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Market View:Turkey Is Cheap, but Too Early for Bottom Fishing #TurkeyEconomy

Market View:Turkey Is Cheap, but Too Early for Bottom Fishing <a class="hashtagger" href="">#TurkeyEconomy</a>

Not There Yet

“Uncertainty about potential negative future outcomes can cause stress and is a central feature of anxiety disorders. The stress and anxiety associated with uncertain situations may lead individuals to overestimate the frequency with which uncertain cues are followed by negative outcomes, an example of covariation bias. Using functional magnetic resonance imaging, we found that uncertainty-related expectations modulated neural responses to aversion. Insula and amygdala responses to aversive pictures were larger after an uncertain cue (that preceded aversive or neutral pictures) than a certain cue (that always preceded aversive pictures). Anticipatory anterior cingulate cortex (ACC) activity elicited by the cues was inversely associated with the insula and amygdala responses to aversive pictures following the cues. Nearly 75% of subjects overestimated the frequency of aversive pictures following uncertain cues, and ACC and insula activity predicted this uncertainty-related covariation bias”

-“Uncertainty during anticipation modulates neural responses to aversion in human insula and amygdala.” Sarinopoulos I, Grupe DW, Mackiewicz KL, Herrington JD, Lor M, Steege EE, Nitschke JB. Cereb Cortex. 2010;20:929–940.

Avoid group think

When it comes to markets, especially emerging markets please try to avoid “group think”. It is very important to know that the consensus thinks but sometimes it pays to be contrarian. Remember the start of the year when almost everyone was optimistic at much higher levels and valuations? That was then and after a lousy performance the general mood seems just the opposite now.

For the really long term fundamental investors there are already attractive opportunities such as Turkish sovereign external debt, which are a screaming long term buy, in my view.

But for investors’ who want to have a view on timing as well (the majority I guess), I think it may be too early to bottom fish eventhough I expect the positive mood to continue into next week and despite the potential for a “benign” NFP number today to result in a short term bounce in EM.

Year to date, Turkish assets have significantly underperformed peers. In 2019, I think I will become a bull again on some global risky assets. Turkish equities are likely to become star performers in EM next year but probably not for the reasons perma bulls have been preaching. I do not think we’re there yet. Not until the Fed blinks.

EM outlook still negative

For the time being, on global risk asset markets I’m quite negative and think the pressure we are seeing right now is well founded and likely to intensify possibly until the FOMC meeting in December. For US equities, at these levels, even a modest rise in volatility may be enough to trigger a positive feedback loop where rising volatility creates incentives to sell, leading to higher volatility, and in turn to more selling. I do not think DM will be isolated from the stress in EM.

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Thus, our strategy continues to be relatively straightforward and simple. Bu simple does not equal easy as we pretty much all operate in an environment of constant “news” bombardment. For example, a study from the McCombs School of Business suggests that our cognitive capacity is significantly reduced when our smartphone is within reach — even if it’s off!!! With so many “news” and some of them conflicting, making decisions is probably getting harder than ever.

What’s happening now is not surprising, not idiosyncratic and have been flagged well in advance. Despite the proliferation of quant trading, markets are still largely and/or over longer time frames driven by human emotions, which have not changed. There are so many similarities with prior cycles and many smart people have discussed these before.

If not now, then when?

Some call these cycles rotating bubbles. Plaza Accord leading to the Japan bubble…the S&L crisis leading to a binge borrowing in Latam, which was followed by the Tequila crisis in ’94 on the back of shocking Fed hikes. Asian crisis in ’98 followed by Russian default and LTCM rescue. An interesting aspect here is that liquidity starts flowing from the epicenter of the turbulence to what it perceives more attractive like late 1999-2000 Nasdaq bubble.

We have been seeing some shades of the same dynamic as suggested by the narrowing participation in the S&P 500 and Nasdaq, in my view. This also suggests that a final melt up is possible, eventough this is not my expectation for the next weeks.

The Fed is further tightening policy in response to domestic conditions, the ECB will not further expanding its asset purchases, the BoJ is increasingly emphasizing the negative side effects of its balance sheet expansion and the PBoC seems in a bind due to extreme leverage in formulating its policies and outlook for relations with the US, which suggests another CNH devaluation should not be ruled out.

Also read:  To Go Forward, Turkey Must Look Back #TurkeyEconomy

Also, the flattening of the US yield curve is likely to impact not only EM borrowers but a wider base, as the incentive for banks to lend decreases. Thus, the fact rising global funding costs have hit capital importing areas should hardly be surprising. This is especially important given the large stock of dollar borrowing by non-banks outside the United States, which has now reached $11.5 trillion according to the BIS.

Thus, I think the best thing that could happen to EM is a mega correction that forces the Fed to change policy but I as we have seen in February, a garden variety sell off will probably be not enough.

But there are also darker scenarios for the global economy out there. One has been described Agustín Carstens, (General Manager of BIS) on 25 August at Jackson Hole. Here are some selected excerpts from his remarks:

“Today, we must recognise the potential for real and financial risks to interact, to intensify and to amplify each other. Protectionism could set off a succession of negative consequences. If all the elements were to combine, we could face a perfect storm.”

“Consider that non-US banks provide the bulk of dollar-denominated letters of credit, which in turn account for more than 80% of this source of trade finance. The Great Financial Crisis highlighted the fragility of this setup, since non-US banks depend on wholesale markets to obtain dollars. Ten years on, we should not forget how the dramatic fall in trade finance in late 2008 played a key part in globalising the crisis. Any dollar shortage among non-US banks could cripple international trade.

On top of that, trade skirmishes can easily escalate into currency wars, although I hope that they will not. As we saw earlier with Mexico, imposing tariffs on imports tends to weaken the target country’s currency. The depreciation could then be construed as a currency “manipulation” that seemingly justifies further protectionist measures. If currency wars break out, countries may put financial markets off-limits to foreign investors or, on the other side, deliberately cut back foreign investment, politicising capital flows.”

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