The S&P hit another record high yesterday, which seems to happen with eye-rolling frequency these days. And it got me thinking about a reader email that landed in my inbox last week—perhaps the most refreshingly honest market question I've heard in years: "What, exactly, is the stock market based on now?"
Not fundamentals. Not technicals. Not economic data. Not historical precedent. Not major news.
I actually laughed out loud, then nodded in recognition. Then poured more coffee. Because damn if that question doesn't perfectly capture the surreal disconnect many of us feel watching these markets in 2024.
Here's the thing—markets aren't irrational right now. They're differently rational. The old playbook where earnings disappointments tank stocks and strong economic reports lift them? That's been replaced by... something else. Something weirdly elusive.
Look at last week's jobs report. Numbers came in hot—way too hot if inflation's your worry—yet the market rallied anyway. Why? Because traders collectively decided this meant the economy was stronger than expected, which apparently outweighed concerns about delayed rate cuts. But rewind two months and a similar report triggered a sell-off because... inflation fears. Same data, completely opposite reaction.
I've spent over twenty years on trading floors (God, that makes me sound ancient), and I've never witnessed sentiment diverge so dramatically from traditional metrics. It's as if we're all playing poker, but half the table thinks we're playing blackjack.
The Rationalization Machine
One model I find useful is what I call the "Rationalization Machine." Markets move based on this messy stew of liquidity, positioning, and sentiment—then we humans backfill reasons that sound intelligent enough to repeat at cocktail parties.
"Oh, stocks went up on bad economic news because it means the Fed will be more dovish."
"The company missed earnings but provided strong guidance, so the stock rallied."
"Investors are looking through near-term weakness to long-term potential."
These explanations aren't necessarily wrong. They're just... conveniently elastic enough to explain whatever happened after the fact.
The truth? Market movements—especially short-term ones—have always been driven more by sentiment and liquidity than by some rational discounting of future cash flows. That's nothing new. What's new is the sheer scale of the disconnection and our collective willingness to swallow increasingly tortured explanations.
Sentiment Feedback Loops
So what drives future sentiment if not fundamentals? Primarily, past sentiment. Markets are massive feedback machines. Momentum begets momentum until something—anything—breaks the pattern.
Think of markets as a stadium crowd doing the wave. There's no logical reason for you to stand up and raise your arms at a particular moment—you do it because the people next to you just did it, and the people next to them will do it next. The wave continues until enough people get distracted or tired.
Market sentiment works the same way. We're in an optimistic phase punctuated by occasional panic attacks of varying severity. A crash is essentially a collective panic attack. A bubble is an irrationally exuberant state that primes conditions for that eventual panic.
And yes, that's probably the state we're in now. (Sorry to be the bearer of obvious bad news.)
The AI-Liquidity Complex
If I had to pinpoint what's different this time (dangerous words in finance, I know), I'd highlight two factors:
Unprecedented liquidity: Despite all those rate hikes, there's still enormous money sloshing around the system seeking returns. Much of it is concentrated in fewer hands, and those hands tend to move together.
The AI narrative: Unlike previous tech booms, AI offers a genuinely transformative technological shift that could reset productivity curves. The problem isn't that AI isn't important—it absolutely is—it's that markets struggle to price revolutionary technologies with appropriate nuance.
When you combine massive liquidity with a compelling narrative about the future, you get a market that can rationalize almost any price action. Bad earnings? "AI will fix that." Economic slowdown? "AI will accelerate growth." Inverted yield curve? "This time is different because of AI."
I've heard variations of these explanations in every analyst call I've sat through this quarter.
Finding Signal in the Noise
So what's an investor to do in this environment?
First, acknowledge the reality. Markets aren't "wrong"—they just operate on different timescales and with different incentives than you might expect. The price is the price, regardless of whether it makes sense to you or me.
Second, extend your time horizon. Short-term market movements have always been noisy, but the noise-to-signal ratio is currently off the charts. The longer your investment horizon, the more fundamentals assert themselves.
Finally, maintain perspective. Remember that markets have always been this way to some degree—periods of seeming rationality punctuated by mass delusion. What feels unprecedented is usually just unprecedented in our limited experience.
As for our current market state? It reminds me of something an old trader told me over whiskeys after a particularly bizarre trading day: "The market can remain seemingly irrational far longer than most people expect, and then suddenly become brutally rational when least convenient."
I suspect we're in for both. Maybe bring an umbrella.
