“Turkey for me, Turkey for you” – Adam Sandler, “The Thanksgiving Song”
It seems not too long ago the financial news was celebrating Apple hitting $1 trillion in market cap. As of now, Turkey and the threat of contagion are dominating the headlines. Reminder, media companies need your attention and they are well aware of what is going in the markets.
So, the soup du jour over the last few weeks has been Turkey because as the country continues to experience economic troubles. If you follow macro trends, specifically currencies, then you well aware of the economic malaise in Turkey well before it made flashy headlines.
Turkey’s consumer price index is up 15.85% year over year, the unemployment rate is at 10%, and over the last 5 years, Turkey’s stock market, as represented by MSCI Turkey is down 67% in US dollar terms.
Trump’s tweet the other day regarding imposing tariffs on steel and aluminum exports from Turkey kickstarted this new wave of selling. The Turkish fell off a cliff relative to the US dollar after the tweet. Although, when stepping back, the Turkish Lira has been declining against the dollar for the last 10 years. Look at that, the three Ts: Trump, Turkey, and Telsa. Moving on.
Implications for US Based Investors
Most people have exposure to investments in foreign countries. And when you have exposure to non-domestic investments you are subject risk to investment risk, a country-specific risk, and currency risk. This post is not to for me to give my opinion on where the Turkish Lira is headed but to highlight the complexities when a US-based investor invests in a security that is in a foreign country. Investment risk is based on fundamentals of business. Currency risk is more complicated and also unavoidable unless you decide to hedge this risk which in the case of Turkey would be extremely costly.
For US-based investors, currency risk arises when the US dollar ($) strengthens or appreciates against the currency your investment is in, in this example, we are talking about the Turkish Lira. In other words, you are essentially converting your US dollars into the Turkish Lira, and then using the Turkish Liras to buy an investment domiciled in Turkey. So if the Turkish Lira is falling against the US dollar, then you return on the investment would be lower. Also, if the Turkish Lira is appreciating against the US dollar then your investment is worth more. If this is confusing, I like to think in terms of travel. If the US dollar is getting stronger relative to the Turkish Lira, then a US traveler going on vacation in Turkey will convert $1 dollar into 7 Turkish Liras, at the start of the year, $1 bought 5 Turkish Liras; If you book a vacation at 5 and then you wind up going when its at 7, your vacations will cost less than anticipated.
The MSCI Emerging Market Index is one of the most widely followed indexes for emerging market countries. The top five countries that represent this index is China (31.8%), South Korea (14.08%), Taiwan (11.84%), India (8.99%), and South Africa (6.77%). Turkey represents a fairly small part because its stock market is small compared to China or India.
Akbank TAS is a large position in the MSCI Turkey Index at around 8% of the ETF that tracks the MSCI Turkey portfolio. It was down 15.24% today. Akbanks TAS weighting in the iShares MSCI Emerging Market is only 0.04%.
Contagion – Should we be worried?
Contagion is always the word the gets overplayed when an Emerging economy is suffering a collapse of this magnitude. The question investors always ask themselves, what banks have the most exposure to Turkey? Global banks like BNP Paribas have been cited. Others are turning to the question, what other countries look like Turkey? Brazil, Mexico, and Italy are being watched very closely to see if the contagion can spread.
Greece and Cyprus are relatively recent examples where “fear of contagion” can make investors take risk off the table. Right now, there are some funds that are profiting from the collapse of the Turkish Lira. Managed futures strategies are betting that the trend that seems to be in place for quite some time will continue.
What makes investing so hard is trying to find the signal within in the noise. Will contagion spread to global banks? At this time, we have no idea. What I can tell you that Turkey is a small part of the global economy and even smaller part in terms of investable assets. Unless you are trading the Turkish Lira, smart investors use the volatility to add to positions in a portfolio that they really like.