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The Beginning of Another European Crisis?

John Jagerson and Wade Hansen

Investors are continuing to whip the market back and forth on trade concerns, but the recent focus is a bit different. We have to shift our concentration from concerns about trade slowdowns with the United States’ largest trading partners (China, Canada and Mexico) to one of its smallest — Turkey.

If you have been following the news, you know that the governments in the U.S. and Turkey are in dispute about trade tariffs and the return of a U.S. national, Andrew Brunson, who the Turkish government has accused of being involved in an alleged 2016 coup attempt.

The dispute over Brunson has likely heightened tensions over the trade dispute, and Turkey’s government increased tariffs on U.S. autos to 120% and alcoholic beverages to 140% on Wednesday. Taken by itself, the tariffs are not an existential threat to the U.S. economy, but, unfortunately, traders are worried that this could be the pebble that starts an avalanche.

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At its low on Monday, the Turkish lira was down 47% against the dollar in 2018. The Central Bank of Turkey (TCMB) has stepped in over the last two days to halt the decline, but it seems unlikely to be a permanent change. The markets care about financial instability in Turkey because it can become a problem for two of its largest trading partners — Greece and Italy.

As you can see in the chart below, the recent declines in the iShares MSCI Italy Capped ETF (NYSEARCA:EWI) — the Italian stock exchange-traded fund — are very correlated with the decline in the Turkish lira (blue line). If Turkey can’t import from its partners because the currency is weakening, the partners will suffer economic damage as well. What investors worry about is how much this might spread to other key economies in Europe.

iShares Italy ETF (EWI) versus TRY/USD: Chart source — TradingView.com

The lira’s trauma isn’t the only trade issue investors are worried about, but it adds more complexity to an already touchy international economy. Worsening trade conditions will hit industrial, technology and commodity stocks in the short term, which could drag the S&P 500 back into its previous consolidation range.

Worries about financial contagion spreading from Turkey have also increased demand for U.S. Treasury bonds, which flattens the yield curve and is a negative for banks. The only sectors positioned to take advantage of market conditions like this are utilities and other income-payers, such as real estate investment trusts (REITs).

The Bottom Line

The deteriorating relationship (trade and otherwise) between the U.S. and Turkey has traders worried it could trigger a broader decline. We think this is likely to be a short-term issue and not the catalyst for the end of the bull market. However, uncertainty about the global economy will increase volatility in the short term. This could be good for long option traders because big moves are more likely, but accurately forecasting which stocks will move, and in what direction, will be difficult.

You can learn more about identifying price patterns and using them to project how far you think a stock is going to move in our Advanced Technical Analysis Program.

InvestorPlace advisers John Jagerson and S. Wade Hansen, both Chartered Market Technician (CMT) designees, are co-founders of LearningMarkets.com, as well as the co-editors of SlingShot Trader, a trading service designed to help you make options profits by trading the news. Get in on the next SlingShot Trader trade and get 1 free month today by clicking here.

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