Will There Be a Spillover Effect?

Given all of the geopolitical turmoil of late that’s rocked many of the biggest emerging markets in the world, it’s logical to ask ourselves if there will be a spillover effect — some call it “contagion” — here in the U.S. equity markets.

During the past month, stocks in the S&P 500 have maintained their upward bias in the face of geopolitical tumult, climbing about 2.6% in the past four weeks. And though we have seen some selling in stocks during the past couple of days, that selling certainly hasn’t been anywhere close to the selloff we’ve witnessed in those markets closest to the latest political upheaval.

For example, in perhaps the most inflamed hotbed of geopolitical turmoil, Russia, we’ve seen stocks tumble nearly 15% during the past month. In just the last five trading sessions, the Market Vectors Russia ETF (RSX) has plunged 6.3%. The chart here of RSX clearly shows the damage done to Russian equities since tensions with Ukraine began earlier this year.

But the Russian bear isn’t the only market that’s seen a big pullback of late. There also has been some extreme selling in Chinese stocks, as serious concerns over that country’s faltering economic growth, as well as fears that the so-called “shadow banking system” has come under pressure, have caused stocks in the benchmark iShares FTSE China 25 Index (FXI) to tumble well below their 50- and 200-day moving averages.

Flying somewhat under the radar in terms of mainstream news coverage are the myriad problems in Turkey, particularly the latest drop in that country’s debt market. That nation’s yield curve now has inverted, meaning that long-term debt instruments now have a lower yield than short-term debt instruments of the same credit quality. This kind of situation is what has been historically present right before major recessions.

If there is a spillover effect in Turkey that negatively affects Europe, or if the troubles in Russia and/or China persist, it may not be long before the U.S. bull market stumbles.