Why the bull market could run through 2026

Key Concepts

• S&P 500 Target: The projected level of the S&P 500 index by the end of the year.
• Earnings Growth: The increase in profits reported by companies.
• Bifurcated Market: A market where different sectors or types of companies are performing very differently.
• Valuations: The assessment of a company's worth, often expressed as a Price-to-Earnings (P/E) ratio.
• Tech and AI Trade: The market segment driven by technology companies, particularly those involved in Artificial Intelligence.
• M&A Activity: Mergers and Acquisitions, which can boost financial sector earnings.
• Earnings Surprise: The extent to which actual earnings exceed analysts' estimates.
• P/E Multiples: The ratio of a company's stock price to its earnings per share, indicating how much investors are willing to pay for each dollar of earnings.
• Growth Index Fund: An investment fund that focuses on companies expected to grow at an above-average rate.
• Cyclical Groups: Industries that are sensitive to economic fluctuations (e.g., industrials, discretionary, energy).
• Tariffs: Taxes imposed on imported goods.
• Unemployment Rate: The percentage of the labor force that is unemployed and actively seeking work.

Market Outlook and S&P 500 Target

Jonathan Gallib, Managing Director and Chief Equity Strategist at Seport Research Partners, anticipates a resumption of the market rally, having raised his year-end S&P 500 target. While the current week has been characterized by choppiness, with an earlier sell-off in tech followed by a recovery, Gallib believes the market is poised for further gains. He suggests that a rally of 3-4% from current levels is implied by his year-end target.

Long-Term Market Drivers: Earnings

Gallib emphasizes that the more significant driver for the market is not the immediate outlook for the next few weeks, but rather the trajectory over the next 14 months. He identifies earnings as the primary catalyst. The market is currently expecting a double-digit earnings growth year, projected at approximately 13-14%. Even if actual earnings growth falls short of this expectation, Gallib believes it will still support healthy returns.

The Confounding Strength of Earnings Amidst Macro Noise

Gallib notes that the resilience of earnings has been somewhat confounding, especially in the face of various macroeconomic headwinds such as government shutdowns and trade tariffs. Despite these challenges, earnings have held up remarkably well.

Bifurcated Earnings Growth: Tech vs. Traditional Sectors

A key observation is the bifurcated nature of earnings growth.

• Tech Companies: Are experiencing robust growth, with year-over-year increases estimated at around 27-28%.
• Financials: Are showing a growth rate of approximately 23-24%, largely driven by increased M&A and deal activity. This sector represents about half of the S&P 500's overall earnings.
• Traditional Cyclical Groups: Sectors like industrials, discretionary, energy, and staples are delivering much lower growth rates, in the range of 2-4%.

This divergence means that while a significant portion of the market is growing at a mid-20s percentage rate, the other half is experiencing low single-digit growth.

Strong Earnings Season Performance: Beating Expectations

Beyond the growth rates, the health of earnings season is also strong from a "surprise" perspective.

• Companies are beating earnings expectations by an average of 9%. This is considered an exceptionally strong number, as typically companies beat lowered estimates by only 4-5%.
• Revenue (top-line) growth is also exceeding expectations, with companies beating by 2%.

This strong performance in beating estimates is observed across virtually every sector.

Addressing Valuation Concerns: Earnings Growth vs. Multiple Expansion

Gallib argues against the common perception that the market is becoming excessively expensive due to rising valuations. He contends that investors often mistakenly assume that when the market rises, valuations must be increasing.

• Tech Sector Performance: While the broad suite of tech companies has risen by approximately 26-27% year-to-date, Gallib states that about 22% of this increase is attributable to earnings growth, with a much smaller portion coming from an increase in valuations.
• Mix Shift: The overall market's higher P/E ratio is attributed to a mix issue, where the market is becoming more growth-oriented and tech-centric, rather than individual companies experiencing problematic P/E expansions.
• Large-Cap Tech Valuations: Gallib points out that for many large-cap tech companies (e.g., Nvidia, Oracle), their P/E multiples are actually lower today than they were two years ago, contradicting media narratives.

Investment Strategy: Overweighting Growth Sectors

Given the bifurcated market, Gallib suggests that investors should consider overweighting the groups that are performing better on an earnings basis, which are predominantly the tech and growth-oriented sectors. He draws a parallel to the past, where investing in growth index funds significantly outperformed broad S&P 500 investments over 15 years.

• American Exceptionalism in Tech: Gallib believes that "American exceptionalism" is most evident in the tech sector, with some contributions from healthcare or biotech.
• Non-Tech vs. Global Markets: The non-tech portion of the S&P 500, when compared to the rest of the world, appears relatively similar.
• Fundamental Strength, Not Speculation: The strong performance in tech is driven by companies doing "something really special," reflected in their revenues and earnings, rather than pure speculation. Gallib expects this trend to continue for the next three to twelve months, with all market signals supporting this outlook.

Potential Roadblocks and Risks

Despite his optimistic outlook, Gallib acknowledges potential risks that could slow down the market rally.

• Economic Slowdown: While economists initially expected tariffs to significantly impact the economy, their effect has been minimal so far. However, it's possible that tariffs could have a delayed impact, leading to a weaker economy. While a slight economic slowdown might not derail AI implementation, a significant increase in the unemployment rate could cause companies to curb spending.
• Weakening Job Market: Gallib notes the peculiar situation of a seemingly strong economy for market purposes, yet a tepid job market. He suggests the possibility of negative job growth once government reporting resumes, which could prompt corporations to cut back on spending. While he doesn't believe these scenarios are likely, he considers them real risks that are being closely monitored.