A Turkey in the Coal Mine
by Dr Leila Heckman, August 14, 2018

Having lived through the Asian crisis in 1997 (I was in Korea in Dec. 1997 when the won was depreciating 10% a day) and the Russian default/devaluation in 1998 (I was in Russia in July 1998), I can appreciate concerns about what is happening in Turkey spreading to other markets around the world.

However, in 1997, there were definitely differences from today. Before the Asian crisis, the Thai baht was pegged to the US$, and many of the emerging Asian markets were running large current account deficits (imports were higher than exports which had to be financed). For example, Thailand and Malaysia had current account deficits of 9.5% and 5.3% of GDP, respectively.   Currency reserves were running out. (They could not finance their $ denominated debts and imports.).  In 1997, Emerging Asian markets were down 48% while the US was up 34% and Europe was up 24%.  Equity contagion was contained to Asian markets.

In 1998, during the Russian default and currency crisis, the US hedge fund LTCM got into trouble.  There was more contagion around the world, centered around August 1998.  However, for the year, the US was up 30% and Europe was up 29%. It was the Emerging Markets which got really hurt for the year.  Russia was down 83% and Latin America was down 35%.

Turkey is somewhat of an outlier today.  The lira’s decline reflects multiple investor concerns regarding Turkey, including its heavy reliance on short-term funds from abroad, the potential impact of U.S. economic sanctions, and a lack of confidence in the Erdogan regime’s economic policies.  It is running a large current account deficit of 6.3% of GDP –similar to the level of the Asian markets in 1997.  However, today most other markets around the world are not running current account deficits.  In fact, the average emerging market has a current account surplus of .2%.

That said, we have been in a bull market since 2009, and the bull market has gotten “long in the tooth”.  On the positive side, forecasted earnings growth, especially for U.S .companies, looks strong for 2018 at 22% and for the rest of the World markets at 10%.  The price-to-earnings ratio for the overall World market at 20x is not in bubble territory, although there are individual stocks might be bubbles. We have found that declines of 20% or more in World markets tend to be associated with large earnings declines (e.g.in 1990, Gulf War and oil price spike). At this point, I doubt whether the situation in Turkey can tip the world into recession and cause double digit earnings declines.  But then again, we still have the credit bubble in China, unresolved Brexit, trade wars that could cause more serious damage to the World markets.

Leila can be reached at lheckman@dcmadvisors.com .