Volatility has once again returned to the equity markets, and although it is nowhere near Thanksgiving, we decided with recent geopolitical developments that it was a good time to talk a little “Turkey”. We know what you’re thinking, “What’s all the fuss over a delicious meal? And how does that have anything to do with stocks and bonds?” No, we are not talking the family-gathering, recipe-exchanging, eat-until-you-are-in-a-food-coma kind of turkey…but the Middle Eastern nation, trading partner of the US, strategic ally of NATO, capital “T” kind of Turkey. Here’s the fuss.
At a NATO summit a few months back, President Trump and Turkish President Recep Erdogan met and worked a deal between the two countries to each release a person of interest for the respective administrations. The US would negotiate for the release of a Turkish woman held in Israel and Turkey would release an American pastor held in a Turkish prison. When Turkey only moved the American to house arrest instead of releasing him, President Trump felt betrayed and retaliated by threating to impose tariffs on Turkish steel and aluminum. This action created additional international trade concerns in an already contentious environment. It should also be noted that US-Turkish relations were already on thin ice prior to the recent turmoil.
The reality of this situation is that the prisoner release was simply window dressing. The bigger issues in US-Turkish relations are 1) the involvement of Turkish bank Halkbank in a scheme to breach US sanctions against Iran by “money laundering” billions of dollars of Iranian oil proceeds, and 2) the purchase by Turkey, a NATO member, of a Russian missile defense system. It appears that Erdogan wanted to use the captive American pastor as a bargaining chip to avoid any further action by the US against Halkbank, a plan which seems to have backfired on Erdogan.
Turkey’s economy is not running smoothly and Erdogan is becoming increasingly desperate. In an act of world class “spinning” worthy of any CNN or Fox report, he is now saying that all of Turkey’s troubles are due to the American “conspiracy” to devalue Turkey’s currency, the Lira, and impede trade with sanctions and tariffs. Turkey is in desperate need of economic reform and needs to get inflation, which is running at around 15%, under control. As far as Erdogan is concerned, his leadership is not the problem, but the Americans are the problem.
So why would Turkey, a small emerging market country, cause markets in general so much angst? It is actually more a worry about contagion, that is, that the problems of one country will spread to other countries. Something similar happened to Asian currencies and markets during the Asian financial crisis of 1997.
One key culprit for possible contagion among EM countries is the strength of the US dollar against EM currencies. EM countries typically have a large amount of debt to fund and support their economies. Much of this EM country debt is denominated is US dollars. As long as the borrower is generating enough US dollar-based income (by exporting goods to the US, for example) this is not a problem. The problems appear when a country’s US-dollar income falls relative to its US-dollar expenses. Turkey starts out with a strike against it, since it imports more than it exports, meaning it does not have a surplus of US dollars. US sanctions will cut further into Turkey’s exports (reducing US-dollar income) at a time when the falling value of the Lira has almost doubled the cost of its US-dollar debt over the past 12 months.
As a result of this contagion fear, emerging market funds have been under performing the broader US markets this year. But not all EM countries are in the same difficult situation as Turkey. Some strategists are predicting that the dollar’s strength has peaked, which may be a positive for those Emerging Markets that have done a better job in managing their economies.
Well, that about wraps us our little “Turkey Talk”. It might not be as tasty as that wonderful feast in late November, but we hope our turkey will hold you over for now. Any one feeling like a nap?