Turkey & Russia: A Tale of Two Currencies
by John Mullin, August 13, 2018

The Turkish lira depreciated substantially against the U.S. dollar last week, extending a losing streak in which the lira has depreciated roughly 40% year-to-date. 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.

The Russian ruble also experienced renewed weakness last week, hitting a two-year low against the dollar and extending its depreciation to over 10% year-to-date. The ruble’s weakness primarily reflects the anticipated impact of new U.S. sanctions.
What do these developments portend for equity investments in the two markets? We offer two main insights:

First, country equity markets tend to outperform their global peers following big currency depreciations. In our recent paper, Big Currency Depreciations: What Happens Next?, we examined the USD return performances of equity markets in countries that have had currency depreciations of 10% or greater over three-month periods. We found that, historically, these markets have outperformed the global benchmark by a remarkable 14% on average over the subsequent twelve months. However, the paper also shows that the volatility of these markets is substantial. Consequently, while there are potential gains to investing in Turkey or Russia at this point, the potential for loss is also substantial.

Second, as international equity investors, we look at multiple indicators to assess these markets’ prospects, and our analysis draws a clear distinction between Turkey and Russia. As shown in the August 2018 edition of our All-Country Equity Allocator, we are underweight Turkey but overweight Russia.

Turkey is what we term a “value trap” market, which means that it offers inexpensive valuation indicators, but generally poor growth, risk, and momentum indicators. The market’s key negatives are its recent history of rapid credit growth and its large current account deficit (which exceeds 6% of GDP). Additional negatives for Turkey include widening soverign risk spreads and negative equity price momentum. On top of these negatives, the Turkish market’s fortunes are hurt by increasing short-term intererst rates (which are themselves a response to recent currency weakness and accelerting inflation).

Russia, like Turkey, offers inexpensive valuation ratios. However, its risk and growth indicators are generally more favorable than those of Turkey. Russia’s most important positive at this point is that it is a major oil exporter at a time of firm global oil prices. As a consequence, and in contrast with Turkey, Russia runs a large current account surplus (exceeding 4% of GDP). Also in contrast with Turkey, Russian sovereign risk spreads have been relatively stable (despite a modest recent increase) and Russian equity price momentum is strong on a year-over-year basis.

John Mullin is a Senior Portfolio Manager on the International Equity team at DCM Advisors. John can be reached at jmullin@dcmadvisors.com.