If you’re biased against equity rallies built on hype, greed, mania and other manifestations of human psychology run amok, I have some potentially distressing news: All market rallies are, to a greater or lesser extent, a function of humanity’s penchant for irrationality. The same is true of selloffs, by the way.

Of course, some rallies are more susceptible to allegations of mania than others, just like some selloffs are better described by reference to overwrought despair than to deteriorating fundamentals. When you throw in the “contributions” of systematic investor cohorts, it’s sometimes hard to know exactly what the lines and quotes on your monitors actually represent. Markets are supposed to be efficient, but how realistic is that when humans are incurably mercurial and the unemotional trading performed by machines lacks nuance and context?

I digress. Only not really. 2023 is all about discerning the artificiality of the US equity market (note that “artificiality” may be an amusing misnomer considering it typically refers to man-made facsimiles of natural phenomena, whereas here we mean machines imitating man). The rally is narrow, we know that. And we know it’s built on what may be seen, in hindsight, as fantastical assumptions about the potential for generative A.I.

That said, there’s a (very) strong case that generative A.I. is, at the least, an “iPhone moment,” as Nvidia CEO Jensen Huang recently put it. It may be an industrial revolution moment. Or it may be the metaverse all over again, which is to say more hype than substance.

Whatever it is, the mere prospect of a new tech epoch is singlehandedly bolstering the market. As one bank noted Thursday, better than 100% of the S&P’s market cap gains in 2023 are down to just seven stocks, three of which account for almost three-quarters.

As Bloomberg’s Cameron Crise astutely observed, the Nasdaq 100’s outperformance to US small-caps is now approaching 30% over the last three months.

Although Crise suggested that might be a sign of “significant instability,” he was quick to point out that the 25% outperformance mark for big-tech was also met twice as the dot-com bubble inflated. As I put it last week, trying to short bubbles is a fool’s errand. Nine times out of 10, you’re not going to time it correctly.

“There have been plenty of comments on the narrowness of the market — particularly when it comes to all things A.I. — but even on an equal-weighted basis, our US Growth factor rose by 4.6% [in May] while value stocks went in the opposite direction, losing 3.7%,” SocGen’s Andrew Lapthorne wrote Thursday. The figure on the left below shows that this dynamic, while not exclusively a US phenomenon, is certainly most acute for US growth shares.

The YTD performance disparity between SocGen’s growth and value factors is 16%. And yet, as Lapthorne went on to note, growth stocks are still down 20% from the highs, and even as the Nasdaq rallied, nearly 2,000 companies in the composite remain 50% or more from their two-year peaks. “So, this could just prove to be a bear-market rally,” Lapthorne suggested.

Meanwhile, a BofA indicator tracking sell-side equity allocations is close to flashing a contrarian “buy” signal. The gauge, which measures strategists’ recommended equity allocation, fell to 52.5% in May, very close to levels which historically represented buying opportunities.

According to Savita Subramanian — who on Thursday said that “watching our model approach a ‘Buy’ signal in recent months is like watching paint dry, and smacks of low conviction in a trendless market” — the hit rate when the indicator threw off a buy signal in the past was 94% (versus 81% unconditional), with a median 12-month return of 21%.

I should mention that the indicator (the dark blue line in the figure) is one of five inputs into Subramanian’s official S&P 500 target. Currently, it’s the most bullish of the bunch.

“We see other reasons to be optimistic on stocks besides the fact that the world is so pessimistic,” Subramanian continued. “A newfound corporate focus on efficiency — automation, doing more with less, A.I. — could drive productivity gains, and investors tend to pay higher multiples for permanent cost reduction.”

One way or another, it’s all about A.I.