US inflation picked up in January to its fastest pace in five months. Headline CPI increased 0.5 per cent with the core up 0.3 per cent, above expectations of increases of 0.3 per cent and 0.2 per cent respectively. Year on year, headline CPI was up 2.1 per cent and core 1.8 per cent.

Markets initially reacted negatively but rallied to close well into the green. Bond yields surged to well above the levels that triggered the market correction on 2 February, the 10-year yield settling at 2.91 per cent. January retail sales fell 0.3 per cent against expectations of +0.2 per cent.

Markets have apparently forgotten about the recent past as risk-on and FOMO (fear of missing out) juices resurfaced.

In geological speak, foreshocks or tremors are sometimes a warning of pending danger. They are caused by the Earth's tectonic plates rubbing against each other, continued friction and ultimate breaking the cause of more damaging earthquakes.

Tremor-like movements have occurred on global stock markets since the US January jobs report on 2 February revealed annualised wages growth of 2.9 per cent. This was the highest in eight and a half years, and above expectations of 2.6 per cent, signalling a possible revival of inflationary pressures.

The revelation moved bond yields at the longer end of the curve (10-year and beyond) and into territory not seen for several years with the 10-year yield at 2.85 per cent. The 10-year yield is commonly referred to as the risk-free rate and dictates the discount factor used in equities valuations, the underlying reason equities markets are closely linked to bond yields.

The economic plates of tightening monetary policy and stimulatory fiscal policy are rubbing against each other and causing tremors but have not yet broken.

While the speed of the sell-off in equities markets may have surprised, the magnitude, the market performance in the 13 months from 1 January 2017 to 30 January 2018, and the shake-out since 2 February must be put in perspective. Individual market performances have not been equal, and neither will the correction.

The recent action in US markets hardly registers compared with the performance of the 13 months to 30 January. But this is a false level of comfort. My advice--don't stand in the way of surging bond yields. A US 10-year yield of 3.5 per cent plus is a very real possibility later in the year.

 

Exhibit 1: Market movements from 1 January 2017

chart

Source: Morningstar

 

The surge of the US 10-year bond yield to 2.85 per cent seemed to trigger complacent equity investors into action. A somnolent, unprepared, and brazen volatility index (VIX) shook violently. These were foreshocks or tremors in the global financial markets.

Don't forget record US margin loans of US$650 billion at last count also hang like the sword of Damocles. The return of volatility and wild market swings will increase the anxiety of those with loans against equity and ETF positions.