Market Strategy Radar Screen Weekly August 13, 2018

Riders on The Storm Revisited

Turkey's crisis likely more of a geopolitical concern than risk to the global economy

Beware the “strong man/strong woman” syndrome when it comes to government leadership: messing with policy that better belongs in the hands of an independent central bank. A case study in why central banks should be independent from political leadership appears to be unfolding in Turkey as it faces its travails head-on.

Consider the fates of countries whose economies and markets have been thrown into turmoil by what we’ll term political, ideological and philosophical meddling by government leaders whose fiscal policies go against practical monetary policy and as a result roil the markets.

Among countries that have made headlines in the current cycle as a result of political meddling within the emerging and frontier markets are Argentina, Venezuela and Turkey. While Argentina has begun the process of extricating itself from the results of mismanagement officiated by a prior administration, it still has considerable distance to go before it “gets out of the woods.”

Turkey as a member of the European Monetary Union (though it has not yet qualified to adapt the euro as its currency), with economic output of around $900 billion (USD), annually has increasingly earned headlines in the financial press this year. Its currency (the lira) has been pummeled in the FX market as a result of policies and actions taken by its government under the leadership of President Recep Tayyip Erdogan.

Ironically, Erdogan was regarded in the early 2000s as an innovator who was lauded globally as a progressive leader who successfully advanced the standing of his country among nations of the region and the world both from a geopolitical and economic perspective. In passing years, Turkey’s leader introduced political and ideological policies that fed strife within Turkey and negatively impacted its relationships with other countries including the United States. An attempted coup that failed against Erdogan two years ago made matters worse and resulted in harsh retaliation against opposition to the government.

A Turkey in the Coal Mine?

Over the course of the last week, we have been asked if the problems that are currently assailing Turkey might present a systemic risk to the world markets.

We are quick to respond that we believe that the present situation in Turkey somewhat parallels (in raising levels of concern among investors) the Greek crisis of 2010. At the time, fears rose that a default by Greece on its debt would destroy the European Monetary Union and its singular currency. It didn’t happen.

Most country-born crises are often found to be idiosyncratic or specific to issues within the country involved and unlikely to contaminate neighboring nations. Risks tend to be centered on lenders that get caught up in financial crisis.

The current situation has raised concern about the exposure Turkish banks and banks in neighboring countries might have to its currency crisis.

We believe that while among developed and emerging market banks, there might emerge one or more player(s) who will sustain damage as a result of Turkey’s crisis, the efforts of regulators on the European continent and in the UK over the last eight-plus years to fortify their respective banks (via improved regulation and government administered “stress tests)” will likely mitigate damage—should it occur—and prevent development of systemic risk or contagion from spreading.

As we prepared to publish this week’s MSRS, news crossed the tape that the Turkish lira had extended its drop against the dollar and other currencies but that Turkey’s Banking Regulation and Supervision Agency had responded and stepped in to limit swap transactions on the lira. The agency’s action was reported to help pare some of the currency’s earlier losses.

Turkey’s situation has been made worse over the last week as a result of sanctions against the country by the US tied to the detainment of an American cleric in Turkey.

A mix of mis-steps and policy inflexibility by Turkey’s leadership, trade tensions, high inflation, a sizable currentaccount deficit and a currency that has declined around 40% are likely to remain problematic for Turkey for some time until a path to resolution is found.

We are reminded of prior currency crises (recall: Cypress, Greece, Argentina, Thailand, Malaysia and others). In those situations, international organizations such as the IMF (International Monetary Fund) and the World Bank had to step in to work with domestic government officials and others involved (including businesses and investors) to get things back in order.

Usually the longer it takes to arrive at a solution, the more it costs the troubled country and its economy. That said, we are not expecting that the situation in Turkey will deteriorate to the extent that it poses a threat to the world economy.

Everything must change

We attended Oppenheimer & Co.’s 21st annual Technology, Internet and Communications Conference last week. In meeting after meeting listening to the presentations of technology company CEOs, CFOs and other executives, we were reminded of the ubiquitous position technology has in the lives today of both business and the consumer.

Whether it is cybersecurity, Big Data, or the Internet of Things, a myriad of innovations have irrevocably changed the way products are manufactured, services are delivered, and inventions are created. Innovation has altered the ways individuals, institutions and even equipment and machinery interact with one another.

Perhaps “this time is different” will always be a risky phrase for a strategist to hang his or her hat on, but there can be little doubt that the way a lot of things are done has decidedly changed. While change inevitably brings risks, it often is accompanied by equal or greater number of opportunities.

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