What is causing equity markets to wobble?

What is causing equity markets to wobble?

The fall in equity markets in recent days is the result of bond yields moving higher, and the medium term outlook being unpredictable, according to David Jane, who runs £880m across three multi-asset funds at Miton.

The S&P 500 index is expected to open 1.2 per cent down today (6 February) and the Dow Jones Industrial Average 1.8 per cent lower.

Yesterday (5 February), the S&P 500 index ended the day 4.1 per cent down and the Dow dropped 4.6 per cent or 1,175 points — its steepest ever fall in points.

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Mr Jane noted the sell-off was sparked by better than expected economic data and wage growth in the US.

This prompted the market to expect US interest rates to rise at a faster pace than was previously expected by many, as the central bank would put rates up to stop inflation becoming so high that it destabilised the economy.  

Mr Jane said such a scenario is self evidently bad news for bond investors, because higher interest rates push bond prices downwards.

This is because higher interest rates will mean companies and countries coming to the market with new bonds will have to offer a higher interest rate to reflect the higher interest rates offered by cash.

So those who own, and want to sell, existing bonds, will have to take a price lower than face value to make the existing bonds as attractive as those coming to the market.

By taking a lower price, they are pushing the yield upwards.

But Mr Jane said it is not as simple as saying that, because the fall in bond prices is happening because investors have become more optimistic about the economy, and that equities would perform well.

He said equities are suffering because higher bond yields mean higher borrowing costs for companies, and for investors who borrow to invest, while the returns available on equities become less attractive as bond yields rise, because the gap between the dividend an investor can receive from an equity, and interest payment on a low-risk asset such as cash, reduces as interest rates rise, so equities are less attractive.

He said the continued weak performance of the dollar is a positive for global growth.

Mr Jane said he is not going to take any rash action, and instead wait to see whether the current sell-off continues.

James Bateman, chief investment officer for multi-asset at Fidelity, said a fall of the kind we have seen in equity markets so far is not news in the context of history.

But he said the major impact for investors could be that technology companies under perform, while those parts of the equity market which have underperformed could do better.

This is because of the opportunity cost of only shares that don't pay a dividend.

Mr Jane noted that investors might have been willing to forgo the income of a regular dividend when inflation and bond yields were low, but as bond yields rise, technology companies become less attractive investments.