It’s 3 Months Until Thanksgiving….Too Early to Talk Turkey?


August 15, 2018, by pathwise

You may have (or may not have) seen recent news that Turkey is undergoing some “problems.” For those of you who haven’t paid much attention, a US vs. Turkey “spat” has ensued. It’s interesting because this spat is really a disagreement over a pastor who has been held in Turkey for a few years now, and some Turkish prisoners held here in the USA. However, since both sides have confrontational individuals at the helm, this has turned into a war of words, sanctions, etc. and the markets have reacted strongly. Turkey has seen a very large drop in the value of its currency. The news media has been reporting that this could lead to a “contagion” across emerging markets, and hence, developed markets such as the US, and could even lead to a recession. So we wanted to address our thoughts.

The problem that you will hear about is the fact that Turkish companies have a healthy amount of debt that is denominated in foreign currencies. Many news outlets may try and make the historical connection to the late 1990s when many emerging markets had a debt crisis because they owed a lot of money in foreign currencies, and didn’t have “reserves” of foreign currencies to pay them. However, today’s situation differs considerably. While individual companies in emerging markets certainly may be at risk, we feel that a debt or currency crisis similar to what occurred in the 1990s is remote, at best. Our beliefs stem from the fact that the economies of emerging markets are much more intertwined than they were 20 years ago, with many companies having operations (in income) that they generate in foreign currencies. Additionally, most exchange rates are free-floating, something that helps minimize the risk of a collapse versus a “pegged” currency. Finally, when you look at countries in aggregate, the amount of foreign currency reserves is actually quite healthy.

That being said, there are always risks and uncertainties when investing in equities that have the potential to cause significant shorter-term price declines. Whether it is a trade war, a geopolitical event, an unexpected economic shock, a monetary policy mistake, or innumerable other factors, stocks can deliver big losses, at least over shorter-term (one- to three-year) periods. Market corrections and bear markets happen. An investor must be able to withstand these drops, stay the course, and stick to their long-term plan (assuming it was well-designed and aligned with their financial objectives, to begin with). We currently find emerging markets attractive for long-term investors and the key reason why we are slightly overweight EM stocks versus our strategic allocation is that we believe EM companies in aggregate are underearning relative to their normalized potential, and this is not priced into their stock prices. (They trade at about half the Shiller P/E ratio that US stocks do, according to Ned Davis Research). US stocks, on the other hand, are over-earning slightly and are expensive. From the outset, we have managed the shorter-term downside risk stemming from EM stocks in our portfolios by having only a modest overweighting there.