Market Week in Review

What’s driving the currency crisis in Turkey?

On the latest edition of Market Week in Review, Chief Investment Strategist Erik Ristuben and Sam Templeton, manager, global communications, discussed the recent strong performance in U.S. markets as well as the financial crisis engulfing Turkey.

S&P 500 tests all-time high as strong earnings power markets

U.S. markets have surged in recent weeks, Ristuben noted, with some of the major indexes nearing all-time highs set in January of this year. Case-in-point: the S&P 500® Index, which hit 2,863 on Aug. 7—flirting with its record close of 2,872 set on Jan. 26. Why the recent gains? In his mind, it all comes down to earnings.

“Over the past six months, it’s been a battle royal in the U.S. stock market between corporate earnings and valuations,” Ristuben said, “because while earnings have been very strong, U.S. stocks have also remained very expensive, in my opinion.” Because of this, Ristuben believes it’s taken the market awhile to process just how incredible quarterly earnings have been.

“What I believe we’re seeing now is the market realizing that, earnings-wise, things basically don’t get any better than this,” he said, emphasizing that the earnings growth seen so far this year—roughly 24% in both the first and second quarters—is virtually unprecedented this late in the market cycle.

The Turkish financial crisis: A contagion for global markets?

Turning to the financial turmoil unfolding in Turkey, Ristuben explained that over the past few years, the nation has been running a red-hot economy by borrowing money, leading to both a fiscal deficit and a current account deficit (i.e., importing more goods and services than it exports). One of the main problems with this, he said, is that a lot of the debt that Turkey has been issuing is U.S. dollar-denominated.

“Because of this, the market is now fundamentally becoming concerned about the country’s stability—and becoming incrementally unwilling to extend easy credit to Turkey,” he said, adding that this has resulted in tremendous downward pressure on the Turkish lira. So, is there a way out of this crisis for Turkey?

In Ristuben’s mind, there are three options for Turkish president Recep Tayyip Erdogan to weigh. The first, he said, is implementing capital controls—in other words, taking measures to prevent money from flowing out of the country. However, Ristuben doesn’t believe this is a viable option, because it would likely lead to a banking crisis (since Turkey finances most of its debt from foreign sources). The second option, Ristuben said, is for Erdogan to massively raise interest rates in order to control the plunge in the value of the lira. However, he noted that doing this would be economically painful for the country. The third option, from Ristuben’s vantage point, is to turn to the International Monetary Fund or another third-party for assistance.

All told, what’s happening in Turkey appears to be a classic emerging markets debt crisis, Ristuben said, not unlike ones that have wreaked havoc in other nations over the past several decades. Importantly for investors, however, Ristuben believes that the issue should remain relatively isolated to Turkey rather than rippling through the global marketplace. “We’ve seen this movie play out before, and very rarely does it turn into a contagion that spreads throughout the world,” he concluded.

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