Gas prices are well above $4, ceasefire negotiations are on ice and airlines are warning that they’re running out of jet fuel. So, it sure seems odd that stocks are at record highs.
Blame CNN. No, really. Not for world events or the machinations of the markets, but for the perception that those two things are connected.
CNN (and the media as a whole) has forever linked current events with the performance of the stock market — it’s right there in a little “Dow” bug at the bottom of the screen during live news coverage.
That’s why we often view the stock market as a mirror. But the market isn’t a mirror; it’s a prediction engine.
Stock fluctuations are barometers for how a vast array of information — robust profit performance, a CEO gets sick, a competitor builds a better product, AI threatens an entire line of business — changes the perceived value of a particular company’s shares and its long-term earnings potential.
Once Wall Street believes the ramifications of a big news event have been appropriately priced into a stock, it often moves onto the next thing – often faster than Main Street has.
“It often feels like the stock market operates in an alternate universe,” said Kevin Ford, market strategist at Convera. “It’s less an alternate universe than an alternate timeline.”
Markets have operated on an alternate timeline before.
-
In March 2009, stocks began to rally, despite an ongoing deep recession that lasted several more months.
-
Markets rebounded sharply just a month after the pandemic plunged the global economy into the deepest-ever recession that took years to recover from.
-
After President Donald Trump imposed historic tariffs in August, the market kept rising.
But headlines still matter. The market is priced for perfection, the saying goes, and investors are pricing stocks for the expectation of how much profit they’ll deliver in the future.
New information, such as an escalation or de-escalation of a war, increases the uncertainty around those profits, and it forces traders to re-price their bets.
That’s why the Iran war shook the stock market in late February. The Nasdaq, filled with tech stocks that are particularly sensitive to inflation, took news of the war particularly hard. It fell into correction territory — when a stock or index falls 10% or more from a recent peak. The Dow followed suit and the S&P 500 nearly got there, too.
But then, on the last day of March, the market’s perception of the war shifted. Trump and his administration started seeking opportunities to end the war.
Stuff stopped blowing up, and markets moved on: The S&P 500 gained nearly 3% that day and never looked back. Stocks have gained another 10% since then.
The economic situation hasn’t changed – if anything, it got worse: The Strait of Hormuz remains closed, locking in a fifth of the world’s oil and other crucial supplies, raising the risk of shortages and price spikes in the future.
The market knows all that. Investors just believe that risk is appropriately priced into stock prices.
“I don’t see a market ignoring risk; I see markets making a judgement that the global economy and corporate earnings can absorb it,” said Nigel Green, CEO of deVere Group. “Markets don’t wait for certainty, they move as soon as the worst-case scenario starts to fade.”
The prediction engine is often wrong, and the worst-case scenario is still very much a possibility.
Peace talks don’t happen over a period of days or weeks, they happen over a period of months. Iran has shown no urgency to open the strait while negotiations continue. Meanwhile, the supply chain is getting stretched again and could break this summer if the strait remains closed. Shortages could send prices surging. Injecting more uncertainty into an economy that’s already full of it could tip it over the edge into a recession.
But risk runs both ways. There’s no certainty that when the market gets something wrong, it will be a negative risk. The market could also miss out on a massive buying opportunity.
Earnings are strong, AI is fueling a massive technology investment boom, and the economy has remained robust. The Citi Economic Surprise Index — a measure of how much better or worse the economy is performing compared to the market’s implied expectations — has been on a tear, on its longest positive run in nearly two decades. In other words, the markets keep underappreciating how strong the economy is. It’s hard, as a trader, to ignore surprisingly good news.
“It’s not that the headlines aren’t real — the headlines are real, and they’re scary,” said Rick Gardner, chief investment officer at RGA Investments. “But we’ll have a scary headline, and then we’ll get earnings announcements that are knocking it out of the park. That can drown out headlines for investors.”
