All things point to early stage growth cycle, says CIO

In an era marked by uncertainty, James Demmert, founder and chief investment officer of Main Street Research, an investment firm in New York City, Sausalito, Calif. and Greenwich, Conn., remains focused on identifying signals of a new bull market. After a bear market in 2022, he is confident that certain economic indicators point towards a growth cycle ahead that is still in its early phases.  

“A new bull market has begun,” Demmert explains. The clues he sees for this shift hinge on factors such as inflation, Fed policies, and economic resilience in a “Goldilocks economy”—where conditions are neither too hot nor too cold, providing an ideal environment for stocks.

"Once inflation moved below 4% and we saw that the Federal Reserve was close to being finished with its rate hikes in the summer of 2023, we saw that disequilibrium between the economy and the market come into equilibrium."

Key to Demmert’s approach is analyzing the sectors most likely to benefit from this equilibrium, with technology emerging as a crucial area.

“This is an AI tech-led business cycle,” he explains, emphasizing the importance of AI and related technologies in driving productivity and long-term economic growth. This cycle, he believes, is just beginning, and Demmert sees significant investment potential in both the companies building the technology and those implementing AI to enhance operational efficiency. Companies like Nvidia have been early beneficiaries, but he points investors toward the “second derivative” of AI—firms now deploying AI to improve business outcomes, such as Oracle and Salesforce.

“After 18 months of spectacular performance in companies like Nvidia... it’s time now that investors start to focus on other tech and telecommunications companies,” Demmert says, suggesting that these secondary adopters of AI stand to benefit substantially.

However, Demmert’s optimism is tempered by a focus on risk management, underscoring the importance of strategic safeguards in volatile times.

Demmert insists that investors prepare for downturns through a defensive “Plan B.” His strategy, which he calls "active risk management," involves setting guidelines for when to reduce stock exposure should unforeseen macroeconomic events, such as rising inflation or geopolitical conflicts, arise. This process involves three components. The first is the flexibility to significantly reduce stock exposure, the second is sector management with a defensive tilt and the third is carefully placed stop loss orders. Together, these strategies mitigate the risk of a catastrophic loss in one stock, a sector or the whole portfolio.

“Let’s have the flexibility to withdraw that stock exposure if the Fed, let’s say, has to raise rates or inflation comes back, or let’s say there’s a conflict in the Mideast,” he advises.

Demmert is particularly wary of the national debt, which now stands at 133% of GDP.

“The risk there is that if the U.S. dollar and the credit quality of the U.S. was re-rated downward, I think it would bring on perhaps a 2008-type of decline in stocks,” he cautions. “People keep saying, well, the debt problem’s been there for 30 years, and I have to remind them that it never was 133% of GDP like it is now.”

Another area of interest for Demmert is the energy sector, where conflicting trends are emerging. Given the complex dynamics in the energy sector—between a resurgence in green funds, green bonds, and electrification on one hand, and the Trump administration’s advocacy for a return to fossil fuels on the other, these conflicting directions ultimately will be impacting investment in energy. With some investors pushing towards renewable energy, while others support traditional energy sources as a stable hedge, Demmert believes that, despite the allure of fossil fuels, electrification will remain essential as global energy demands rise.

“Between EVs and AI, we need more supply of electricity,” he says. His firm invests directly in companies like Constellation Energy, which are expanding grid capacity to meet increased demand for renewables. In his view, the energy sector’s future lies in balancing these forces to meet market needs and drive sustainable growth.

In response to broader energy market shifts, Demmert also points to the role of influential figures like Elon Musk, who is currently advising former President Trump on energy policy. This intersection of priorities, he suggests, could result in an energy landscape where fossil fuels and green technologies coexist as complementary components.

As Demmert explains, "I think as investors, we want to put a lot of emphasis on...getting more out of the electrical grid." The expansion of green energy, from electric vehicles to renewable infrastructure, ties directly into the technological trends Demmert champions, as these shifts rely heavily on advancements in AI and digital efficiency.

The need for vigilance in managing these opportunities and risks, especially with AI and energy investments, underscores the importance of a balanced, defensive approach to wealth management. Demmert believes that it is crucial to remain flexible in adapting to shifting market dynamics.

"It’s dangerous to think that the markets couldn’t be derailed,” he warns. While the potential for strong growth exists, the evolving global economy demands that investors not become complacent.

With a clear understanding of past market cycles, Demmert recalls how quickly downturns can happen, pointing to investor complacency as a recurring issue.

“People have gotten used to bear markets not lasting long and recovering quickly,” he notes, urging investors to stay cautious and prepared. For him, the best way to navigate this unpredictable landscape is by balancing growth with robust risk management, particularly in sectors that promise transformation, such as AI and renewable energy.

Demmert projects that the current bull cycle could drive the Dow to 100,000 and the NASDAQ to 50,000 over the next five to six years, powered by advancements in AI and a resilient economy.

“Those are big numbers,” he admits, “but let’s make sure that we’re cognizant of some of these other risks.”