Investment Clock insights

The emerging markets bear market: Turkey is a symptom, not a cause


Trevor Greetham

16 August 2018

Emerging market equities are now officially in bear market territory* as depicted in Chart 1.
The trigger for the most recent bout of weakness wasn’t China, but Turkey. While there are country-specific factors at work in Turkey, the crisis is a symptom and not a cause of a broader malaise in the emerging markets. President Trump’s “America First” trade policy is likely to hurt the emerging countries most given their high level of reliance on global trade but the general economic backdrop is also unsupportive. China is slowing down and industrial commodity prices are falling. Meanwhile, a strong US economy means US interest rates are rising and the dollar is strong and this increases finance costs. There is a high correlation between periods of dollar strength and periods of emerging market underperformance (Chart 2).
We don’t see the situation changing in the near term and expect to see further trouble in the emerging markets over the next few years. We are broadly neutral on equities in GMAP Balanced and the other multi asset funds we manage but our equity exposure is tilted away from the emerging markets and towards the more defensive US market.
A doubling of steel tariffs by the Trump Administration saw the Turkish lira plunge by 20% on Friday. Diplomatic relations are at a low ebb after Turkey refused to release a US pastor accused of involvement in the failed coup attempt two years ago. Turkey needs to get money from somewhere or raise interest rates to stabilise its currency but the US is putting pressure on the IMF and others not to provide funds. Meanwhile, President Erdogan has described interest rate rises as the “mother of all evils” making it hard for the newly appointed Finance Minister to restore credibility with the markets, a task not helped by the fact that he is President Erdogan’s son-in-law.
* A bear market is defined as a loss of 20% or more from the most recent peak.

Emerging market equities are now officially in bear market territory* as depicted in Chart 1.

The trigger for the most recent bout of weakness wasn’t China, but Turkey. While there are country-specific factors at work in Turkey, the crisis is a symptom and not a cause of a broader malaise in the emerging markets. President Trump’s “America First” trade policy is likely to hurt the emerging countries most given their high level of reliance on global trade but the general economic backdrop is also unsupportive. China is slowing down and industrial commodity prices are falling. Meanwhile, a strong US economy means US interest rates are rising and the dollar is strong and this increases finance costs. There is a high correlation between periods of dollar strength and periods of emerging market underperformance (Chart 2).

We don’t see the situation changing in the near term and expect to see further trouble in the emerging markets over the next few years. We are broadly neutral on equities in GMAP Balanced and the other multi asset funds we manage but our equity exposure is tilted away from the emerging markets and towards the more defensive US market.

A doubling of steel tariffs by the Trump Administration saw the Turkish lira plunge by 20% on Friday. Diplomatic relations are at a low ebb after Turkey refused to release a US pastor accused of involvement in the failed coup attempt two years ago. Turkey needs to get money from somewhere or raise interest rates to stabilise its currency but the US is putting pressure on the International Monetary Fund (IMF) and others not to provide funds. Meanwhile, President Erdogan has described interest rate rises as the “mother of all evils” making it hard for the newly appointed Finance Minister to restore credibility with the markets, a task not helped by the fact that he is President Erdogan’s son-in-law.

* A bear market is defined as a loss of 20% or more from the most recent peak.

Chart 1: MSCI Emerging Market Index (rebased to 100 at the 26 January high)

Source: Thomson Reuters Datastream as at 14.08.2018

Chart 2: Emerging Market equities vs the world (and the US dollar index (inverted))

Source: Thomson Reuters Datastream as at 14.08.2018

Past performance is no guide to the future. The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. The views expressed are the author’s own and do not constitute investment advice.