Turkey Signals Weakness In Emerging Markets
Turkey and the markets are revisiting 2014 since global synchronized economic growth has peaked and emerging markets are weakening. The stress in Turkey is only one example of the weakness.
If Turkey was the only catalyst of strife in emerging economies’ currency and equity markets, you would easily be able to profitably fade that trade.
Turkey is a small part of the emerging markets ETF. It is a tiny part of the global economy. However, I’m considering the thesis that Turkey is a symptom of greater weakness. Therefore, there are reasons to be concerned.
The emerging markets ETF is down 18.18% since its late January peak. Clearly that’s not all because of the recent crisis in Turkey.
China is seeing a resumption of growth deceleration and Brazil’s recent data is a mess because of the trucker strike. The strike caused the biggest decline in economic activity on record in May. Tetail sales weakend, and PMI contracted in June.
The good news is the strike is over.
The bad news is GDP growth is only supposed to be 1.7% in 2018. The October election will determine if GDP growth can accelerate to the 2.5% growth expected in 2019.
As you can see from the chart below, economic growth in emerging markets is expected to power 74% of global growth in 2018. Chinese growth is almost 3 times as important to global growth than American growth.
The point here is that if America outperforms the other advanced economies, it won’t prevent global growth from decelerating. Global growth in 2017 was 3.76%. While the estimate below is currently higher, it can easily change if results continue to miss estimates.
Turkey and the Global Economy - Is America Immune?
The saying used to be ‘when the American economy sneezes, the world economy catches a cold.’ In this expansion, there have been colds and flus in various international economies which America did not cause. American markets corrected, and the economy decelerated during these crises abroad. But there hasn’t been a recession yet.
The point I’m making is America hasn’t catalyzed weakness since the 2008 financial crisis roiled the global economy.
Since the global economy is interconnected via trade and markets, it’s tough to say where changes to growth start. For example, the strong dollar is helping to cause emerging market weakness. Is that because of American outperformance or international underperformance?
It’s difficult to determine, but it’s safe to say America hasn’t been the center of these crises’ outside of the debt ceiling debate. That was self inflicted and never had a chance of causing sustained damage.
Turkey Crisis - Remember, in 2012, we had the European debt crisis. And in 2016 emerging markets crashed.
As I mentioned, there were corrections during bouts of international weakness. The Turkish crisis is showing us that emerging market weakness could be the biggest risk factor the S&P 500 faces in the second half of the year.
The Brazilian elections aren’t making mainstream financial press headlines yet. As we get closer that will be the main risk emanating from emerging markets.
As you can see from the chart below, S&P 500 earnings and sales growth continued to be powered by international markets in Q2. S&P 500 firms with less than 50% of their sales in America have 7.2% more earnings growth .
They also have 4.9% more sales growth than those with more than 50% of their sales coming from America.
To be clear, American firms can grow international earnings even in a weak environment as technology firms are expanding their presence. However, earnings are still hurt by the strong dollar.
Turkey and Extremely Long US Expansion Wreaking Havoc On Emerging Markets
It’s always interesting to see the interplay in the global economy because each country is at a different stage in its cycle and some don’t follow one at all.
For example, Brazil is having a tough time recovering because of political instability. China is in a long term trend of deceleration, so the base line estimate is slower growth than the previous year. Europe and Japan are stymied by their demographics which is why we need to look at GDP growth on a per capita basis to understand their cycles.
The American economy is about to be in its longest expansion since the mid-1800s. Because America is so much further along in its cycle than other countries, the Fed is almost done with its rate hikes. That’s part of the reason the dollar is strong and emerging markets are weak.
I don’t see any evidence which suggests the declining Fed balance sheet is affecting markets, but the rate hikes certainly do. The tax cuts are supporting investment which is preventing the strong dollar and global economic weakness from affecting America. To be clear, synchronized global growth has gone from great to good.
We aren’t near a global recession.
Turkey Crisis as it Relates to Record U.S. Expansion (But Not The Longest In Global History)
The chart below gives you perspective on the current U.S. expansion. It’s tough to say when the economy will hit a wall based only on the length of the cycle. The U.S. economy was vastly different a few decades ago than it is now.
It could be fair to say the global economic cycles listed below have more relevance to the current situation than historical domestic ones. This defeats the argument that the cycle needs to end in one year, but it doesn’t guarantee it will last longer either.
I think the overhang of the fiscal stimulus and weakness in manufacturing could catalyze a recession in 2020. Focusing on the emerging markets is important. It helps us figure out if it will be added to the laundry list of negative factors facing U.S. equities and the economy in 2019 and 2020.
While global growth is still expected to be strong in 2018, the first step towards a recession is the end of synchronized growth and overall growth going from great to good. This Turkey crisis will likely be resolved; the ongoing weakness in China and Brazil are bigger factors affecting markets. There is more to emerging markets than weakness in the Turkish lira.
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