Trade is the topic du jour, with Washington having set off an apparent chain reaction in its push to extract concessions from trading partners, whether it be China, its North American Free Trade Agreement peers, the EU, or more lately – Turkey.
The markets have clearly been unnerved by the Turkish situation, as evidenced by the tailspin of the lira, not to mention an unwelcome return of the word ‘contagion’ in the headlines. As any analyst will tell you, momentum tends to feed itself, particularly in an algorithmic age – all you need is a trigger. That said, it is important to step back and look at the bigger picture here. While the situation warrants attention, Turkey is not the proverbial canary for emerging markets (EM), but rather an isolated case with ‘pre-existing conditions’. Indeed, in some respects, it is nothing more than collateral damage, as an economy with relatively high US-dollar debt in the corporate sector, that is now experiencing the hangover after a prolonged period of economic growth, driven by unorthodox policy.
Volatility is likely to remain high over the next six months or so.
From an investor-sentiment perspective, Turkey has been in a vulnerable place for some time due to its current account deficit (dependence on fickle capital flows), inflationary pressures (increasing concern about central bank independence) and troubling political dynamics. In other words, the sucker punch of tariffs and sanctions is merely amplifying existing – and to some degree legitimate – nervousness. As other observers have pointed out, the attendant capital-market flight potentially serves to muddy the underlying causes of Turkey’s economic travails in the eyes of its people. It shifts the blame away from the economic policies of the Erdogan-administration, to footloose foreign investors.
Of course, China is a much bigger piece of the trade story – as the focal point of Washington’s ire. The rhetoric here seems to be ratcheted up on an almost daily basis, but the important thing to keep in mind is that the US buys far more from China than China does from the US – and therefore Beijing is far from defenceless. Lest anyone forget, China is still the US’ biggest foreign creditor. What’s more, it has had time to prepare for an eventual trade-war escalation, with pro-growth policies to boost the domestic economy and a clearly defined strategy of tariff and non-tariff responses to each stage of escalation from the US.
As for Washington’s actions boomeranging back on the US economy, we’re already seeing real pain, particularly in the agricultural sector, through lost sales and reduced profitability – which resulted in the US Department for Agriculture’s recently announced US$12 billion relief package for farmers, reportedly the largest ever offered by the US government on the back of a trade dispute! And, importantly a lot of this lost business is now going elsewhere. Brazilian and Argentine soybean producers, for example, are having a field day due to higher futures prices and increased sales to China. In fact, one of the very likely outcomes of this whole episode is a further acceleration of intra-EM trade, as well as stronger ties with other trading partners, including the EU. Beijing’s massively ambitious ‘One Belt, One Road’ infrastructure initiative is already providing increased speed – and reduced costs – of transport between China and Europe.
Keeping a cool head
The endgame of this saga isn’t straightforward to call, but we believe there’s a strong chance Trump will stop short of an all-out trade conflagration and declare victory (to his voter base) even if all of his goals haven’t been fully met – indeed, we got a glimpse of this following his meeting with European Commission chief Jean-Claude Juncker at the end of July. At any rate, long-term investors need to look beyond all the bluster, and while volatility is likely to remain high over the next six months or so, we are likely to treat any pullbacks as buying opportunities for EM equities.