Originally published by Rivkin Securities
US equity markets rebounded on Tuesday, partially erasing the heavy falls from Monday night. By the close of trading on Tuesday, the Dow Jones Industrial Average had gained 567.02 points (+2.33%), while the broader S&P 500 was 46.20 points higher (1.74%), closing at 2695.14. We should expect the Australian market to follow suit during today's trading session, with the ASX SPI200 futures gaining 99 points in overnight trading, to be currently at 5863. The local share market closed at 5833.34 on Monday, down 3.2%. This was the largest fall for the S&P/ASX 200 in percentage terms since late-September 2015. With the ASX200 closing at a 4-month low, rebounds from current levels will now encounter chart resistance just above current levels, between 5950 and 6000.
An interesting narrative over the past weeks has been how the sell off in US equities was the result of positive economic news, specifically an improving employment outlook. This sounds counter intuitive, in that one would expect equities prices to rally on positive news. Part of this is the relationship with inflation and thus interest rates. If indeed the US employment market is tightening, and economic growth outlook is improving, then inflation expectations start to rise. And with rising inflation expectation comes rising bond yields.
The chart below shows the yield on US 10-year bonds. As shown, yields have rallied strongly over the 3-4 months from a low or around 2.05% to current levels at around 2.84%. Looking slightly longer-term yields have now doubled since July 2016. Higher interest rates flow back to equities as many US companies post the GFC have fuelled growth by utilising debt at low rates. If rates start to rise, their interest costs will also rise, and potentially to a point where it becomes problematic for debt servicing.
Volatility levels have also been a major talking point over the past week, and with good reason. Following a multiyear period of very low levels, equity market volatility has made a resounding comeback over the past couple of trading sessions. As the below chart shows, the Volatility Index, has spiked from levels around 10 to above 30, before settling in Tuesday at 29.88, the highest level since 2015.
The VIX index indicates the level of implied volatility across a range of S&P500 options. When put options are in high demand, in order to hedge downside risks, options premiums rise, and thus so does the VIX.
