Several crucial market warning signals are close to crisis levels as investors grapple with high oil prices and Middle East conflict, all while the AI engine that has powered the stock market sputters.
A pause in attacks in the Gulf has brought some relief as oil pulls back from the $100 mark , but it remains elevated enough to threaten a pickup in inflation, which is keeping long-term government borrowing costs at levels that typically spell trouble for risk assets.
At the same time, the seemingly unstoppable rally in shares with anything to do with AI is hitting a wall of concern about profitability, cash burn and erstwhile scarcity of things like semiconductor chips giving way to a damaging glut, further unsettling traders.
Here is a look at some of the market warning signs.
ON A KNIFE EDGE
Tech earnings are coming in hot, but investors are looking for revenue and profits that will justify the cost of the AI buildout well into the future.
With markets anticipating U.S. rate increases this year, AI hyperscaler bond yields are climbing faster than those on Treasuries and the cost of hedging a deterioration in creditworthiness has soared, right as the scorching rally in semiconductor stocks falters (.SOX).
On the plus side, the ratio of bullish positions to bearish ones on Nasdaq futures is at a 17-year low, as investors have ditched tech stocks, suggesting room for money to return.
That said, the equity-market bull run is fuelled by record debt, which grows along with the market itself.
Margin debt — the amount investors borrow to invest — hit a record $1.5 trillion in June, according to the Financial Industry Regulatory Authority, leaving investors' net balance with their brokers in a $1 trillion deficit for the first time.
Investors who owe more than they have in cash are far more likely to sell into declines in stocks than to buy them.
THE 5% TEST
U.S. 30-year Treasury yields have remained above 5% for the longest stretch since the early days of the financial crisis in 2007.
This level itself is not necessarily a trigger for a market selloff, but higher long-term rates can raise the costs of loans, such as mortgages, squeezing consumers and possibly undermining President Donald Trump's affordability push ahead of the November midterm elections.
If investors expect more in return for lending to the U.S. government for 30 years, those higher borrowing costs could spill into other markets such as corporate credit.
Raymond James Chief Investment Officer Larry Adam says spreads on some of the riskiest corporate bonds had reached a 15-month high, suggesting markets are demanding more compensation to lend to weaker borrowers.
"Investors are increasingly more discerning as markets price in tighter Fed policy and a more challenging environment for the weakest borrowers," he added.
THE COST OF OIL
Sure, oil has retreated from $100, but it is still up 27% in dollar terms on an annual basis — positive for U.S. producers, but punishing for non-U.S. consumers. Euro zone and UK importers are paying nearly 30% more than they were a year ago.
The weaker an importer's currency, the worse the pain. Just look at Japan, where the value of its imports is at a record high.
Indian refiners, meanwhile, are paying 40% more for Brent-linked crude, although they have been big buyers of heavily discounted Russian oil for the past few years.
Argentinian and Turkish refiners are paying nearly 50% more. Shipping has also become far more expensive. Given the peril in navigating the Strait of Hormuz, and now the Red Sea, tanker rates for key routes to Asia from the Middle East are around 600% higher year-on-year.
FAVOURITE FUNDING CURRENCY FLASHING RED
The yen, trading at almost 164 per dollar , has slumped to four-decade lows and investors are on edge for potential intervention by Japanese authorities to shore it up.
Reports that the Bank of Japan is considering a faster pace of rate hikes and a flurry of warnings from Japanese finance minister Satsuki Katayama have done little to support the currency, battered by relatively low Japanese rates, the energy shock, and Prime Minister Sanae Takaichi's expansive fiscal plans.
Low interest rates and historically low volatility have made the yen a popular funding currency for carry trades — borrowing in yen and investing in higher-yielding assets such as U.S. stocks and bonds. A sharp appreciation in the currency in the case of intervention could force investors to unwind those positions, quickly, as was the case in August 2024.
