Pulling back on Turkey
08/17/18

Similar to the way some nasty down days in recent months have occurred when the word “tariff” dominated headlines, “Turkey” has been the latest t-word to rattle the market.

It sure did on Wednesday, when the S&P 500 (SPX) fell more than 1.2% intraday and the Nasdaq 100 (NDX) nearly 2% amid Turkey worries.

But as noted in “Tariff tantrums, trading ops?” stock-market declines associated with tariff headlines have frequently turned out to be buying opportunities. Is “Turkey” shaping up to be something similar?

The Turkey financial crisis is a complex issue that is still unfolding, and only the foolhardy would speak with certainty about its end game or its implications for the US equity market. For now, many analysts appear to be leaning toward the opinion that the risk of widespread financial contagion that could, for example, trigger a global recession is fairly limited.1 Next week, of course, could bring a different outlook.

But on a more relevant note for traders, yesterday’s price action may have hinted that immediate reactions to dire Turkey headlines may sometimes be overdone.

Nasdaq 100 (NDX), 3/13/18–8/16/18. Nasdaq 100 (NDX) price chart. Just another pullback?

Source: OptionsHouse

Consider the price action in the NDX (daily chart, above). On Wednesday, the index’s 1.87% intraday drop took it right around the level of a trend line that has captured most of it major swing lows over the past few months.

Yesterday, though, the NDX rebounded, closing up on the day and also making a higher low and higher high. Traders who bought on Wednesday’s weakness were certainly sitting pretty yesterday, but where does that leave the rest of us going forward?

While an initial bounce off a trend line looks nice, it’s difficult to draw many concrete conclusions from it. But a review of 55 similar pullbacks since October 1985 (nearly 33 years) showed the NDX tended to continue to rally—more strongly than usual—in the 10 trading days after them. In fact, the index’s average gains one, five, and 10 days after these pullbacks was at least twice its average historical returns for one-, five-, and 10-day periods.2

Here’s how the pullback was defined:

1. Like Wednesday, the low day of the pullback had to be lower than at least the previous eight lows, and its close had to be 1-2% below the previous day’s close. Also, the day’s high had to be below the previous day’s high.

2. The next day (like yesterday) had to make a higher close and higher low.

Pretty simple. The green bars in the chart below represent the average returns one, five, and 10 days after these pullbacks; the gray bars represent the NDX’s average returns for all one-, five, and 10-day periods since October 1985. Pretty big difference, though: After 10 days, for example, the NDX was up an average of 1.4% after the pullbacks, while the NDX’s long-term 10-day average return is only 0.63%.

NDX pullback pattern average returns, 10/1/85–8/16/18. Outperformed after pullbacks

Source: OptionsHouse (data)

As is always the case when dealing with averages, it’s important to remember any individual instance can be drastically different. For example, although the NDX was higher 69% of the time five days after the pullbacks (38 times), that means 17 other times it wasn’t. Every trade situation is unique.

In this case, more “T” headlines on any given day may have the potential to disrupt market action, but if the news follows the pattern of having a diminishing psychological impact over time, events like these may be opportunities for short-term traders.

Market Mover Updates: Clovis Oncology (CLVS) built on Wednesday’s rally with a 2%-plus intraday gain yesterday.

 

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1 CNBC.com. 'What happens in Turkey won't stay in Turkey': Why this debt crisis could be different. 8/13/18.

2 Supporting document available upon request.