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

Are stock markets about to crash another 20%?

| More on:
a woman

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

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.

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.

More on ⏸️ Investing

Close up of baby looking puzzled
Retail Shares

What has happened to the Baby Bunting (ASX:BBN) share price this year?

It's been a volatile year so far for the Aussie nursery retailer. We take a closer look

Read more »

woman holds sign saying 'we need change' at climate change protest
ETFs

3 ASX ETFs that invest in companies fighting climate change

If you want to shift some of your investments into more ethical companies, exchange-traded funds can offer a good option

Read more »

a jewellery store attendant stands at a cabinet displaying opulent necklaces and earrings featuring diamonds and precious stones.
⏸️ Investing

The Michael Hill (ASX: MHJ) share price poised for growth

Investors will be keeping an eye on the Michael Hill International Limited (ASX: MHJ) share price today. The keen interest…

Read more »

ASX shares buy unstoppable asx share price represented by man in superman cape pointing skyward
⏸️ Investing

The Atomos (ASX:AMS) share price is up 15% in a week

The Atomos (ASX: AMS) share price has surged 15% this week. Let's look at what's ahead as the company build…

Read more »

Two people in suits arm wrestle on a black and white chess board.
Retail Shares

How does the Temple & Webster (ASX:TPW) share price stack up against Nick Scali (ASX:NCK)?

How does the Temple & Webster (ASX: TPW) share price stack up against rival furniture retailer Nick Scali Limited (ASX:…

Read more »

A medical researcher works on a bichip, indicating share price movement in ASX tech companies
Healthcare Shares

The Aroa (ASX:ARX) share price has surged 60% since its IPO

The Aroa (ASX:ARX) share price has surged 60% since the Polynovo (ASX: PNV) competitor listed on the ASX in July.…

Read more »

asx investor daydreaming about US shares
⏸️ How to Invest

How to buy US shares from Australia right now

If you have been wondering how to buy US shares from Australia to gain exposure from the highly topical market,…

Read more »

⏸️ Investing

Why Fox (NASDAQ:FOX) might hurt News Corp (ASX:NWS) shareholders

News Corporation (ASX: NWS) might be facing some existential threats from its American cousins over the riots on 6 January

Read more »