Turkish Crisis Causes Modest Decline in U.S. Stocks

Turkish Crisis - Stocks Fall As Expected

Turkish Crises, among other reasons led to the stock market falling as expected. Personally, I had been bearish on stocks in the near term because they were overbought according to the CNN Fear and Greed index. The S&P 500 fell 0.71% and the Nasdaq fell 0.67%. The VIX increased 16.77% to 13.16. If I was a bull, I would want this volatility because if stocks go up in a parabolic move, a sharp correction like we had in January will occur. If I was a bear waiting to pounce, I would have hoped for the market to accelerate after hitting a new record so I could get heavily short.

The CNN Fear and Greed index fell from 70 to 60 which still signals greed. Therefore, I have become neutral on stocks in the near term. The fear of a double top could turn into a self fulfilling prophesy if stocks fall over 5%, but I don’t see that happening since earnings have been great. The only real sign of weakness in the economy is from the housing market.

Materials were the worst performing sector as they fell 1.43%. The best sector was energy as it was the only one in the green. It increased 0.43% because oil was up 1.2% to $67.63. Even with this increase, oil was still down on the week. This was the 6th straight week of declines which is the worst losing streak in 3 years. Oil is down because the dollar is up and global growth outlooks are dimming because of a potential trade war.

A Turkish Catalyst

The excuse for the decline was the 14% decline in the Turkish lira. Personally, I think this is an excuse to sell off because Turkey is a very small economy. It makes up less than 1% of the Vanguard Emerging Markets ETF which is why even with this massive decline, the Vanguard index was only down 1.99%. Make no mistake about it, the decline in the lira was massive. I just don’t think it is relevant enough to cause any weakness in the American economy.

The Turkish lira has been weakening for years. The Turkish lira has been declining because of geopolitical worries, worries about its ability to collect taxes, and the fact that the government will soon run out of land to sell to the private markets. Recently, the lira has been falling because the central bank refuses to raise rates enough to support the currency.

The lira was down 20% at one point in the day because Trump authorized the doubling of the metals tariffs on Turkey. Turkey was kicked while it was down. The Turkish stock market fell 14.5% on Friday and is now down 42.3% year to date. The entire Turkish stock market is only worth $150 billion which is about the size of Netflix. If Netflix was down 14%, the entire global market wouldn’t sell off.

The Turkish President, Recep Tayyip has done a terrible job of handling this crisis as he was quoted as asking the Turkish people to "change the euros, the dollars and the gold that you are keeping beneath your pillows into lira," noting this is "a domestic and national struggle." This is the equivalent of asking employees in a company to buy its stock when it is down 14% in one day. The employees are going to run for the exits; a CEO asking that is a sign the company is desperate.

Turkey is clearly desperate, which isn’t great for European banks that have exposure to the country, but nothing to worry about if you own American stocks. Deutsche Bank stock was down 4.68% and UniCredit stock was down 4.73% in sympathy of this situation. The fears of contagion are low.

Dollar & Treasuries

The dollar was up 0.68% to $96.27 which is its highest level since June 2017. The strong dollar is about to be a big headwind for international firms. This explains why the Russell 2000 was only down 0.24%. On a year over year basis, the strong dollar will really hurt profits starting in February 2019. A strong dollar combined with tough earnings growth comparisons might stymie the stock market in 2019.

This situation explains why the Fed funds futures market moved to expecting fewer rate hikes in 2018. The strong dollar is threatening emerging markets, American exports, and international earnings. The best case scenario is to have a stable dollar. Even though the Fed has previously hinted that it wouldn’t react to problems in emerging markets, the higher the dollar gets, the fewer rate hikes there will be.

As you would expect in a risk off trade, the treasury market rallied. It’s very interesting to see yields falling with modestly increasing inflation. As I explained in a previous article, the results were largely in line. That being said, sometimes the market reacts to a strong report even if it expected the results. The 10 year yield fell 5 basis points to 2.87%. My call for the 10 year yield to fall because of weakening growth has worked out even though growth hasn’t been weak outside of the housing market.

This is an intermediate term projection, not one for a few weeks. The 2 year yield fell 4 basis points which makes sense because fewer rate hikes are expected. This means the difference between the 10 year yield and the 2 year yield is 27 basis points. The bulls should be happy with the lack of severe flattening after this move. It’s fair to say that the curve didn’t flatten much because investors don’t anticipate this Turkish crisis bringing a recession closer.

Economic Weakness Coming?

The ECRI leading index continued to weaken in its latest update as growth is only 0.6%. That’s down from 1% growth last week. As you can see from the chart below, the current year over year comparison isn’t even that difficult. It will interesting to see how the growth rate changes in the next month when the comparison gets even easier.

 

 

 

 

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