Just when you could hear steady snoring from the dealer’s desk across the investment floor, the sleepy summer was shattered by the sky falling on Turkey.
The country had been ailing for some time, with inflation running unsustainably hot and the currency bleeding value despite the central bank more than doubling interest rates to 17.75 per cent in less than two months.
But in early August the trapdoor opened and the currency plummeted and Turkish bond yields ballooned. The government bond yield is well and truly inverted: 10-year debt yields 21 per cent, while two-year debts yield 27 per cent.
At 5.5 per cent of GDP, Turkey’s current account deficit is worse than the UK’s (that’s saying something) and President Recep Tayyip Erdogan has made several worryingly incoherent economic pronouncements. US tariffs and embargos on the nation for its refusal to release a US pastor held on terrorism charges just exacerbated the country’s meltdown.
The scale of the rout in Turkish assets seems a little overblown to us, but that’s financial markets for you.
Bad news snowballs – especially when the number of shorts on your bonds increases four-fold in seven months. Still, we were nowhere near Turkish assets when it blew up, so it’s a little academic.
What’s not academic is the effect the crisis has had on other emerging markets. As is typical, many investors have reacted to Turkey’s problems by selling all emerging markets, lock and stock.
This kind of response has become particularly pronounced in the passive-obsessed world of today. These knee-jerk index-level reactions make for increased volatility, but they also create great opportunities for savvy investors to buy assets at an undeserved discount.
We bought the GAM Emerging Bond fund, which invests solely in dollar-denominated debts in the developing world, as emerging market bond spreads reached 400 basis points.
Its exposure to Turkish government bonds is about 2.5 per cent, but we believe the chance of Turkey defaulting is low.
Its public debt to GDP is low at just 40 per cent and the government should come to terms to prevent the bad reputation and extraordinary pain that will come with a sovereign default.
Our research shows that few other emerging markets are as reliant as Turkey on foreign investment to service their debts. Most are actually in better financial shape than a few years ago, which gives us the confidence to move against the crowd here.
If the Turkish currency crisis does mutate into a larger problem down the road, we feel it’s most likely to be through the developed world, not the developing.
Several European banks have substantial Turkish debts on their books. Spanish lenders have about a quarter of their capital and reserves in Turkish assets.