Optimism Is Driving the Stock Market; Is It Irrational Exuberance?

Question: Why is the stock market exceeding expectations, surging to 22 record highs in the first three months of the year?

Answer: When the stock market was booming in the 1990s thanks to the dot.com frenzy, Federal Reserve (Fed) Chairman Alan Greenspan famously called it “irrational exuberance.” Back then, everything seemed peachy—the economy was soaring, valuation metrics like PE ratios were hitting record highs and there were no signs of a recession.

Fast forward to today, and it feels like déjà vu all over again. The S&P 500 has shot up over 25% since hitting a bottom in October. Folks seem convinced that hefty returns and ever-expanding PE multiples make sense. But here’s the kicker—most investors also expect the economy to slow.

So why is the market still defying gravity? Is it another case of overoptimism destined to pop like the dot.com bubble? Or is this time different? It’s probably a bit of both. Two major forces are driving this rally:

• First, nearly everyone is banking on interest rates falling later this year as the Fed has hinted. But the Fed hasn’t actually cut rates yet, and credit is still tight, so investors may be getting ahead of themselves.
• Second, many investors believe artificial intelligence, or AI, is going to be the next big thing, ushering in a golden age of earnings growth, especially for the tech giants like Alphabet (Google), Meta, Microsoft and Nvidia. AI is likely to be transformative, but which companies turn their AI investments into substantial profits is still a gamble.

Here’s where things differ from the past. Google is not Pets.com. Even if its AI dreams vanish, it and the other tech giants have extremely profitable core businesses. Even if their stock prices take a hit, these companies aren’t going under anytime soon. If a recession does rear its ugly head, it probably won’t be too brutal, especially with the Fed ready to swoop in with more rate cuts.

So yes, there’s a bit of irrational exuberance driving this rally, and it might lead to a market shakeup. Or maybe bullish investors are onto something, and AI’s going to transform the world sooner rather than later. The key for savvy investors? Understand that all things are possible. Don’t worry that you don’t have enough invested in the market or assume that it will soon correct.