PMC Weekly Review - July 22, 2016

A Macro View – The Turkish Coup Attempt and its Market Implications

In discussing Emerging Markets investing, the BRIC countries (Brazil, Russia, India, and China) typically dominate the conversation, but the space comprises several other diverse economies. In fact, both the International Monetary Fund (IMF) and Morgan Stanley Capital International (MSCI) classify 19 other countries as “Emerging Markets”, and Turkey is one of them. Referred to as “The Gateway to Asia”, Turkey is the 17th largest economy in the world, and President Recep Tayyip Erdogan’s goal is to grow it to be in the top 10 by 2023. The country is a vital member of NATO and the G-20, and is pursuing European Union membership. Terrorist attacks and political instability have made Turkey a more prevalent headline recently, and investors should be cognizant of the unforeseen effects these types of events can have on broader Emerging Markets.

Turkey’s most recent appearance in global headlines occurred this past Saturday (July 16) when a group of rebel military officers attempted an unsuccessful coup d’état while President Erdogan was on vacation. The at-times violent insurrection involved troops, tanks, helicopters, and fighter planes in and over Istanbul and Ankara, and ultimately resulted in nearly 300 deaths and the arrest of more than 6,000 coup plotters and sympathizers.

Turkey is no stranger to military coups, which have taken place in 1960, 1971, 1980, and 1997. What exactly motivated the plotters – Kemalist disdain of the increasing clout of the Islamism pushed by Mr. Erdogan’s Justice and Development Party (AKP), followers of former ally-turned-foe Fethullah Gulen, or some other motivation – is unknown. Whatever the impetus, Mr. Erdogan has taken the opportunity to summarily purge the judiciary of nearly 3,000 justices, presumably those who might be sympathetic to the plotters. He also renewed his call for the US to extradite Pennsylvania-based cleric, Fethullah Gulen, a former ally in the AKP and leader of the Gulen faction, a liberal Islamic social movement. To thwart the coup attempt, President Erdogan urged Turkish citizens to take to the streets and defend his government. They did, and the coup failed, ending in success for him.

Following last weekend’s events, the iShares MSCI Turkey ETF (TUR) opened on Monday with a decline of more than 6% from Friday’s close, continued to fall through Thursday’s market close, and is down roughly 16% so far this week. From an investment perspective, the timing of the coup attempt was unfortunate, as the country was gaining traction from global investors, and the MSCI Turkey Index had risen nearly 20% so far in 2016. According to the Wall Street Journal, non-residents put roughly $13 billion to work in Turkey in the first quarter of 2016, which is almost double the $7 billion invested in the first quarter of 2015. Furthermore, The Financial Times states that GDP has averaged 4.3% since 2000, and the country has a sound fundamental backdrop. Nonetheless, the market clearly exhibited fear surrounding the coup attempt.

Whereas there is little doubt this event will lead to further political instability in Turkey (especially given the recent announcement of a state of emergency), the recent turmoil begs the question: What implications will it have on global financial markets, and, more specifically, Emerging Markets? The answer may not be readily apparent.

Despite the selloff in Turkey, other Emerging Markets and major US indices were relatively unaffected during the week. Notwithstanding the short-term lack of volatility in broader markets resulting from the Turkey situation, several investment professionals share the view that the intangible risk lies in widespread fear of investing in other emerging countries, which would impede the current Emerging Market rally. That said, the asset class has always carried higher political risks, but can still be an important element of an overall asset allocation, especially given the current global macroeconomic landscape. Murat Toprak, of HSBC, stated, “In a world of low and negative interest rates, investors still need to put capital to work,” suggesting that to completely abandon Emerging Markets based on this type of event would be an extreme decision. Although idiosyncratic country risks tend to be the norm in Emerging Markets investing, the asset class consists of multiple economies offering diverse investment opportunities, and investors who take on this risk premium historically have been rewarded with attractive returns over the long run.

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