Why are US stocks living in an alternate reality?

Stocks seem to be moving in an alternate reality: while indices are hitting historic highs and the market is in a bullish recovery, the underlying economic fundamentals and the real economy don’t seem to fully support this. So what are the forces and factors that explain this “unexplained” rise? From monetary policy easing to investor sentiment to tech waves, the market seems to be moving at a pace that often seems independent of the real economy. In particular, counting all the workers in a country the size of the United States is not easy. However, the latest revision to nonfarm payrolls, which showed that they were initially overstated by 910,000 in the 12 months to March, does not boost confidence. It was the largest change in history and at the lower end of estimates. Still, it’s not terribly surprising, and the history of revisions shows that inaccuracy is nothing new. Of course, this does not bode well for the US economy. So how is it that stocks celebrated this news by hitting a new all-time high? From a low five months ago, a week after the “Trump’s Liberation Day” tariffs were announced, the S&P 500 is up 31%. This is highly unusual; since 2005, only the recoveries following the Global Financial Crisis and Covid have seen larger five-month increases. What is even more surprising is that this recovery occurred despite the fact that the April 2 tariffs were maintained. If it made sense to sell then, the worsening economy should provide even more reason to do so now. This bizarre rise already deserves a place in the books. But there are some explanations. Bonds Falling bond yields, which lowers the cost of money and widens the multiples that can be justified for stocks, are clearly a factor — but it’s notable that even after they fell in reaction to the latest jobs data, 10-year yields remain higher than they were when stocks began their rally after “Trump’s Emancipation Day.” Lower yields are clearly good news for stocks only if the economy is doing well. Despite the shocking revision in jobs data, there are signs that this is the case. One piece of data supporting stock advocates is the latest survey of small businesses from the National Federation of Independent Business, which found a significant decline in both complaints about higher prices and difficulties finding staff. That sounds like a drop in inflationary pressures. Meanwhile, consumer inflation expectations remain relatively stable. The latest New York Federal Reserve survey of consumers shows long-term expectations unchanged at 3%, the upper limit of the Fed’s target. Annual expectations rose slightly, but the overall picture remains healthy. While July’s inflation data showed a rise in prices for goods directly affected by tariffs, there is a strong argument that they remain stable enough to allow the Fed to cut rates more aggressively. July’s increase in the personal consumption expenditure (PCE) index, which excludes outliers, was the lowest since 2020. The trend in prices remains significantly higher than before the pandemic. In this case, Thursday’s inflation would have to be a real “black swan,” well above the agreed-upon 3.15% core inflation forecast, to prevent the Fed from cutting rates next month. That seems to outweigh all other concerns for equity investors.