Blue-chip Dow Jones has largest single-day point drop as investors see inflation growth, rate increases ahead
Tuesday, February 6, 2018
DAVID BERMAN, TIM SHUFELT, CHRISTINA PELLEGRINI
Global stocks fell sharply Monday, with market experts blaming the sudden downturn on everything from steep valuations and the prospect of rising inflation to the influence of specially programmed computers and a herd-like reaction among investors.
The Dow Jones Industrial Average, a key barometer of the U.S. stock market, was down more than 1,500 points – or 6.3 per cent – for a brief moment before recovering to end the day at 24,345.75, down 1,175.21 points – or 4.6 per cent.
But the turmoil spread well beyond U.S. markets, hitting Canadian, European and Japanese stocks.
The Canadian dollar fell by almost two-thirds of a cent as investors rushed to the safety of the U.S. dollar.
The downturn, which comes amid an unusually long period of market calm over the past two years, appears puzzling because it follows upbeat economic reports on employment, strong global economic activity and, in some cases, record-high stock markets.
However, investors are now adjusting to the prospect of rising inflation and interest rates.
These investor concerns were punctuated on Friday after a U.S. employment report showed that wages rose 2.9 per cent in January over last year.
That’s good news for workers.
But investors expect the U.S.
Federal Reserve could respond with additional interest-rate hikes beyond what financial markets had already been expecting, potentially weighing on economic growth and corporate profits.
Monday’s drop also comes as concerns about stock valuations mount.
The bull market has been going on for almost nine years, and by some measures U.S. stocks are at their loftiest levels since the 1990s bubble in technology stocks. Bank of America analysts warned late last month that investors were pouring into stocks with such enthusiasm that it would likely lead to a “tactical pullback.”
A number of market experts, though, were quick to blame Monday’s harrowing decline on computers that are programmed to react to market conditions in the blink of an eye, because the Dow mysteriously shed 800 points within minutes.
“The machines take over at some point and they just trade on themselves,” said Mark Yamada, president of PUR Investments, a Toronto-based portfolio manager that also designs algorithmic investment software.
Yet another explanation is that many investors may have used automated sell orders to protect gains in their portfolios.
Once the selling starts, it can create the sort of feedback loop that has led to so-called flash crashes.
“When you have computers trading with each other, in millions of trades, it doesn’t take much to get these kinds of ‘air gaps.’ Then you’re just in free fall,” said Robert Sneddon, president and chief portfolio manager at CastleMoore Inc. in Toronto.
Whatever the cause of the selloff, the damage is starting to add up.
The Dow saw its worst oneday decline since 2011 – coincidentally, on the same day that Jerome Powell began his term as the new chairman of the Federal Reserve.
The broader S&P 500 closed at 2648.94, down 113.19 points, or 4.1 per cent. After a promising start to the year, the index is now down almost 1 per cent in 2018 and is 7.8 per cent off its record high in January.
Canada’s S&P/TSX composite index fell 271.23 points, or 1.7 per cent. It closed at 15,334.81.
In Europe, Germany’s DAX index fell 0.8 per cent, Britain’s FTSE 100 fell 1.5 per cent, and Japan’s Nikkei 225 fell 2.6 per cent.
Signs of anxiety appeared elsewhere, too. The U.S. dollar and U.S. government bonds rose as investors flocked to safety.
And the CBOE Volatility index, an oft-cited gauge of investor worries, more than doubled to its highest level in 2 1/2years.
Investors were already on edge when Monday’s session began.
The S&P 500 fell 2 per cent on Friday and notched its worst weekly performance in more than two years, obliterating a New Year rally that was propelled by profit-boosting U.S. corporate tax cuts.
David Rosenberg, chief economist and strategist at Gluskin Sheff + Associates Inc., pointed out that U.S. tax cuts have already been baked into stock prices but additional rate hikes by the Fed have not.
“This is classic late-cycle stuff – overheated economies cause market rates to rise, Fed tightening expectations intensify, and these lead to stock market corrections,” Mr. Rosenberg said in a note.
Adding an ominous point, he noted that the 1987 crash, when the Dow fell 22.6 per cent in a single day, also coincided with strong underlying fundamentals – U.S. gross domestic product in the fourth quarter was strong, zooming corporate profits were being propelled by tax cuts, and unemployment was low – suggesting that an upbeat backdrop doesn’t have to support stock prices.
The slide in U.S. stock prices over the past week or so has wiped out all the returns of a stellar January.
And with little in the way of hard news to identify as a clear catalyst for the latest frenzy, professional investors are left trying to decipher investor sentiment, which can be elusive and fickle.
“We’re seeing an abrupt change in psychology,” said William Lin, portfolio manager at Caldwell Investment Management. “For that psychology to entrench, if this week is a down week, it will make it much more likely.”
Mr. Yamada said the rest of this week should prove crucial in distinguishing this selloff as either a mere blip on an otherwise upward trajectory or a turning point in the bull market.
“If there is a change in sentiment in the market, you’ll notice it in the next couple of days,” he said.
Others, though, say the market is vulnerable because many broker-dealers aren’t willing to take on risk like they used to.
“There’s no appetite inside many firms for risk on days like this,” said Anthony George, a trader at AltaCorp Capital Inc. in Toronto. “It’s become common to have these crazy moves, and it doesn’t seem to frazzle anybody.
That’s what’s broken with the markets.”