• Valuation: High valuations in tech, potential for value in other sectors.
• Portfolio Management: Trimming winners, reorienting exposure to cyclical sectors, chasing performance.
• Federal Reserve (The Fed): Dovish stance, potential rate cuts, impact of data uncertainty.
• Buy the Dip: Strategy of buying during market downturns, potential limitations.

1. Government Shutdown and Market Impact

• The US entered a government shutdown, but historically, shutdowns have been a "nonevent" for both the economy and markets.
• Short-term effects might include a rise in jobless claims and lowered airline traffic, but these are temporary and unlikely to interrupt the overall market trend.
• Jason mentioned the longest shutdown was 35 days under the Trump administration in 2018, but the S&P was up 10% during that time.
• Since 1981, there have been 14 shutdowns, with GDP up close to 3.8% during those periods.

2. Market Trend and AI Momentum

• The "trend is your friend" in the markets, with an upward trend in equity markets.
• Jim emphasizes the strong momentum behind AI stocks like Nvidia, suggesting it's difficult to bet against them.
• Any dip in the markets is highly likely to be bought, driven by professional managers trying to catch up to their benchmarks.
• Approximately 25% of professional managers are beating their benchmark this year, leaving 75% feeling "desperate" to improve performance.

3. Broadening Trade and Sector Rotation

• The market rally is broadening beyond AI, with strong performance in pharmaceuticals and healthcare.
• Shannon notes that the S&P equal weight has outperformed the market cap weighted S&P over the last week.
• Utilities have shown significant correlation to the AI trade due to power demand for data centers.
• The broadening trade encompasses sectors outside of technology that are integrating and implementing AI innovation in their businesses.
• Jason suggests reorienting exposure into sectors that have not grown as much, such as healthcare.

4. Utilities and Infrastructure

• Utilities are a top-performing sector in the S&P 500 year-to-date, partly driven by the AI trade.
• There's potential for a global industrial impulse to drive growth in 2026, increasing power demand.
• Infrastructure improvement is necessary in the US and abroad, supported by fiscal stimulus in Europe.

5. Valuation Concerns and Earnings Season

• Technology is trading at about 31 times forward earnings, compared to a ten-year average of 21.5.
• Shannon believes the broadening trade is less about valuation concerns and more about positioning for future earnings growth.
• Third-quarter earnings are expected to be fairly conservative, creating opportunities in sectors outside of technology.
• Earnings season kicks off in earnest in two weeks with the financials, driving positioning ahead of potential beats.

6. Portfolio Management Strategies

• Jason suggests trimming some winners in tech to reallocate to cyclical sectors.
• It's prudent to take a little off the top from tech due to lofty valuations, even though earnings have supported the expansion.
• For those with cash on the sidelines, consider investing in more cyclical-oriented names.
• Jim emphasizes the "chase" among portfolio managers to improve performance before the end of the year.

7. Federal Reserve and Interest Rate Policy

• Tom Lee suggests a strong seasonal Tailwind is underway, with the upside higher given the Fed is dovish.
• Jim believes the Fed is likely to err on the side of caution and cut rates, especially with data uncertainty due to the shutdown.
• The probabilities of a rate cut in the upcoming meeting (October 29th/30th) are considered high.

8. "Buy the Dip" Strategy

• Tom Lee urges investors to "look through the messiness of the shutdown" and buy the dip if stocks are weak.
• Jim agrees that the dip is currently buyable, driven by the chase for performance among fund managers.
• The strategy of buying every dip will eventually not work, but it is currently effective.

9. S&P 500 Target

• Tom Lee projects the S&P 500 at 7000 by the end of the year, roughly 4% higher from current levels.

10. Conclusion

The market is currently experiencing an upward trend driven by AI momentum and a broadening rally into other sectors. While a government shutdown poses some uncertainty, historical data suggests it has minimal impact on the market. Portfolio managers are chasing performance, making dips buyable in the short term. The Fed's dovish stance and potential rate cuts further support the bullish outlook, with some analysts projecting the S&P 500 to reach 7000 by year-end. Investors should consider rebalancing their portfolios by trimming tech winners and reallocating to cyclical sectors with potential for future growth.