Three Key Triggers for a Third Wave in Market Pullback

The S&P 500, Germany’s DAX, and Japan’s Nikkei 225 have all rebounded from their early August lows, a pattern that Christopher Watling, CEO and chief market strategist at Longview Economics, describes as classic pullback behavior. Watling explains that pullbacks typically unfold in three waves: an initial wave of selling, a relief rally that recoups some losses, and a third wave that retests or breaks below the previous lows.

Adding to the pattern, safe-haven assets like the yen and Swiss franc also sold off during this rebound. However, Watling notes that his firm’s model still sees room for a further move toward safer assets.

The crucial question now is whether a third wave will occur and what might trigger it. Dhaval Joshi, chief strategist at BCA Research’s Counterpoint service, suggests that the yen carry trade and the AI stock bubble are closely linked, and any of three factors could cause them to unravel.

Joshi points out that selling the yen has helped inflate AI stock valuations. By comparing movements in the euro/yen exchange rate to the ratio of the 30-year Treasury yield against the forward earnings yield of U.S. tech stocks, he illustrates this connection.

He argues that while the sellers of yen may not be the same as the buyers of AI stocks, these actions are intertwined, creating a reflexive relationship. The AI bubble, he says, has been fueled by leverage from borrowing yen.

Even though the Bank of Japan has signaled it will keep interest rates low, the yen remains vulnerable, especially if other central banks cut their rates. Joshi also questions the longevity of the AI stock boom, noting that most tech giants from the early 2000s, aside from Microsoft, eventually faded.

He believes Nvidia is unlikely to be a long-term winner, and that only a few companies will emerge as dominant players in AI, putting the inflated valuations of today’s AI superstars at risk.

Joshi warns that if any of the three pillars—Japanese interest rates, the yen, or AI investments—start to weaken, the entire structure could collapse.