The Independent Market Observer

The Real Lesson from Turkey’s Crisis

Posted by Brad McMillan, CFA®, CFP®

Find me on:

This entry was posted on Aug 14, 2018 12:25:47 PM

and tagged Commentary

Leave a comment

Turkey's crisisAs Turkey’s crisis rumbles on, investors are on the watch for signs of contagion. Emerging markets in general are getting hit, so contagion remains a possibility. Still, there are reasons to believe the crisis will burn out in Turkey itself.

Turkey is an outlier

The main reason the crisis may not spread is that Turkey is exceptional in many ways—none of them good. It has borrowed more, as a percentage of its economy, in foreign currencies than any other country. There are only a handful of countries that are even close, including Hungary, Argentina, Poland, and Chile. Recently, its central bank effectively lost its independence and is now politically unable to take measures that might mitigate the crisis. In other words, Turkey is both more exposed and less able to do something about it than any other country. Notably, while the other exposed countries are also taking hits, no country is as bad as Turkey. Turkey is an outlier.

Other countries are also suffering, of course, but they are doing something about it. Argentina, for example, has seen its currency decline. But its central bank is raising rates, which appears to be constraining the damage. Emerging markets in general are seeing the same reaction. The damage is real and substantial, but it doesn’t yet seem to be spreading in a systemic way. We will keep watching, of course. But at the moment, the crisis seems to have paused—and may well subside instead of spreading.

Emerging markets are changing

If there is no systemic spread, problem solved, right? Yes, in the short term. But I think the real lesson of the Turkey crisis for us as investors extends well beyond whether we get yet another meltdown in emerging markets. Instead, it points to a real change in the nature of emerging markets in general—one that investors should be very aware of.

First, the Turkey crisis wasn’t supposed to happen. Nothing new there—no crisis is. But the narrative around emerging markets is that governance has improved enough that we were not going to see some of the historical problems come up again. Markets were supposed to discipline governments, and governments were supposed to have learned their economic lessons. Turkey shows us that both of those assumptions are wrong, in one very significant case. Signs are they might be wrong in others as well.

Second, and even more important, the growth and attractiveness of emerging markets to investors lie in the assumption that they will be able to trade within a global community and will be able to rely on that community for support and assistance when necessary. The Trump administration’s decision to impose tariffs on Turkey in the middle of its crisis calls the second assumption into serious question, and the whole ongoing trade war calls the first into question as well.

In other words, perhaps emerging markets are not as solid, as political economies, as investors had assumed. Perhaps the environment that supported the positive changes is now eroding. These two components are the real foundation of what makes emerging markets attractive as investments in the first place. The progress over recent decades and the investment returns have been real. We need to pay attention to whether that trend is changing.

What does this mean for investors?

To be clear, I don’t think the trend is changing—yet. There are many emerging markets where governance remains effective, where policy is supportive of investment, and where it makes sense to be invested. We do, however, need to be more selective in what we do and not just make broad bets on an asset class. Going forward, investing in emerging markets will be more complicated and difficult than it has been over the past decade or so. As investors, we need to pay attention and to be thoughtful and careful.

Mind you, that should always be the case.


Subscribe via Email

Crash-Test Investing

Hot Topics



New Call-to-action

Conversations

Archives

see all

Subscribe


Disclosure

The information on this website is intended for informational/educational purposes only and should not be construed as investment advice, a solicitation, or a recommendation to buy or sell any security or investment product. Please contact your financial professional for more information specific to your situation.

Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets.

The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. All indices are unmanaged and investors cannot invest directly in an index.

The MSCI EAFE (Europe, Australia, Far East) Index is a free float‐adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the U.S. and Canada. The MSCI EAFE Index consists of 21 developed market country indices.

One basis point (bp) is equal to 1/100th of 1 percent, or 0.01 percent.

The VIX (CBOE Volatility Index) measures the market’s expectation of 30-day volatility across a wide range of S&P 500 options.

The forward price-to-earnings (P/E) ratio divides the current share price of the index by its estimated future earnings.

Third-party links are provided to you as a courtesy. We make no representation as to the completeness or accuracy of information provided on these websites. Information on such sites, including third-party links contained within, should not be construed as an endorsement or adoption by Commonwealth of any kind. You should consult with a financial advisor regarding your specific situation.

Member FINRASIPC

Please review our Terms of Use

Commonwealth Financial Network®