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Traders work on the floor of the New York Stock Exchange (NYSE) on February 6, 2018 in New York City.Getty Images

The world's investors are transfixed by the wild spectacle unfolding in the stock market, as violent swings up and down are wiping out and creating vast sums of money in the blink of an eye.

One day after the single worst session for U.S. stocks in six years, the losing streak was ultimately interrupted by the time the closing bell rang on a manic day of trading Tuesday. A late-afternoon buying spree vaulted U.S. benchmarks back into positive territory, with the Dow Jones industrial average gaining 567 points, or 2.3 per cent. Canadian stocks also pared back recent losses with modest gains on the day.

But the fears that first seemed to be stoked by U.S. wage growth have now become globally infectious, as European and Asian stocks succumbed to the downturn on Tuesday. At least US$4-trillion in global stock market value has been erased in the selloff.

This sudden convulsion in market sentiment after many months of steady gains is raising the spectre of a sustained pullback or even a bear market in equities.

And when volatility makes such an emphatic return to a tranquil market, at a time when stocks are richly valued, the tug-of-war between fear and greed can amplify the market's fluctuations, said Jason Mann, chief investment officer of Toronto-based Edgehill Partners.

"You get these waves of people cutting risk," Mr. Mann said, adding that it's anyone's guess how far it can go. "My gut tells me this is more just the market readjusting to the reality of higher interest rates, but in a market that was really overbought."

If Tuesday was any indication, that adjustment could be a messy one.

The day started with an extension of Monday's losses, which wiped out the gains made by U.S. stocks through the entire month of January. The direction of the market quickly shifted, then shifted again, and again, in a day that saw no fewer than five reversals of at least 400 points.

The explanations being offered up for the drama range from algorithmic trading run amok, to the collapse of ETFs betting on low volatility, to fears that U.S. inflation – as evidenced by rising wages – will bring an end to the bull market.

Several commentators and economists have been quick to point out that the stock market is backed up by sound economic fundamentals. In terms of both global growth and corporate earnings, there is little to suggest weakness ahead.

The broadest global economic expansion since the financial crisis is under way, global profits are forecast to rise by 14 per cent this year, and U.S. crude oil prices recently hit a three-year high.

None of that, however, can necessarily prevent a good old-fashioned market freak-out.

"Sentiment plays a larger role, especially in late-stage bull markets," Dan Suzuki, senior equity and quantitative strategist at Merrill Lynch, said in a recent note to clients.

Investors' perceptions and attitudes have been trending in one direction for so long, that a reality check was long overdue, Mr. Mann said.

Up until the middle of last week, all signs suggested the U.S. stock market was sizzling hot. The S&P 500 index had gained 25 per cent over the prior year, sentiment indicators suggested a high level of investor optimism, several discount brokerages in the U.S. and Canada struggled to keep up with demand from new investors, and there seemed to be no limit to the upside in cannabis stocks and cryptocurrencies.

Meanwhile, Canada has mostly sat out the latest leg of the U.S. bull market, as a pipeline bottleneck has cheapened domestic crude, and NAFTA renegotiations have cast a pall over Canadian forecasts. As a result, Canadian stock valuations have lagged U.S. counterparts, making stateside equities much more vulnerable to a sudden shift in investor sentiment.

"You can have a good economy and still argue that stocks are too expensive," Mr. Mann said.

Prior to this latest bout of volatility, stocks in the S&P 500 index were trading at about 18.5 times forward earnings, which stands in stark contrast to the 10-year average of 15.5.

"The stock market may or may not have an overvaluation problem," Ed Yardeni, a veteran U.S. economist and strategist, said in note. "That depends on whether historically low inflation and interest rates justify today's historically high [price-to-earnings ratios.]"

Suddenly, U.S. economic readings have given investors reason to suspect stocks may have gotten too expensive. If inflationary forces are building, that could force the U.S. Federal Reserve and other central banks to withdraw stimulus more aggressively than planned.

That is a lot to digest for a market that has come to take ultra-low interest rates for granted, Mr. Mann said.

"I think of this as a corrective pullback putting us a little more in line with normal valuations."

A rout in global equities deepens in Asia as inflation worries grip financial markets.


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