Dow drops by more than 1000 points twice in week

Reuters

The world has turned uglier for stock market bulls and leveraged bond market bulls are on the road to financial suicide, assisted merrily along by a fee-driven Private Bankerji.

"If there is going to be a recession, it will be next year, not this year, but there could be a slowdown in the United States economy as inflation is picking up, which could lead to stagflation in Q2 and Q3", he said.

Here's what's driving the volatility. The strength of the global economy and corporate earnings are still providing support for stocks.

The is the one to watch, and while many strategists targeted rates under 3 percent for this year, they acknowledge the risk is to the upside with yields potentially climbing to 3.25 percent. Businesses will eventually have to raise prices on the stuff they sell to afford their growing payrolls. The deal looks set to increase the US federal deficit and may stimulate inflation, encouraging the Federal Reserve to hike up interest rates quicker than anticipated. The central bank has been unable to significantly raise its interest rates over the past decade, fearing it could stymie the economic recovery and perhaps cause prices to fall. After all, underlying the selloff is the fear that an unexpected bout of inflation generated by the combination of a tax cut package on top of an economy that is already supposedly operating close to its full potential, will force the Fed to tighten monetary policy more quickly than expected.

Market expectations for Fed interest rate hikes also faded.

"The increase in share prices has been powered by the prospect of large corporate tax cuts in the USA, so it is noteworthy that company directors have started to sell shares in their own companies in large numbers".

Simply put, when a country's macro-economic situation deteriorates, bond prices fall and bond yields rise, as investors seek more return on bonds to compensate for the risk involved.

The bank left interest rates where they were at 0.5% at its meeting, but said a strengthening economy meant interest rates were likely to rise sooner than the markets were expecting. Investors bailed out when Fed officials began talking about slowing their bond purchases. The DBS CIO Investment Insights - 2018 noted that between December 1998 and January 2000, the US Treasury (UTS) 10-year yield rose 202 bps and the S&P 500 Index correspondingly gained 13 per cent. Why do rising bonds hurt stocks?

That's why he suggests investors muddle through the volatile patches, such as the last couple of weeks where both bond and stock prices went south.

Thursday marked another day of sharp swings in recent sessions including the S&P 500's biggest drop in more than six years that pulled equities away from record highs. A supply glut could devalue bonds. When bond prices go lower, their yield increases. The surge in Treasury yields pushed the VIX's bond-market cousin to its highest since April. "This week has been pretty topsy-turvy, but on the worst days (for stocks), you saw bonds do exactly what you thought they would do: They rallied".

The dramatic market purge sent the Dow temporarily down to correction levels - more than 10 percent from its all-time high of 26,616, reached in January.

A cooling-off period would be a good thing.

"It looks to me like a typical type of scenario when you see a single stock flash crash where you'll see bids just disappear, stop orders get kicked", said Joe Saluzzi, co-manager of trading at Themis Trading in Chatham, New Jersey.

"Stocks look like they are set for a correction of some sorts after huge losses over the last few sessions that has left many bulls anxious that the bull run may have come to an end", said AxiTrader analyst James Hughes.

Editor's note: This story is an updated version of a report that was first published February 2. There could be a little groupthink taking place in the downturn.

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