It was another eventful week around the globe, with broad but uncertain implications for financial markets. Most notable is escalating financial and economic turmoil in Turkey, which feels at least a little similar to episodes sourced in Greece or Italy in the recent 8 years; the term “contagion” spiked in financial searches on Friday and again being discussed is the interconnectedness of global finance. Since the beginning of 2018, the Turkish Lira (currency) has lost -41% against the US dollar and inflation in the country hit 16% last month. The S&P skidded -0.74% on Friday, but finished the week down just -0.2% and remains firmly positive month-to-date. All told, major US indexes are managing to absorb the unexpected potholes in the road so far and remain in close proximity to the all-time high levels last observed in January; but these headlines may mean a firmer ceiling on attaining new highs is imposed. At the same time, international markets continue to be a significant drag on investors committed to the discipline of maintaining some international diversification.
Diving deeper, the situation of financial strain in Turkey merits attention, especially as it would seem many in the country pin at least some of the blame directly on shifting policies in the US (evidenced by headlines of citizens setting US dollars on fire). With significant outstanding debt in US dollars, the country is experiencing eye-popping inflation, while its currency and stock market are in apparent freefall. If that were not enough, Spanish, French, and Italian banks are the European institutions most concentrated holders of Turkish debt; recall those are the countries that on more than one occasion since the financial crisis in 2009 created fits of their own for unfavorable debt and financial conditions. Other emerging market countries with significant dollar-based debts also experience currency and stock market pain of late, arguably provoked by the strengthening of the US dollar in 2018. Here in the US, corporate earnings continue to support the view that our economy is robust. And with inflation still showing intermittent signs of upward drift, the US Fed cannot provide much help from abroad (in the form of pausing in its pace of hikes – this would in theory slow further USD strength). Nor does the Fed likely want to appear constrained by foreign liquidity concerns and indebtedness (issues they have no say in). At the same time, countries like Turkey who export metals have been the direct target of several stiff tariffs from the US recently, and there are few signs that trade-related frictions will ebb.
So what we are left with is a question some respected strategists (like Strategas Research Partners) are posing: is the strain situation in Turkey the “something” that breaks? Historically, the US Fed has tightened until something broke (a policy mistake), at which point the countdown began for the onset of a broader recession. So far, the market’s relatively restrained reaction to the situation unfolding with Turkey implies risks and exposure related to the situation are still perceived as manageable. Additionally, history reveals a few instances where crisis abroad did not spread to US soil. But uncomfortable memories and lessons provided by 2009 taught us that the financial system is better thought of as an interconnected web rather than perfectly isolated silos, even if by almost any measure the global financial system is much healthier than it was a decade ago. When looking at the US in isolation, it would appear that the US economy still retains the momentum and business & consumer confidence to progress upward – but our pursuit of de-risking client portfolios incrementally over the last 12 months looks of increasingly timely.