The stock market and Forex are related, but often, currency traders can focus on their area without paying too much attention to what’s happening in equities. However, the stock market occasionally flashes warning signs that are beneficial for forex traders to take note of. After all, when a market correction (or crash) occurs, it inevitably spills over into the currency markets.
The issue with stocks that has some analysts worried at the moment is the rise in AI. Part of it is the high levels of enthusiasm among investors. Another part is a worrying large number of small retail traders getting into the market. And finally, there is the historical precedent that major market corrections often happen in October, right after making a series of all-time highs in September.
What’s Wrong With the Stock Market?
Generally, traders like the stock market hitting new highs – right up until it becomes overbought and due for a correction. US indices hit new highs after the Fed announced its rate cut earlier this week, but there was a distinct lack of enthusiasm despite strong hints at further monetary policy easing. The Fed resuming its rate-cutting cycle might be an indication that the upward trend for the market is close to its end. After all, most major market corrections occur during the Fed’s easing cycle.
There are multiple things to be concerned about with the current US stock market situation. First is the high valuations. The benchmark S&P 500 is trading at a PE ratio of over 30x. That’s double the average for the last ten years at 15x. That means a preponderance of companies in the index are likely overvalued, and potentially trading at overbought levels.
Why the AI Concern?
The other factor is that the recent gains have been led primarily by a single sector: AI-driven tech companies, such as Meta, Nvidia and Oracle. Tech now accounts for a 37% weighting in US stocks, the highest level ever. Even higher than at the peak of the dot-com bubble at the start of the century. Many of these companies are trading at triple-digit valuations, meaning that investors are betting on returns in the form of higher stock prices.
Then there is the problem of AI not driving sizeable returns yet. While many companies are ploughing billions of dollars into AI advancements, most of the companies are not seeing a return on investment yet. Some companies – the ones that provide AI infrastructure – are making money. However, companies that provide AI services to clients, such as OpenAI, Google, and Microsoft, are not seeing their net profits increase from AI. Microsoft is a good example, as it offers AI products to consumers at a cost exceeding revenue. But it’s the cloud division that offers AI processing and storage is seeing strong growth in sales and profits.
What Does It Mean for Forex Traders?
A concerning trend is illustrated by Oracle’s earnings last week, which prompted its share price to jump 40% in a day. It did have a solid earnings beat, but the market was reacting primarily to its booked order growth of 300%. That is, for sales that it hasn’t done yet, and might not be completed. The company’s share price is based on the prospect of future income.
If investors sour on AI at some point, then US stocks could enter a period of declines, potentially similar to the 2022 period. That would likely spill over into Forex markets as investors pile into safe havens, supporting the dollar, gold and the yen. Increased market volatility would mean forex traders would be advised to keep a close eye on their stop losses and prioritise money management.
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