Please find below our Market Update for the week ending 17th August 2018.
A brief insight into the latest market dynamics and details of any changes occurring within our model portfolios.
Market data
The Turkish lira has been the worst performing major currency this year, losing more than 40% since the beginning of 2018. If you look at the fall over a longer time span it looks even worse – five years ago, one dollar bought 2TL. On Monday of this week, a dollar could purchase more than 6.90TL, representing a 245% drop since 2013. There are a range of reasons for the currency’s weakness. Over recent weeks, attention has focused on an extraordinary dispute between Turkey and the US, a NATO ally for more than 60 years. The US State Department had imposed sanctions over Turkey’s detention of an evangelical pastor from North Carolina, USA – measures that have rattled markets and increased uncertainty towards Turkey – and talks in Washington last week failed to resolve the impasse; what makes things worse is the Turkish Government look unfazed by the threat of more sanctions. This has led to the currency being devalued by investors losing confidence in the Mediterranean country.
The currency devaluation is not all because of this pastor, though, there are other factors at play. Looking historically, Turkey has prospered since the Financial Crash in 2008 from an influx of short-term foreign funds, mainly because of ultra-loose monetary policy in the US and Europe, which encouraged investors to seek higher returns in Turkey and other emerging markets. In other words, Turkey benefitted greatly from developed economies’ huge ‘Quantitative Easing’ asset-purchasing schemes, as investors sought higher returns elsewhere. But as the US and eurozone quantitative easing becomes history – at least for this economic cycle – the short-term foreign funds that have propped up Turkey’s growth are getting harder to come by. Investors are urging the Turkish Government to slow down the country’s economy through tax increases and spending curbs in the hope it would reduce the risk of an economic crash and also reduce the current account deficit, which will in turn reduce the dependency on these foreign funds. Slowing down the economy could also stabilise inflation, now running at more than 15%. The obvious solution to this would be to raise interest rates, which will help battle inflation and slow/reverse the fall of the Lira. The only issue is that President Erdogan, Turkey’s most powerful ruler since the foundation of the modern nation, has this year described interest rates as “the mother and father of all evil”, and as a drag on Turkish entrepreneurialism. Against this backdrop, the Turkish central bank has, perhaps unsurprisingly, proved reluctant to increase rates, declining to do so last month despite widespread expectations of a rise.
With an ever-strengthening US dollar and a foreseeable end to Quantitative Easing programmes, this situation in Turkey is likely to repeat itself in other areas of emerging markets in the near future, although political interference has of course exacerbated the problem in Turkey. The MSCI Emerging Market Index, a leading measurement of performance in all emerging markets, has fallen into ‘bear market’ territory this week, tumbling by the most in six months on Wednesday to leave the benchmark nearly 20% lower since January’s high – the typical definition of a bear market. Emerging markets have experienced mounting pressure over the past few months; concerns over the potential impact of trade wars have weighed heavily, while rising US interest rates and the US Dollar’s renaissance have dented the appeal of emerging markets, and also contributed to crises in more vulnerable countries that are dependent on capital inflows, such as Argentina and of course, Turkey.
Gary’s market comments in conjunction with our investment partners
The temptation for Emerging Market investors is to respond to the Turkey induced sell-off by punishing all emerging markets equally. The longer Turkey maintains this posture, the greater the risk that unfavourable technical factors could cause disruptive economic and financial contagion for both the country and Emerging Market assets as a whole (through indiscriminate selling of Emerging Market passive funds).
However, LGT believe the risk may not only be contained, but also may not be linked to other Emerging Markets which are showing overall positive economic data. The currency crisis in Turkey is mainly caused by a punishing market against Erdogan’s politics and reforms, and we wouldn’t be surprised if Turkeys financial conditions continue to worsen if Erdogan doesn’t announce a change of course. This is a good example as to why an active fund within Emerging Markets is critical and allows LGT Vestra to remain confident in their current exposure.
7IM portfolios benefitted from the holdings in Yen, US Dollars and US Treasuries, as concerns over Turkey and Trump boiled over. The currency depreciation put pressure on Turkish companies, which hold large levels of unhedged Dollar and Euro denominated debt on their books. Markets are waiting for a legitimate response from the Government, while the Central Bank stepped in to cut reserve requirements for banks to release money into the financial system. However, they failed to hike interest rates, which some investors believe is the only way to halt the Lira’s slide. It is feared that the crisis could spill into other emerging markets and the EU banking sector, given its exposure to Turkey.
Sources: LGT Vestra and 7IM
