Graphics: Frolopiaton Palm – Freepik.com
Always further, always more, always higher. That was the motto of the stock markets this year. Driven by a mega-hype about artificial intelligence, Nvidia shares were driven ever higher, the euphoria never ended, and many other big tech stocks also rose sharply. Anyone who has been on the stock market for a long time has seen such phenomena again and again, in various forms. And then, when even the last pessimists change their minds, the stock market crash comes. We saw it recently: the last great pessimist, market strategist Marko Kolanovic at the largest US bank JPMorgan, left the bank – whether voluntarily or involuntarily is not known. But if you constantly stand against the bull markets, will you eventually be finished if the bull market continues?
Stock market crash – it had to happen at some point
If it is the case for analysts and strategists, the same is likely to be true for investors. Which hedge fund manager can constantly take short positions and burn money? And how can you justify not being involved in constantly rising markets to investors? For months, more and more investors (professionals and private investors) have jumped on the bandwagon. To put it simply: when the time comes when all investors have jumped on the bull train, there will be no follow-up purchases and the stock market crash can occur. The trigger last week was the significantly worse economic data from the USA. As can be seen explicitly in the charts, it was the ISM data from Thursday and the US labor market data from Friday that helped trigger the stock market crash.
Japan crash and AI doubts
But what has really intensified this crash today is the crash in Asia, especially in Japan. Higher interest rates have rapidly worsened the situation there, the Nikkei 225 fell 13% today. The Japan carry trade is being de-leveraged by the upward crash of the yen (explained in more detail here by Markus Fugmann). Imagine if the DAX were to crash by 13% in one day – today it is “only” crashing by 2.4%. But things could get much worse over the course of the day, because many of the big tech stocks from the USA are showing dramatic losses in German trading today, and the Nasdaq future was already down more than 4% earlier. If you also take into account the losses since last Thursday, you can say: It is a stock market crash. The only question is: how big can the crash get, how long will it last? Is it a short, massive movement, a short cleansing storm? Or a downward movement lasting for months? Nobody can say that in advance.
No soft landing?
Last week’s data shows that the US economy is unlikely to achieve a soft landing, and the downturn could be more severe. And the Federal Reserve has still not lowered interest rates (current base rate 5.25 to 5.50%), but will probably cut it by 50 basis points instead of 25 in September. This narrative of interest rate cut hopes, which has also pushed the stock markets for months alongside the AI fantasy, is currently being completely ignored by investors. The stock market crash is happening because people are looking directly at the economic downturn and the possible lack of real revenue from the use of artificial intelligence.
Leveraged stock trading
Why was the crash in US stocks so severe at the end of last week and probably this week too? US investors in particular like to trade with leverage. They buy stocks on credit through their broker. When stocks are constantly rising, they make a huge amount of money. But when prices start to fall noticeably, leveraged trading accounts break down very quickly, brokers then announce margin calls, and investors are told to quickly put in more money. If no fresh money is added to the accounts, the brokers forcibly close the positions before the account balances slip into the red. A stock market crash is usually made much worse by such forced sales. If hundreds of thousands or millions of small private investor accounts are affected, it becomes a problem for the market as a whole. A crash can continue for days.
But the dynamics of such a market movement are unpredictable for all market participants or observers. No one knows whether we will see a massive stock market crash lasting several days, or a longer downward movement, or even a quick calming down. One can assume that many investors who have only come to the stock market in recent years have only known rising prices. You can’t blame these investors for the fact that a stock market crash is something completely unfamiliar to them. Many are likely to be shocked by disastrous gambling losses, especially when trading derivatives (options, CFDs, etc.). If these investor accounts have been destroyed, there will also be no money for new purchases after the crash.
Stock market crash inevitable after gigantic increases
In the big picture, one can say that the current movement was inevitable – it’s just that it’s not possible to predict exactly when it will happen. Share prices had risen so massively for months that completely exaggerated valuations were reached in many areas. At some point – even if it takes years – bubbles burst, including bubbles in the form of investor expectations and dreams of unlimited growth. Tesla is one such long-standing dream, Nvidia is the latest dream. The company’s massive growth has caused the share price to rise sharply for a long time, and as of Friday evening, the P/E ratio expected for the full year 2024 was 36. Tesla’s P/E ratio is 89, while stocks like Apple and Microsoft have 30. Now today’s falling prices will lower these P/E ratios and move them closer to normality. Values below 20 are considered normal, and higher values are certainly allowed for tech stocks – but only if a company’s growth story continues to work. But hyped companies with valuations that are far too high have more downside potential. With a P/E ratio of 21, Alphabet stock is the cheapest valued stock among the Magnificent Seven – so is it the stock with the lowest potential for setbacks at the moment?
The conclusion is short and sweet: the inevitable cannot be ignored. At some point, exaggerated valuations will be adjusted to reality. Even share prices of hyped companies can rise again after a stock market crash if sales and profits are in a healthy relationship to the share price. But after the stock market crash, the same applies: the next hype, the next euphoria can come. Back to AI, or do you look for a new industry?
The chart shows that since the beginning of the year, great profits have been made for months. Until a few days ago, the Japanese Nikkei 225 was up 26% since the beginning of the year, but now it is down 5.5%. The Dax was up 10% until the middle of last week, but now it is only up 2.9%. The Nasdaq 100 on a CFD basis showed an annual increase of 24% just three weeks ago, but now it is only 7.3%. The European Stoxx600 has also lost from +8% to +1.6%. The stock market crash this week could wipe out the last annual gains.
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