The culmination of a long-brewing financial crisis in Turkey dominated market headlines over the past two weeks. Not surprisingly, Turkey is an insignificant contributor to global GDP, and it has no relevance from a global systemic risk perspective. Given that, the fact that events there actually moved prices in both equity and credit markets warrants a bit of attention.

 

Economic data from the past eight weeks has started to paint a picture of global GDP growth remaining robust, but becoming increasingly concentrated in only the US. This is in direct contrast to the confidence-inspiring “synchronized global growth” of 2017 and early 2018. The change is partly due to an unexpected downshift in Europe and Japan, but the notable deceleration has been in emerging markets and specifically in China.

The issue for emerging markets generally is that they import some of the Fed’s monetary policy. The rising cost of USD-denominated credit makes some of their borrowing more expensive on a go-forward basis, and the corresponding rise in the USD itself makes some existing debt more expensive to repay. Both of these have a restrictive effect on growth. This dynamic is less relevant in China; however, the same outcome has nevertheless occurred due to a government engineered slowdown in credit growth that began shortly after President Xi’s “re-election” in November. It is now being compounded by falling business confidence resulting from the unexpected threat of a trade war. With data now beginning to indicate that the slowdown is accelerating, the government has done an about-face this month by implementing aggressive new spending measures.

 

Ultimately, America’s well-being drives the economies of China and the rest of the world, not the other way around. However, we are in a mid-to-late cycle environment where:

1. The US Fed has been tightening for two years, and is about to hit full-stride in unwinding its balance sheet;
2. The massive benefits of US fiscal stimulus (tax cuts) will be cresting in the coming quarters, while the fiscal impact of them (sharply higher debt service) is just beginning to emerge;
3. Earnings growth is still strong, but the majority of US management teams are highlighting rising costs – from materials, labour or tariffs – as a likely drag on margins going forward; and,
4. Global growth is relying more and more on the above economy alone.

In the depths of summer, the financial implosion of a minor economy appears to have focused portfolio managers on these points and has caused some re-evaluation of risk positioning.

 

We are in this camp. The intent is to reinvest the proceeds either during a broad-market correction – perhaps during the traditionally volatile September / October period – or idiosyncratically if/when wish-list equities are affected by stock specific news. It is also a notable change from our tone through this summer, even as recently as the last update; but as John Maynard Keynes is purported to have said, “When the facts change, I change my mind – what do you do?”.