Sure, there's a risk of a bubble in AI stocks, so invest in them, says Wells Fargo strategist

Wells Fargo's chief equity strategist Ohsung Kwon advises investors to maintain exposure to AI stocks, despite bubble concerns and recent Nasdaq volatility, projecting continued dominance for the sector driven by robust capital expenditure, particularly in semiconductors. Kwon anticipates the AI-led market rally will remain narrow, with S&P 500 targets of 6,650 by year-end and 7,200 by 2026, unless a housing market recovery broadens participation. He identifies a shift in the AI capex cycle as the primary market risk but sees no immediate signs of it turning.

Analysis

Wells Fargo's chief equity strategist, Ohsung Kwon, posits that the artificial intelligence trade will continue to dominate the market, advising investors to remain exposed despite signs of 'froth' and recent volatility, such as the Nasdaq's steepest one-month drop. The core thesis is that the market is rotating from rate-sensitive cyclicals back to companies with strong fundamentals, where AI leaders excel. Kwon argues the AI rally is not yet a bubble and investors should own the 'right tail risk' of it becoming one, drawing a parallel to the pre-2000 tech bubble which endured multiple crises before collapsing. The primary risk identified is a downturn in the AI capital expenditure cycle; however, current data, including tech capex levels not yet at historical peaks and Micron's strong AI-driven outlook, suggests this cycle remains intact. The strategy favors 'capex takers' like semiconductor firms. This AI-driven leadership is expected to keep the market rally narrow unless the housing market recovers, for which recent indicators are negative. A contrary long-term signal from Ned Davis Research notes that household equity allocation has reached a record 50.5%, historically a bearish indicator for 10-year returns.

Key Decisions for Investors

• Consider maintaining or increasing exposure to the AI sector, specifically focusing on semiconductor firms and other 'capex takers' that directly benefit from sustained corporate AI spending.
• Evaluate trimming positions in rate-sensitive cyclical stocks that rallied on easing expectations, as the market appears to be shifting focus back to fundamental earnings growth, where AI companies are leading.
• Monitor the AI capital expenditure cycle as the key risk factor; any signs of a slowdown in spending by major tech firms could signal a reversal in the current market leadership.
• While the near-term thesis is bullish on AI, acknowledge the long-term risk indicated by record-high household equity allocation, which may temper market returns over the next decade.