A warning from Turkey for emerging-market investors

published 18 July 2016

160718-turkey-b — Investors in emerging markets need to be keenly aware of politics

The big news over the weekend was an attempted coup in Turkey.

It seems to have been quashed, with President Recip Tayyip Erdogan now launching a crackdown on the military and the judiciary.

But what does it mean for the wider market?

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This is not a cathartic moment

I don't know a great deal about Turkey. My very basic understanding is that there have been a number of military coups over the long term and that they've usually been designed to protect secularism in the country. The last such (successful) coup was in 1980.

This one seems to have come out of nowhere, inasmuch as no one seemed to be expecting it. It's been stopped, but it's not clear what the outcome will be.

And Erdogan is the kind of leader increasingly authoritarian, a bit unpredictable, prone to the odd erratic comment, apparently now thinking of bringing back the death penalty, uses the word "cleanse" in relation to human beings that makes most people nervous.

In short, this is a process of potentially increasing instability, rather than a cathartic moment. And that's likely to be bad news for investment in Turkey.

What you have to watch out for in emerging markets

But they're diversified they're spread around a lot between different countries. And Turkey shows why.

Every emerging market, bar none, can be made to sound "sexy". They are the ultimate "story" stocks. China probably exemplifies this better than anywhere else.

The classic China story of the early noughties went something like this: "China has 1.3 billion people. What if they all bought fridges?"

That's your emerging market story in a nutshell. "What if all of the people living in this country managed to attain a standard of living comparable to that of someone living in America or Europe?" That's the basic bull case for investing in an emerging market the hope that one day it'll be a developed market.

In the 1990s, around about the time that Francis Fukuyama was prattling on about the "end of history", and it seemed that everyone had woken up to the idea that democracy and capitalism were the way to go, that hope seemed like a sure thing.

Just as the euro forced the convergence of eurozone bond yields because everyone would one day surely be Germany so emerging markets steamed ahead as one country after another discovered that capitalism works.

Yet, of course, it's not as simple as that. Political change is hard. And it doesn't move in only one direction. Countries can easily fall from grace. Argentina is one of the most infamous cases of a country that went from being hugely rich, its capital known as "the Paris of the southern hemisphere", to being one of the world's ultimate basket case economies.

That said, once it looks as though the political side of things is going in the right direction towards more freedom, more respect for property rights, less corruption markets can bounce back remarkably (almost naively) quickly.

If you need any convincing, just look at how rapidly Argentina has been welcomed back to the fold of mainstream markets. Other markets in South America have been doing well too, as they vote in market-friendly, anti-corruption candidates as leaders.

For me, the biggest point that investors can take from this is that while it's easy to dismiss governance in developed markets though perhaps not for much longer you have to watch politics in emerging markets like a hawk.

So it's all about the governance or at least, a large part of it is. And that's why a bet on Turkey right now looks very much like that a bet. It's not at all clear what will happen next, and nor is it at all clear that the country is going in the right direction under Erdogan.

The tricky thing for Turkey is that it needs to attract foreign capital it's one of the top three emerging-market debtors. If the lira continues to fall, that'll make life very difficult for the Turkish central bank and also potentially inspire further capital flight.

As far as the economy goes specifically, tourist numbers were already down heavily following recent terrorist attacks. The attempted coup will not help matters. This is not the sort of environment that attracts foreign money. "From an investor's perspective, Turkey looks more and more like a political basket case", as Dani Rodrik at Harvard told the FT.

Turkish stocks had been beating wider emerging markets this year up around 15% compared to 11% for the MSCI emerging market index. I doubt that will continue, and I'd be waiting for more clarity before I considered investing there.

John Stepek is a senior reporter at Bloomberg News and a former editor of MoneyWeek magazine. He graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.