Chief economist update: Wall Street has fallen, prepare to be greedy

Wall Street has fallen! Repeat, Wall Street has fallen!

The financial headlines made sure that you, I and Irene are spooked even before Halloween - with accompanying rationales at that.

Wall Street plunges as investors seek safety - Sky News
Sudden jump in US interest rates prompts Wall Street stock plunge -
Wall Street plunges on rising rates - The Australian
Wall Street sinks on IMF's trade war concerns... - ABC News
'The Fed has gone crazy': Trump points finger for Wall Street tumble - The Sydney Morning Herald

Yes folks, it's because of the trade war, it's because of the Fed, it's because of rising bond yields, the IMF's downgrade to global growth, and add to these, the US equity market's overvaluation and slowing momentum.

These are all rational rationales explain the 3.3% drop in the S&P 500 index overnight, along with losses of: 3.2% on the DJIA; 4.1% for the Nasdaq composite; and 2.9% on the Russell 2000.

Horror of horrors! For we all know that what happens on Wall Street does not remain on Wall Street. When the US sneezes, the world catches pneumonia!

So much so that the VIX index - the "fear gauge" - jumped by 44% overnight to a reading of 22.96 points.

Last night's tumble on Wall Street is the worst since the 5th of February - that was blamed on rising bond yields, and expectations of a more aggressive Fed and slowing global growth momentum. Trump hasn't declared war on trade at the time but the fear was there - the VIX index surged to a three-year high reading of 37.32.

For sure, the rise and rise of US bond yields are giving equity investors a run for their money. The increase in the US 10-year Treasury bond yield to around 3.2% has reduced the S&P 500's premium to 3.7% compared with the long-term average of 4.4%. Similarly, the higher yield investors could get from buying US Treasuries now outmatches the dividend yield (1.86%) they could get from the S&P 500.

Sell? Dump stocks? Head for the hills? ...or buy this dip and as per Warren Buffet, "be greedy" now that many are "fearful"?

The February 2018 flash dive - when this recent bout of market angst is being compared - provides a sobering lesson. After dropping by 10.2% to three-month low in February (from what was then the record high set in the previous month), the S&P 500 index set a new one on the 20th of September ... despite the rise in bond yield to 3.1% on that day from 2.8% (in February), the Fed has already lifted rates twice (March and June), with another two expected (in September and December), Trump's trade war already underway, emerging markets in turmoil, slowing China, etcetera.

The same "risks" - real or imagined - that's failed to keep equities down. If ever, the recent rise in bond yields is a good omen. Recall the fear over America heading for a recession because of the flattening yield curve that's under threat of inverting? The yield differential between the 10-year and 2-year Treasuries has now steepened to 0.4% from a 0.2% less than two months back.

Likewise, for all the talk over surging US inflation, inflation expectations - as measured by the yield differential between nominal US bonds and TIPs - haven't risen sharply. The differential on the 5-year's currently at 2.1% from 1.9% at the start of 2018 and 2.2% from 2.0% on the tenners - more or less within the Fed's 2.0% target and suggesting that the Fed could pause its move towards policy normalisation should the current equity market sell-off turn into something more sinister.

Read more: Wall StreetNasdaqnominal USRussellSky News SuddenSydney Morning Herald YesTreasuryUS TreasuriesWarren Buffet
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