The dispute between the US and Turkey began following Turkey’s refusal to release an American pastor who has been detained for nearly two years.
The Turkish lira and stock market took a bigger hit when President Donald Trump's administration approved the doubling of tariffs to 20 per cent and 50 per cent on Turkish steel and aluminium respectively. Turkey supplies only 1 per cent of the US's imported aluminium and less than 4 per cent of its steel in 2017.
However, the market is pricing in concerns about Turkey’s high inflation and current account deficit, as well as foreign currency debt and the direction of economic policy under President Recep Tayyip Erdogan.
More recently, the Trump administration announced a 10 per cent tariff on $200bn of Chinese imports, and threatened to increase the rate to 25 per cent in 2019 if no deal was reached to ease the tension between the two countries. China retaliated by imposing tariffs of up to 10 per cent on $60bn of US imports.
While it is true that many emerging market regions borrowed too much when interest rates fell to ultra-low levels after the financial crisis, most economies are in relatively good shape.Global stock markets sold off in response to the trade conflicts characterised by a risk-off sentiment, sending emerging markets lower. However, there is the risk of contagion, much of which has already been felt through most emerging market currencies.
The chart below shows the year-to-date performance of the FE Invest Approved List funds. Some of the more underperforming funds have been facing issues.
Source: FE Analytics
Having met with Edward Lam, portfolio manager of Somerset EM Dividend Growth, he stressed that the macroeconomic case for Turkey has changed, which has forced him to reassess his holding in the country.
Coming into 2018, the fund’s relative exposure to Turkey stood at around 5 per cent, but he has been progressively selling this exposure down which proved to be a good move.
However, he is maintaining his position in one company on a stock-specific basis.
A larger chunk of the fund’s underperformance is coming from the fund’s largest holding in SK Hynix, a South Korean semi-conductor company. The stock fell alongside other chipmakers after Morgan Stanley warned that elevated inventory levels and stretched lead times leave "no margin for error", cutting its outlook for the sector from ‘in-line’ to ‘cautious’.
It also pointed to a slowdown in global manufacturing in 2018, suggesting more caution around trade tensions.
James Donald, portfolio manager of Lazard Emerging Markets pointed to the lack of central bank independence, along with President Erdogan’s unwillingness to raise short-term rates, which has recently strained the Turkish lira.
He added to his Turkish exposure on weakness in the second quarter to one company that benefits from a depreciating lira, as close to half of its revenue is derived from outside of Turkey.
Lazard also holds a position in SK Hynix which explains part of the underperformance.
Fidelity Emerging Markets increased its position in Sberbank on weakness, which has fallen further since the first round of sanctions were announced in April. The addition of a Brazilian energy company, on the back of its constructive view on the oil price, prior to the truckers’ strike also contributed to underperformance.
The fund has, more recently, underperformed, driven by its exposure to the China A-share market, resulting from trade war talk and concerns about the state of the Chinese economy.
While it is true that many emerging market regions borrowed too much when interest rates fell to ultra-low levels after the financial crisis, most economies are in relatively good shape, reflecting the FE research team’s positive stance on emerging market equities.
According to data from Bloomberg, foreign exchange reserves for the 12 largest emerging market countries, excluding China, stand at $3.15trn, up from less than $2trn in 2009.
Except for China and Turkey, current account deficits have turned into surpluses, despite tighter funding conditions resulting from higher US interest rates. Emerging market fundamentals continue to be robust - earnings growth expectations for 2018 remain steady at 18 per cent and estimates for 2019 were revised slightly higher to 11 per cent.
Dividend and free cash flow yields remain higher in emerging markets compared to developed markets.
Emerging markets are also expected to grow more than twice as fast as developed markets in 2018 and 2019 at 5 per cent versus 2.3 per cent, respectively.
As a result, we believe the risks surrounding Turkey and Argentina, and the US-China trade tensions are unlikely to cause significant contagion and change our positive stance on emerging markets.
Tanvi Kandlur is a fund analyst at FE
