Investors are in a love-hate relationship with the stock market

The S&P 500 has so far been pummeled this week, with Monday’s 2.1% fall being followed by flat Tuesday trading. The malaise has spread beyond the U.S.: Japan’s Nikkei 225, the Stoxx Europe 600 and the MSCI Emerging Markets Index all tumbled on Tuesday.

What is far less clear is why. Yes, the ISM Manufacturing purchasing managers’ index for August was a bit weaker than expected, following a similar bad print coming from China in the weekend. Then, on Tuesday, U.S. job-opening data for July came in below expectations too.

However, this doesn’t say much about the health of the economy that wasn’t already known. Plus, the market reaction isn’t telling a straightforward story. Investors did rotate out of “consumer discretionary" companies—apparel, specialty retailers and automakers—and into more defensive “consumer staples"—food and tobacco brands. But financial firms are also cyclically sensitive, and they fell less than average. Technology companies have suffered more than industrial ones, which are supposed to be the focus of the concerns.

A possible explanation: Investors are struggling to reconcile a market in which everything has performed great, yet nothing seems worth buying.

On the one hand, asset allocators have been hard-pressed to do wrong this year. The S&P 500 is still up more than 15%, boosted by artificial intelligence. Japanese stocks are up more than 10%, and European ones have gained almost 8%. Gold and crypto have staged big rallies. Even those who ventured into long-suffering U.S. small-capitalization stocks have made money, despite doing relatively worse. With the Federal Reserve all but certain to slash interest rates this month, bonds could finish the year with price gains too. Commodities have been a sore spot but, even there, losses have been small.

Against this backdrop, it is no wonder that investors report being incredibly bullish: Surveys by the American Association of Individual Investors are hovering around levels that signal extreme optimism. A tepid environment for manufacturers notwithstanding, economic growth remains robust and is expanding geographically.

When looking at each asset class individually, though, any excitement vanishes.

Take AI-linked stocks. Massive capital expenditures by giants such as Alphabet and Facebook-parent Meta Platforms have led to revenues at semiconductor companies and data-center owners surging, but broader adoption of the technology remains sluggish. This raises the possibility that “AI infrastructure" companies are riding a wave of unsustainable earnings, just as Cisco did during the dot-com bubble.

Such concerns are now coalescing around the largest of such companies, Nvidia, which lost $278.9 billion of market value Tuesday—the biggest one-day decline on record for a U.S. company.

Meanwhile, non-AI stocks in the S&P 500 have rallied powerfully since August and are now trading at more expensive price-to-earnings ratios. U.S. growth may be strong, but it is still expected to slow this year and the next, which makes it hard to see strong value in cyclical stocks. Big brands are losing some of the pricing power they had after the pandemic, which makes consumer staples a less obvious haven. Utilities, another traditional defensive sector, have also become pricier since they are an AI-related play.

Overseas, political turmoil has returned to Europe, where the economy is improving but still lagging behind expectations. Stocks in the U.K., Italy and Spain seem to be looking up, but investors have burned their fingers there previously. Japan, which was finally delivering on its promise to investors, now has to grapple with higher interest rates and a stronger yen. And gold seems overstretched at the current levels.

What to do? Wealthy individuals and institutional investors seem to have chosen none of the above by piling into alternative assets, namely private debt.

Those who don’t have those options seem to be swinging between giddy optimism and sudden pessimism. All eyes are on Friday’s U.S. payroll data. If it shows another uptick in the unemployment rate, the market could take it badly.

Other factors may be amplifying the swings. September is historically the worst month for stocks—and it has the most number of declines larger than 1% for the S&P 500 on the first trading day of the month, according to Bespoke Investment Group. The market also suffered a volatility-induced selloff in August, and this usually leads to relapses a few weeks later.

Nevertheless, it is encouraging that the market hasn’t fallen into the old pattern of thinking that bad news about growth is good news because the Fed will make all troubles go away. Whether the economic slowdown ends up being severe or not, unconditional love is rarely the wisest investment strategy.

Write to Jon Sindreu at jon.sindreu@wsj.com