The action in US markets over the last two trading sessions (Friday and Monday night) is pointing to a rout. The confidence and exuberance that took US indices around 10% higher in January has melted along with bond markets. Two important questions confront local investors – how low can it go, and how will it affect Australian shares?

Some investors are scratching their heads and wondering what has changed. The short answer is very little.

The trigger for the sell-off was stronger than forecast wages data on Friday night, indicating wages are growing in the US at an accelerated 2.9%. This raised inflation expectations, and with it the forecast number and size of interest rate rises this year. This in turn took US ten year bonds to their highest yield in four years, and close to a technical bear market. Investors shifted focus from the strengthening US economy that is driving rates higher to the impact of higher rates on company bottom lines and share valuations, and the selling began.

It looks like a good, old-fashioned market panic is on. At the moment the downward momentum in US markets is strong. Valuing a market is fraught, but an examination of Pes in light of prevailing interest rates can help. Over the period 2014-2017 the average ten year bond yield in the US was close to 2.20% and the average forward PE for the S&P500 was 16.2x. As at this morning, the PE stood at 16.7x and the ten year bond yield 2.76%.

One way to read this is that the S&P500 has further to fall to reach a PE that reflects the changed interest rate environment. If that PE is around, say 15.5%, there is a further 8% or so for the index to fall.

This co-incides quite nicely with the big picture technical outlook:

On the weekly chart the accelerating up trend produces multiple trend lines at increasingly steeper angles. The sell down has breached the higher of these trends. Investors may note the support level close to 2,400 intersects the lower, longer term up trend. This technical support zone is also roughly 8% lower.

This analysis points to a rocky ride for equity investors over the coming weeks.

However Australian investors may fare relatively better. The PE comparison for the Australia 200 index is currently 15.7x versus a four year average at 15.2x. However the interest rate environment is very different. The average ten year bond yield for the comparison period is 3.1%, versus the current level close to 2.9%.

This points to a much gentler local downdraft. The technical picture shows multiple major supports between 5,950 and 5,650. Predicting the turning point is always difficult. Nevertheless, the positive economic outlook means there is a potential buying opportunity coming for investors well placed to buy a corrective dip.