Dow Jones industrials drop 500 as stock market losses deepen

Global stockmarket indices

The optimism helped lift stock markets ever higher, extending the boom into its ninth year.

The Dow Jones industrial average plunged a heart-stopping 1,500 points in afternoon trading on Monday before gaining back some ground - and finishing at 24,342, or down 4.6 percent - as volatility returned to the stock market with a vengeance after a year of rare tranquility.

When the macro-economic situation deteriorates, investors seek more return on bonds to compensate for the risk involved.

The Dow was up over 26 percent from January 2017 to January 2018.

"It is hard to see the 10 year US Treasury breaking much above 3 to 3 ¼% without a sustained increase in inflation, which would raise expectations of more aggressive central bank tightening". Actually, the historical experience points to rising wages growth as being positive for profits as it drives stronger spending - until of course it turns into an inflation problem prompting tight monetary policy - but we are still a long way from that. Greater debt and higher interest rates would exert further downward pressure on stock prices.

For all the alarming headlines, this isn't a true correction yet.

As bad as Monday's drop is, the market saw worse days during the financial crisis.

The Dow has swung more than 2,100 points in the last two sessions, a decline pushing more than 8 percent and shattering long-term momentum. (The S & P 500 is down about 7 percent from its prior record level).

Many analysts pointed to a seemingly unusual cause for the turbulence: rising wages. "Most of the recent moves were driven by the U.S., with Treasury yields trading at nearly 2.90 percent, with at least probably some marginal willingness on behalf of investors to scale into the market again at those levels". It's Treasuries that are supposed to be in a bear market, after all. "I believe this, too, shall pass".

In a odd way, investors are nervous that the global economy is doing too well.

Yet many investors in the world's biggest bond market are smiling.

We are still a remote, narrow-based economy with a small and illiquid bond market. The market downturn isn't being driven by bad economic news.

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The sell-off started because of the Friday "jobs report". Overall, it looked like good news. Add to these, the Fed's Beige Book report for January which found that: "Most Districts cited on-going labor market tightness and challenges finding qualified workers across skills and sectors".

Wall Street is REALLY anxious about inflation. "Investors are looking at high gross domestic product growth in the first quarter". On a basic level, inflation is the rise in prices of everything from rent to groceries to gas to college tuition.

We had a look at this issue last week in Higher global inflation and higher global bond yields. Notably, this compares to a much higher sensitivity factor of 50% for peers Wells Fargo and Capital One.

Many investors have anxious that after years of market volatility being suppressed by ultra-low interest rates around the world, the good times were bound to come to a hard landing. A drop of 10 percent from a peak is referred to on Wall Street as a "correction". Will it mess up? The Federal Reserve combats inflation by raising its interest rates. This leads businesses and consumers to close their wallets, and the economy to tank. The Russell 2000 index of smaller-company stocks sank 56.18 points, or 3.6 percent, for 1,491.09.

US stock index futures extended their losses on Monday, with the Dow futures falling over 300 points, as bond yields continued to rise.

We think structural global sources of demand for yield, including de-risking pensions, will effectively cap the rise in bond yields and we would be surprised to see the U.S. 10 year Treasury rise much beyond 3% by the end of 2018.

"This is a reality check that the market was price to a perfection that didn't exist", says Swonk. The Reserve Bank of India cancelled a scheduled bond auction on Friday, triggering a relief rally in the bonds, which had climbed a 23-month high a day earlier amid concerns over higher-than-expected fiscal deficit projection for the next financial year.

Hence, our interest rates track the U.S. rates very closely. But Powell, a lawyer, is untested.

But no one is sure that will happen. He just started in the top job. You can modify assumptions such as interest-earning assets, non-interest income, earnings multiple, forward P/E multiple and others to see how sensitive Bank of America's shares are to the Fed's rate hikes.

The bottom line is: The economy is doing well but stocks might not race up from here. Investors who ignore market fluctuations and hold their bonds to maturity will always get their money back, plus they collect interest along the way. Yes, there are concerns about inflation, but they have yet to materialize. Stocks were hit hard across the board with only technology surviving Monday's bloodletting in the Dow.

Stocks have also been on a tear because they have been one of the only investments with a decent return.

Growing wages reflect the strength of the American economy. On the downside, stock prices probably won't be as insanely good.

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