Turkey and Emerging Market Stress

The S&P500 dipped about 0.25% last week. Volume was very light, so this data didn’t suggest that investors were concerned. On the other hand, the VIX index did jump about 20%; while the closing level was still nothing to get worried about, the sudden spike should raise some concern that US equity investors may be getting worried.

In US macro news, the flow was light. The most important reports shed some light on US inflation. Both producer and consumer prices came in very close to expectations. That said, the annual CPI increase of 2.9% is still greater than the annual wage growth. This means that for the first time in many years, US workers are suffering from negative real wage growth. In other words, their paychecks are not keeping up with inflation.

With respect to technical analysis, the S&P500 is still enjoying a bullish set-up on the weekly charts. The bad news is that on the daily charts, the signs are pointing to the possibility of a short-term drop in prices. From an overstretched position (at the upper Bollinger band), the MACD indicator turned bearish, suggesting that some more near term selling may lie ahead.

All that said, our Simple Rule is still solidly bullish, which means “stay long” the S&P500 index.

Finally, we may see the currency crisis in Turkey become the spark that leads to the short term sell-off in US equities. In part due to US political pressures, the Turkish Lira has fallen to near record lows against the US dollar. This in turn has helped to cause other emerging market economies to suffer currency stress of their own. The Brazilian Real, for example is falling to multi-year lows. The same is happened to the Argentinian Peso….and several other emerging market currencies.

The resulting problem is that these nations will have trouble servicing their respective dollar-based debts……which could lead to severe stress or even failure for the banks that made these dollar loans. And if this happens then other banks, even ones that do not hold large amounts of EM debt on their balance sheets could get stressed. This in turn could lead to general global credit stress and spill over to global equity markets.

As mentioned many times over the years, US equity markets remain over-valued by historical standards….and as we have seen, they can remain over-valued, or become even more over-valued, for many years after first becoming over-valued.

So the trigger to reverse investor psychology can come from anywhere, whether it’s a currency crisis in Turkey or some other financial or geo-political event anywhere in the world.

So let’s see if Turkey actually becomes a trigger for a meaningful sell-off. As of now, it’s still too early to tell.

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