As tensions in the Middle East ease, market sentiment improves, and investors gradually digest expectations for potential Federal Reserve rate hikes, Wells Fargo Securities believes U.S. stocks still have room for further gains and has raised its year-end target for the S&P 500 index.

Wells Fargo has increased its target for the S&P 500 at the end of 2026 from 7300 points to 7950 points, implying approximately 5% upside from Monday's closing level.

This adjustment coincides with the planned formal signing of an interim peace agreement between the U.S. and Iran in Switzerland this Friday.

The market widely believes this agreement could end the months-long conflict, restore normal traffic through the Strait of Hormuz, and thereby alleviate global energy supply pressures.

Wells Fargo equity strategist Ohsung Kwon stated that the thawing relations between Washington and Tehran are alleviating market concerns about the macroeconomic environment.

He noted that the inflationary pressures previously driven by rising oil prices are expected to gradually recede, while market sentiment has cooled from excessive optimism to relatively neutral levels, creating new upside potential for the artificial intelligence (AI) related sector.

Kwon wrote in the latest report, "Market sentiment has completed a reset, creating conditions for the AI trade to regain strength."

Based on this assessment, Wells Fargo advises investors to continue allocating to the semiconductor sector and increase holdings in cyclical stocks.

The institution believes that as the Middle East conflict gradually concludes, economically sensitive industries are poised for catch-up gains, while previously favored defensive sectors may lag.

Although market focus is shifting from geopolitical risks to the first interest rate meeting chaired by the new Fed Chair Wash this week, Wells Fargo views the market's initial expectations for the "Wash era" as relatively mild.

Kwon indicated that inflation remains the most significant risk factor for U.S. stocks, but primarily if the Federal Reserve chooses to combat it with further rate hikes.

He pointed out that if the Fed allows the economy and inflation to run somewhat hot in the future, rather than implementing aggressive tightening policies, stocks will remain one of the most effective assets for hedging against inflation.

"If the policy choice is to let the economy run moderately hot and digest debt pressure gradually through inflation, this environment is actually favorable for equities," the report suggested.

Wells Fargo maintains that despite recent market discussions about AI sector valuations, artificial intelligence will continue to be a key driver for U.S. stock gains.

The institution notes that following recent adjustments, sentiment indicators related to the Nasdaq 100 index have returned to neutral, suggesting capital may flow back into the AI industry chain.

Particularly in the semiconductor field, with ongoing global data center construction, AI infrastructure investment, and corporate digital transformation, the industry's fundamentals remain solid.

However, Wells Fargo also cautions investors that the path ahead for U.S. stocks is not without risks.

Firstly, the approaching U.S. midterm elections could introduce market volatility.

Kwon noted that historical data shows the S&P 500 index has a 71% probability of experiencing a correction exceeding 10% in the second half of midterm election years, meaning political uncertainty could impact market sentiment.

Secondly, the AI industry may face stricter policy regulation in the future.

Kwon pointed out that some voters' attitudes towards AI technology development are not entirely positive, and if U.S. politicians begin pushing policies to restrict AI development, it could impact a key force that has driven U.S. stock gains over the past year.

He stated, "Any policy discussions about slowing the pace of AI development could put pressure on market indices."

Wells Fargo believes that against a backdrop of easing geopolitical risks, recovering market sentiment, and a still-solid AI investment thesis, the long-term upward trend for U.S. stocks is not over, but investors must remain attentive to periodic volatility caused by inflation, monetary policy, and potential regulatory changes.