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The Dow Jones just crashed: Here’s exactly why stock markets are tanking

Volatility returned to leading US stock markets overnight, with the Dow Jones Industrial Average of the US’s leading 30 companies plunging 6% at one point in just a single session.

That represented the largest intraday drop in Dow Jones history!

The index closed 11,078 points lower or 4.6% lower, with the broader S&P 500 index of North America’s top 500 companies falling 4.1% lower and the NASDAQ 100 Index of leading tech companies falling 3.9%.

The sell off should be put in the context of a two-year surge in US equity markets with indices levels now only returning to levels printed in November 2017.

What’s going on?

The first factor in play is old-fashioned profit taking as investors book huge capital gains on the back of surging stock prices over the last two years.

The other factor is an expectation that U.S. cash and debt rates will rise faster-than-expected after a jobs report last Friday showed stronger-than-expected wages and employment growth.

Put simply, if US risk free rates (cash, short term debt, benchmark US-10 year treasuries) move higher then investors will value risk assets (equities) lower in compensation for the fact that the return on risk free assets is rising.

After all, equities are valued on their ability to deliver an excess return over the risk free rate and investors will demand a greater margin of safety (lower share prices) in achieving those returns as risk free rates rise.

That’s the bad news. The good news is that the U.S. economy is strong, with European economies also awakening from previously feeble growth levels.

In Australia stocks that might come under pressure in a rising risk-free-rate environment include highly-valued growth stocks such as WiseTech Global Ltd (ASX: WTC), or the bond proxies such as Transurban Group (ASX: TCL), Telstra Corporation Ltd (ASX: TLS), Sydney Airport Holdings Ltd (ASX: SYD) and Scentre Group Ltd (ASX: SCG).

All of these could come under selling pressure as investors demand higher yields (>5.5%) in compensation for the additional risks (including debt profiles) of investing in them.

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Motley Fool contributor Tom Richardson has no position in any of the stocks mentioned.

You can find Tom on Twitter @tommyr345

The Motley Fool Australia owns shares of and has recommended Sydney Airport Holdings Limited and Telstra Limited. The Motley Fool Australia owns shares of WiseTech Global. The Motley Fool Australia has recommended Scentre Group and Transurban Group. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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