The Butterfly Effect In US Equities

I imagine that many readers are familiar with the term “butterfly effect”. In common parlance, its oversimplified definition is that a large weather system can be influenced by a small perturbation, such as a butterfly flapping its wings thousands of miles away. In actuality, it describes an aspect of chaos theory when “a small change in one state of a deterministic nonlinear system can result in large differences in a later state.” We can write dissertations about whether markets are deterministic and nonlinear, and to what degree chaos theory is applicable to markets[i], but this morning’s market activity appears to be a wonderful illustration of the butterfly effect in US equity markets.

On Friday evening I got an alert on my phone saying that the Turkish president removed the country’s central bank governor. My trading week was over by the time the news arrived, with a quarterly triple (not quadruple) witching expiration behind us. I have to admit, my first thought was not “I need to buy NQ futures on Sunday night”, but that would have become a solid trade by the time that US markets opened on Monday. It appears that the news out of Turkey is another example of the butterfly effect in global financial markets.

I am by no means an expert in Turkish politics, but it is hardly a sign of economic stability when a president fires his third central bank governor in less than two years. Markets are not happy when central bank independence is threatened, let alone usurped by political leaders, especially when that becomes somewhat routine. No one should have been surprised that the Turkish lira plunged by more than 15% against the US dollar (it has since improved to -10% today) or that major Turkish equity indices fell by about 10% this morning. While it is not uncommon for local stock indices to rise when a nation’s currency is devalued, that occurs when investors believe that the weaker currency will spur exports. That was not the interpretation for investors in Turkish assets. Markets gave this move a true vote of no confidence.

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Disclosure: The analysis in this material is provided for information only and is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the ...

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