Why Ankara and Buenos Aires remain important to global portfolios
Last summer, many analysts, including this column (24 Aug 2018), were wondering whether Turkey was about to pull the rug from under global financial markets. Ankara’s currency, the lira, was in free fall as the economy overheated and found itself over-reliant on foreign capital for funding, via a large current account deficit. A stronger dollar, fuelled by higher US interest rates, was draining away liquidity and the reluctance of President Recep Tayyip Erdoğan to follow what was seen as orthodox policy in the West – namely to jack up interest rates – was making matters worse.
Emerging Markets are recovering alongside developed ones from the sell-off seen in late 2018
Source: Refinitiv data
Yet last winter’s wider market panic is seemingly becoming a distant memory. As this summer approaches, Turkey seems to barely warrant a mention, even though inflation is still near 20%, the lira trades 10% lower against the dollar compared to January, and the economy is in recession, thanks in part to the prevailing 24% interest rate which the Central Bank of Turkey is using to defend its currency.
“As this summer approaches Turkey seems to barely warrant a mention, even though inflation is still near 20%, the lira trades 10% lower against the dollar compared to January, and the economy is in recession.”
Sliding currencies may reflect economic and political worries concerning Ankara and Buenos Aires
Source: Refinitiv data
The weak economic outlook is having a political impact, too, with President Erdoğan’s Justice and Development Party (AKP) losing ground in this year’s local elections (which may explain why he was less than keen on those lofty interest rates). The opposition CHP party won five of the country’s six major cities, although a contested ballot in Istanbul is about to be re-run.
“Another election which may require more of advisers’ and clients’ attention is the one due to be fought in Argentina in October.”
Another election which may require more of advisers’ and clients’ attention is the one due to be fought in Argentina in October. An inflation rate of more than 50% and a near-halving of the peso’s worth from nearly 23 to the dollar to barely 45 are pouring the pressure on right-wing President Mauricio Macri and giving impetus to the opposition’s campaign, spearheaded by his left-wing predecessor Cristina Fernandez de Kirchner, whose policies are blamed by many economists for the country’s current woes.
Small earthquakes, no-one injured
Yet it is easy to see why some economists and strategists are arguing that any upsets in Ankara and Buenos Aires are just local difficulties that should not unduly influence the performance of advisers’ and clients’ portfolios.
- Turkey is a small part of the emerging markets indices. It represents just 0.7% of the assets of the Vanguard FTSE Emerging Markets Exchange-Traded Fund, which tracks the performance of 1,083 individual emerging market equities. Argentina, meanwhile, is not even classified as an Emerging Market, but a Frontier one and the Buenos Aires exchange provided just 11% of the assets of the largest tracker in this field, the MSCI Frontier Markets 100, although that does at least rank it as the third largest weighting (behind Kuwait and Vietnam).
- No other emerging markets have anything like the same inflation problems as these two, with most leading EM nations coming in at 5% or below.
- Even after his embarrassment in the local elections, President Erdoğan looks unassailable after constitutional changes and the AKP’s crushing General Election win of 2018. And while Mr Macri could be unseated – especially as he appears to be reaching for the desperate (and surely discredited) measure of price controls to try to fix inflation – global markets have witnessed the arrival of left-wing Governments in Argentina before without being unduly concerned.
Equally there remains the risk that such a view is complacent. An economic crisis and currency slide in Malaysia in 1997 went on to have global implications in 1998, as the FTSE All-Share and FTSE All-World stock indices both fell sharply as ripple effects led to a devaluation in Russia and the meltdown (and subsequent bail-out) of the Long-Term Capital Management hedge fund.
Contagion is possible. Losses in one market can lead to fund redemptions or the search for liquidity from others. That is why “all correlations go to one” during financial crises and any fund manager brave enough to have argued two years ago that it would be “different this time” in Argentina under Mr Macri is getting their deserved reward. Buyers of the country’s 100-year bond, issued in 2017, have seen the paper slide to barely 73 cents on the dollar, to add to their currency losses.
“Contagion is possible … That is why “all correlations go to one” during financial crises.”
It remains to be seen whether Turkey’s or Argentina’s problems remain local or go global, but attention should be paid, not least as there remains the risk that a worldwide trend gives Emerging Market assets pause for thought at the very least.
A strong dollar has historically tended to be a headwind for emerging market equities
Source: Refinitiv data
Even though the US Federal Reserve is putting interest rate rises on hold, the dollar, as benchmarked by the trade-weighted DXY or ‘Dixie’ index, keeps rising, thanks to the (relative) strength of America’s economy.
“Keen students of market history will know that a bouncy buck can hurt emerging markets – especially those that have lots of overseas debt.”
And keen students of market history will know that a bouncy buck can hurt emerging markets – especially those that have lots of overseas debt, like Turkey and Argentina, to pluck just two names out of the air. The MSCI Emerging Markets equity index may therefore be trading some 15% below its January 2018 level with good reason after all.