To say that the world is in turmoil to an extent not seen since the 1960s is an understatement.
The war in Ukraine is now in its fifth year. The war in Iran continues with no end in sight, despite Trump’s optimistic talk. NATO may be nearing the break-up stage as Trump pulls U.S. troops out of Germany.
Energy prices are soaring, inflation has accelerated sharply again, consumer confidence has fallen sharply, debt is at an all-time high and supply chains are breaking down.
Yet the major U.S. stock indices are at or near all-time highs.
What accounts for record stock prices amid almost unprecedented turmoil?
There are a number of key factors supporting stocks. The most obvious is the AI frenzy. This has two aspects. The first is that AI applications can improve productivity. The second is that the build-out of data centers with the most advanced semiconductors has led to a $1 trillion capital investment tsunami as Microsoft, Amazon, Google, Meta, OpenAI, Anthropic and other AI providers build their server farms.
The next factor is related to the first and is often called the picks-and-shovels trade. The idea is that those who benefit in a gold rush are not the gold miners but the merchants who sell tools, clothes, supplies and other goods the miners need.
In the AI gold rush, the winners are electricity suppliers, builders, hardware manufacturers (semiconductors and servers) and small towns where the server farms are located. These suppliers will do well today whether AI lives up to its promise or not.
Passive Aggression
Another major factor is passive investing. An enormous amount of U.S. wealth is held in 401(k)s, IRAs and assets under management by wealth managers.
Relatively few of the account holders (or, for that matter, wealth managers) really understand active stock investing or risk management. Instead, they buy index funds, ETFs or other equity basket products that track the stock market itself or a specified segment.
When money is put into these index funds, the manager buys the stocks in the index. That buying pushes stock prices higher. That attracts more money, more buying and more gains in a positive feedback loop that drives stocks even higher. No Ph.D. is required. You just buy the index, sit back and enjoy the ride.
FOMO and TINA
Two other factors related to the passive investing feedback loop are fear of missing out (FOMO) and the idea that there is no alternative (TINA). It’s difficult to show up at a cocktail party or the country club when all of your friends are touting their stock gains and you’re not in the market.
It’s also difficult to put money in 4% cash equivalents or assets like gold when stocks seem set to deliver 10% returns as far as the eye can see.
FOMO and TINA have nothing to do with fundamental stock analysis. But they are real and powerful drivers of human behavior.
It’s not all fairy dust, however. There are actual fundamental drivers behind stock gains. Corporate profits are coming in strong (despite some high-profile missed estimates). U.S. energy self-sufficiency will keep the lights on in the U.S. and help prevent 1970s-style gas lines — even if we are not immune to the impact of higher prices.
That’s the argument for higher stock prices despite global problems.
What could possibly go wrong?
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