Stocks in the US have been under pressure over the last couple of weeks, but the US Stock Correction risk is not all that surprising, considering this is historically the worst month for equities. Investors note the “September effect” that typically leaves the benchmark S&P 500 trading lower by 0.7% to 0.9% on average. At the moment, it’s down 0.5%, and could experience further downside, at least according to analysts at Morgan Stanley.
Currencies are not immune to the move, although it might be as dramatic. Generally, a drop in the stockmaket implies a shift in risk sentiment, and could imply that safe haven assets like the dollar, gold and the Swiss franc might outperforming in the coming days. But, a closer look at what’s driving the move could give us a better understanding of where markets are heading and how to trade under the circumstances.
US Stocks Risk 7.0% Drop
Morgan Stanley sent a note to clients this week warning that US stocks could drop as much as 7%, if energy prices remained high and there was increased volatility in the bond market. Of course, part of that seems a bit of bad timing, as crude prices continued to decline over the weekend despite tensions in the Middle East. Lower crude prices would also help alleviate some of pressure on bond yields, as it would imply less pressure on the Fed to hike and potentially restrict the US economy.
However, the investor note brought up some worrying signs for the stock market, which could be particularly relevant for forex traders. Indices have generally performed positively so far this year,
and the market has been largely aware of the problem that the gains are concentrated in a relatively small number of tech stocks. As long as the tech market continues to outperform, US indices could rise. While a rising tide lifts all boats, as the saying goes, the rest of the US stock market isn’t seeing near as much gains.
Sentiment at Multi-Year Lows
Market sentimetn has trended lower through this year, despite higher highs in the stock market. Interestingly, the drop didn’t start with the war in the Middle East (although accelerated after February 28). A quick resolution of the conflict with Iran might not be enough to pull sentiment back up and help carry the stock market higher. At the same time, valuations have compressed, which is normal as the Fed hikes rates. What matters is that compressed valuations have generally two very distinct effects on markets, depending on the underlying fundamentals. On the positive side, it means that stock prices are less “stretched”, and could pop higher, particularly if the Fed holds rates or even cuts.
What a Correction Means for Forex Markets
The negative scenario is that investors are increasingly hesitant to invest in speculative stocks that typically have higher valuations, like AI-backed tech stocks. If enough investors become
worried about a correction, it becomes a self-fulfilling prophecy. The concurrent drop in investor sentiment suggests the latter scenario is more prevalent, particularly since the market is operating in a low-information environment between earnings seasons. The US Stock Correction could therefore become more relevant to forex markets if the shift in risk sentiment
continues.
A stock market correction could lead to a jump higher in gold, while commodity currencies decline. Though, a correction is not a market crash, and it could provide “buy-the-dip” opportunities that could eventually cap the upside for the dollar and gold heading into the traditionally more volatile month of October. The US Stock Correction could therefore remain a key theme for markets heading into October.
