- Soothing words on China from President Trump calm down markets
- Investors still hoping for Xi-Trump summit this month, possibly in Korea
- Friday panic may highlight fragile nature of margin-fuelled stock markets
- Dow Jones Transportation index could yet have its say
“Stock markets, cryptocurrencies and the oil price are all regaining some ground after Friday’s rout, but gold and silver continue to power higher, even as President Trump offers soothing words about the hoped-for summit between China and the USA, to suggest that someone, somewhere is still feeling nervous,” says AJ Bell investment director Russ Mould.
“You can understand why that might be the case, when even just one wobbly day’s trading leads to such an outpouring of grief on social media about heavy losses, especially from the crypto community, because this suggests the foundations of the bull run may not be as strong as you would like them to be.
“In his magisterial book ‘A Demon of Our Own Design,’ Richard Bookstaber picks out three facets above all others which lead to market storms, panics and crashes: debt, complexity and opacity.
“Sceptics will argue that the crypto universe offers all three, especially as many traders and owners of cryptocurrency use leverage, or positions funded by margin, to gear up their returns. However, stock market participants are borrowing heavily, too, if the latest data from FINRA is any guide.
“Unfortunately, the data comes with a bit of a lag, but the most recent dataset for August showed $1.1 trillion in margin debt. That was one-third higher than the same month in 2024 and represented a new all-time high for the amount of money borrowed by investors to fund their portfolio positions.
“This is all well and good when markets are rising, as higher asset valuations cover the borrowing. It is not good if markets are falling, as the investor is left with a liability that they have to fund, and one that is associated with a security that may be worth less than when they bought it. If they are unable to post enough cash to fund any shortfall, they can find themselves on the wrong end of a margin call and be obliged to sell assets to meet the gap. If many investors are in the same position at the same time, the result can be a cascade of forced selling which quickly becomes self-reinforcing.
Source: FINRA, LSEG Refinitiv data
“It is noticeable how dips in the S&P 500 are marked by slower growth, or even outright declines, in margin debt, although which comes first is a matter of debate. Either way, the rapid accumulation of margin suggests it may not take too much of a stock market stumble to create a shake-out of some proportion, and this may be why President Trump was quick to offer calming social media posts over the weekend.
Source: FINRA, LSEG Refinitiv data
“Such technical matters do help to explain why storms can suddenly blow up out of nowhere. The consensus is still that there will be a US-China trade deal of some sort, that the US economy and corporate earnings will continue to grow at a healthy clip (thanks at least in part to AI) and that the US Federal Reserve will look to provide policy support, through lower interest rates, should there be any unexpected signs of a slowdown.
“But one well-tested signal does not look quite so healthy at the moment, and so it is one to bear in mind.
“Robert Rhea’s Dow Theory suggests that where the Dow Jones Transportation index goes, the Dow Jones Industrials will eventually follow.
“This is because a strong economy will see strong sales of goods, with the result that fresh product must be put back on shelves for customers to buy. Trucks, ships, planes and trains will therefore be needed and strong demand for their services will be reflected in the Dow Jones Transportation index.
“The opposite also holds true, in that a weak economy will see weaker end sales and thus have less need for the services of truckers, ship owners, rail operators and airlines.
“It is tempting to dismiss this as a historical example that is no longer relevant, given how industry is barely one third of US economic output, and the rise of businesses that rely more on intangibles, such as intellectual property and brands, to sell software and professional services reduces the importance of those that move manufactured goods from factory to warehouses or stores.
“All the same, the Dow Jones Transportation index peaked last November. It has since sagged to levels no higher than those of spring 2021, when the US and global economies were trying to shake off the after-effects of Covid-19 and lockdowns.
Source: LSEG Refinitiv data
“The Dow Jones Industrials has, thus far, tried to shake off the Transports’ pull. Weakness in the Transportation benchmark, however, does hint at the danger of a US economic slowdown, perhaps due to tariffs and trade, perhaps not, and such a deceleration is not currently factored into bullish analysts’ earnings forecasts for the second half of 2025 and all of 2026.
“Research from S&P Global shows that analysts expect year-on-year earnings per share growth to run between 10% and 19% in each of the next six quarters.
Source: S&P Global
“Such a golden run may help to keep momentum players interested, and if the huge investments in AI start to pay off then maybe these estimates could even be exceeded.
“But there may be trouble if the opposite holds true and earnings disappoint, for whatever reason, especially as the current set of earnings forecasts still leave the S&P on the historically high forward multiples of 28 times earnings for 2025 and 24 times for 2026.”
