Why the bull case is still in play for equity markets

The co-chair of our Asset Allocation Committee, Charles Shriver, started our recent meeting with a punchy summary of where capital markets stand:

“Fundamentals: solid. Macro: mixed. Valuations: on the high side.”

Against that complex backdrop, the committee favors a buy-the-dip approach in equities. We still like small- and mid-caps and U.S. growth stocks, and we prefer emerging markets over ex-U.S. developed markets. At the same time, we maintain overweight exposure to international value stocks, which should provide some diversification in the event of an AI-driven sell-off.

To help guide these tactical positions, we engaged in our favorite sport: the bull-bear debate.

The bearish case

The geopolitical outlook remains challenging. The wars in the Middle East and Ukraine show few signs of near-term resolution.

A meaningful share of global refining capacity is offline, creating a squeeze in diesel and other refined products. Crack spreads—the price differences between crude oil and the products refined from it—are the key indicators to watch because refining capacity is an immediate constraint. This constraint could create a stagflationary mix, adding to inflation while weakening economic growth.

One committee member observed complacency among market participants: “Markets have absorbed body blow after body blow, but there’s a cumulative effect that we may be underestimating. I don’t see how the war in the Middle East gets resolved anytime soon.”

That cumulative effect could reach markets through inflation and higher bond yields. “We could get an inflation shock and a rate shock,” a committee member concluded.

An interest rate-driven equity correction remains a near-term risk, one that has stolen the market’s attention in recent weeks.

In short, valuations remain high at a time when geopolitical, inflation, and monetary policy risks have increased.

The bullish case

The bullish scenario begins with de-escalation in the Middle East and possibly Russia-Ukraine. Under that outcome, oil could fall into the $50-a-barrel range next year, easing inflation and supporting consumers.

Several committee members think AI will accelerate economic growth. This capex cycle represents a major structural change for the economy, especially for productivity. AI bulls and bears agree that existing capital deployment is unprecedented as a share of gross domestic product. Bears see a bubble. Bulls see an industrial revolution.

History suggests both could be right. In any case, the last 20 years may be a poor anchor for the next decade.

“I do think we get through Iran-related economic risks, eventually. Meanwhile, AI is an industrial revolution. I feel it, I use it, I know it’s happening,” a committee member said.

The bulls recognize that the AI trade is becoming more nuanced. Company-level dispersion is rising, creating opportunities for stock selection. Price-to-earnings (P/E) multiples for leading chipmakers have compressed as their growth rates have decelerated.¹ Several AI-related stocks have already sold off, which we view as a healthy reset of market positioning and expectations.

We feel the earnings outlook continues to support equities. “Equities are where the earnings growth is. I want to own equities. I’m fundamentally bullish on what’s happening with earnings growth,” a committee member said.

The bullish scenario would support equities and challenge fixed income. Bond yields may remain range-bound in the near term, with an upward trend over time should stronger nominal growth and productivity gains work through the economy.

The early to middle innings case

Several factors suggest the economic cycle is nowhere near the late stage.

The growing adoption of agentic systems is bullish for AI infrastructure, including memory and storage, networking, and central processing units (CPUs), as my colleagues Dom Rizzo and Frank Shi have highlighted.²

Some analysts on our research platform also see a potential flywheel effect from the emergence of GPU-backed financing. Easier financing could improve chip-making capacity and lead to standardization that attracts more institutional capital. (This is yet another example of how, as asset allocators, we are spoiled to have bottom-up insights to complement our macro views.)

Beyond the AI theme, upward revisions to earnings expectations have recently broadened, and not just in energy-related areas.³ Other key indicators also paint a favorable economic picture: business activity in the U.S., eurozone, Japan, and the UK just reached its highest level since early 2022.⁴

Furthermore, capacity utilization in the U.S. remains depressed,⁵ suggesting that industrial areas of the economy have ample room to expand.

Alex’s AI summary

Toward the end of our meeting, we asked Alex, our voice AI agent, to summarize the discussion:

I'd say the room leaned structurally constructive on equities, but with a clear preference for a patient approach and better entry points rather than pressing risk here. The supportive side focused on resilient earnings, AI-driven growth, and the idea that a sell-off could be a buying opportunity. The cautionary side emphasized rates, inflation, and geopolitical risks plus elevated expectations and the risk of being right on fundamentals, but wrong on price.

Overall, I heard alignment around staying engaged with equities but sizing the bet carefully within the active risk budget and being selective about where to add.

 Charles needed nine words. Alex needed 97. The rest of us needed a meeting.