CHICAGO, IL - FEBRUARY 06: Traders signal offers in the S&P options pit at the Cboe Global Markets, Inc. exchange (previously referred to as CBOE Holdings, Inc.) on February 6, 2018 in Chicago, Illinois. Yesterday the S&P 500 and Dow Industrials indices closed down more than 4.0 percent, the biggest single-day percentage drops since August 2011. (Photo by Scott Olson/Getty Images)
Traders signal offers in the S&P options pit at Cboe Global Markets © Getty

Global stock markets are staging a modest recovery following the wild swings this week that have marked a return of volatility to equity trading after years of unusual calm.

The Dow Jones Industrial Average closed 567 points, or 2.3 per cent, on Tuesday at 24,913, a day after having recorded its biggest one-day points drop ever. The S&P 500 was up 1.7 per cent to 2,695, its best day since Donald Trump was elected US president.

The rally spread on Wednesday to European markets which had been hit hard in recent turbulence. The UK’s FTSE 100 index is up 0.7 per cent in initial trade after suffering its biggest drop since Britain’s 2016 vote to leave the EU on Tuesday, falling 2.6 per cent.

The Europe-wide Stoxx 600 is up 0.7 per cent while Xetra Dax in Frankfurt is up 0.4 per cent.

The trend was more mixed in Asia. In Japan, the Topix index closed 0.4 per cent higher after falling 4.4 per cent the previous day, while the Nikkei climbed just 0.2 per cent, a day after shedding 4.7 per cent. Hong Kong’s Hang Seng index closed down 0.8 per cent.

The focus for many investors during the roller-coaster day on Tuesday remained on the Vix volatility index, Wall Street’s so-called fear gauge, which briefly shot to its highest level since the 2015 Chinese currency devaluation. Funds that allow investors to bet on tranquil markets were at the centre of this week’s fall in equities, plummeting in value.

Credit Suisse and Nomura both pulled volatility-based securities from the market. Shares of Cboe Global Markets, which owns the Vix index, tumbled as much as 17 per cent as investors feared the closures could affect trading volumes.

“When it [shorting volatility] doesn’t work, it really unwinds quickly and you get catastrophic losses,” said Sebastien Page, head of global multi-asset at T Rowe Price. “Why are investors attracted to it? Because in normal times it consistently makes money until it doesn’t and then you lose big.”

At its worst during the turmoil on Tuesday, the S&P 500 was down 9.7 per cent from its all-time high in January, while the Dow did enter technical correction territory, being down more than 10 per cent from its high.

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Stocks in Asia and Europe lost as much as 5 per cent earlier in the day as they caught up with Wall Street’s biggest loss in six years on Monday and as the US opened lower.

The whipsaw trading in US stocks — the S&P 500 fell 2.1 per cent at the opening before paring its losses — came a day after the market suffered its biggest percentage fall since August 2011. The losses were triggered by investors’ concern that an era of cheap money was drawing to a close in the face of renewed inflationary pressures.

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Faster wage and economic growth has been seen across most of the developed world, and investors are now readying for the possibility that policymakers at the Federal Reserve and European Central Bank could tighten policy more aggressively than thought at the end of 2017.

“Markets are coming to the conclusion that the US economy is close to overheating and therefore that the risks of inflation are bigger than the risks of a recession,” said Torsten Slok, chief international economist at Deutsche Bank.

“Higher inflation risk means higher short and long rates,” he added. “With valuations stretched in both equities and credit, risky assets are more vulnerable to higher interest rates than before. The allocation of money from risky assets to risk-free assets is going to be bumpy.”

“We had a very prolonged period of easy monetary policy and if you think about it like a patient, central banks viewed the economy as being on life support,” said Brian Levitt, a senior investment strategist with Oppenheimer Funds. “Given where we are now in the economic cycle, with growth generally strong, the global economy does not need to be on life support.”

The Vix volatility index, true to its name, shifted markedly throughout the trading day on Tuesday. After hitting a session high above 50, it fell back to 31, which was still above its historic average.

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Yields on sovereign bonds, which move inversely to their price, fell across most of Europe and Asia. In the $14tn US Treasury market, however, yields rose sharply on Tuesday. The yield on the two- and 10-year notes were both up 9 basis points at the end of the day, to 2.11 per cent and 2.80 per cent, respectively. At its height on Monday, the 10-year yield neared 2.9 per cent, a level last touched in January 2014.

Mark Haefele, global chief investment officer at UBS Wealth Management, said: “While the speed of the market declines over the past week is jarring, market declines of this overall magnitude are not uncommon.

“In our view, risks of the Federal Reserve raising interest rates too quickly and triggering a US recession over the next two years appear very low.”

S&P 500 largest intraday % drops since financial crisis March 2009 low
RankDateDrop at lowClose (pts)% at close
1May 6 2010-8.59%1,128.15-3.24%
2Aug 8 2011-6.68%1,119.46-6.66%
3Aug 24 2015-5.27%1,893.21-3.94%
4Aug 18 2011-5.27%682.55-4.46%
5Mar 5 2009-4.90%1,200.07-4.25%
6Aug 4 2011-4.82%1,120.07-4.78%
7Aug 10 2011-4.65%1,120.76-4.42%
8Sep 22 2011-4.50%1,129.56-3.19%
9Feb 5 2018-4.49%2,648.8-4.10%
10Mar 30 2009-4.43%787.53-3.48%
Since 2009
Source: Thomson Reuters; Graphic: Peter Wells/FT

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