Global Stock Market Sell-off: 3 Factors to Trigger Third Wave Pressure
Global stock markets, including the US S&P 500 index, Germany’s DAX index, and Japan’s Nikkei 225 index, have all rebounded from their lows in early August. However, analysts warn that this is just a typical bounce from a deep decline, and three different factors in the future could trigger a retest of the early August lows. MarketWatch reported that Walter Lynn, CEO and Chief Market Strategist of Longview Economics, explained that a typical stock price pullback follows a three-wave pattern: the first wave is selling pressure, the second wave is a relief rally, partially recovering the losses from the first wave, and then the third wave, retesting the lows seen in the first wave or even probing lower lows.
Simultaneously, another typical market behavior is occurring: safe-haven assets, particularly the Japanese Yen and the Swiss Franc, are experiencing selling pressure during stock price rebounds. However, Walter Lynn pointed out that Longview Economics’ hedge position allocation model shows that there is still room for funds to shift towards these safer assets.
The question now is, will the third wave materialize? What circumstances could trigger a sudden selling pressure?
Three factors could ignite a resurgence in selling pressure: Japanese interest rate hikes, Yen appreciation, and the collapse of AI stocks. BCA Research’s Counterpoint division’s Chief Strategist, Josh, analyzed the complexity of pricing, indicating that the Yen carry trade and artificial intelligence (AI) stock price bubbles are two sides of the same trade. Once the following three factors occur, they could swiftly unravel this trade.
1. Strong Yen Appreciation
Josh explained that as investors sell the Yen, it has led to the inflation of the AI stock price bubble. He presented a chart showing the Euro to Yen exchange rate trend compared to the ratio of the US 30-year bond yield to the inverse of the US tech stock expected earnings yield (P/E ratio). The two lines showed a close relationship. He stated: “Selling the Yen may not be done by the same group of people buying AI stocks, but the Yen sell-off and the inflation of the AI stock bubble are two ends of the same trading process. Selling the Yen will fuel the AI bubble, and the expansion of the AI bubble will encourage selling the Yen. Therefore, instead of a cause-and-effect relationship, it is more of an interaction. The significance of the Yen carry trade and the AI bubble merging is crucial because all bubbles require leverage, and for the AI bubble, the leverage is borrowing in Yen.”
2. Japanese Interest Rate Hikes
Despite statements from Bank of Japan officials that they will not raise interest rates in volatile market conditions, the Yen remains vulnerable if other central banks lower rates. The market generally expects the US Federal Reserve to cut rates by 0.25% or even 0.5% in September, following the European Central Bank, the Bank of England, and other central banks.
3. AI Stock Bubbles
Another point to consider is whether the AI stock boom can continue, depending on how quickly companies investing in AI can reap rewards. Josh mentioned that the tech superstars of the early 2000s, such as Intel, IBM, Oracle, and Cisco, have mostly lost their shine, with only Microsoft successfully transitioning into a Web 2.0 winner. As for today’s superstars, he believes that Nvidia is unlikely to be a long-term winner, and at most, only one or two companies will emerge as AI winners. Josh stated: “This means that the total valuation of these superstar stocks has inflated to dangerous levels, especially because these AI stock prices have been boosted by the Yen carry trade.” Josh pointed out that Japanese interest rates, the Yen, and high-return investments in AI are like three legs that could break, and once they do, the “whole chair is bound to collapse.”
With these three factors in play, the global stock market could face another wave of selling pressure. Investors need to monitor these developments closely to navigate the market effectively.
Implications of Global Stock Market Sell-off
The implications of a potential third wave of selling pressure in the global stock market are significant. If the three triggering factors come into play, it could lead to increased volatility, sharp declines in stock prices, and a shift in investor sentiment. The interconnected nature of the financial markets means that developments in one region can have ripple effects across the globe. It is essential for investors to stay informed and adapt their strategies accordingly to protect their investments.
Strategies for Investors
In light of the potential risks associated with the current market conditions, investors should consider implementing various strategies to mitigate the impact of a global stock market sell-off. Diversification of investment portfolios, hedging against currency fluctuations, and staying informed about macroeconomic trends are essential steps to safeguard investments. Additionally, maintaining a long-term perspective and avoiding knee-jerk reactions to short-term market fluctuations can help investors navigate turbulent times successfully.
Conclusion
As the global stock market faces the possibility of a third wave of selling pressure, investors must remain vigilant and prepared for potential market downturns. By understanding the factors that could trigger a sell-off and implementing sound investment strategies, investors can protect their portfolios and capitalize on opportunities that arise in volatile market conditions. It is crucial to stay informed, adapt to changing market dynamics, and seek professional advice when needed to make informed decisions in uncertain times.