Friday, 25 May 2018

Tabloid Turkey.

My Tabloid-o-meter shot into the red this week on two matters - Oil and Turkey. I have had very successful runs in both over the last two years but with the amount of noise surrounding them, I have reversed my positions as both are likely to correct. However, I am going to leave oil for now and concentrate on the Turkish noise.

Watching the crowds form around the Turkish sell-off is like watching a fight break out in the school playground.

Two kids start shoving each other, a crowd gathers, others see the crowd and ask what’s going on, more join as the playground’s attention starts to get sucked in by the gravity of the situation. They are told by those who didn't know what was going on what is going on, but Chinese whispers are propagating the further out the crowd is from the epicentre. Teachers are called and kids start Facebooking the action. The media notice and a reporter arrives, then the TV crews (let’s stay this is a Beverly Hills school) and suddenly a 'school-fight expert' is on the screens. To fill time and tighten the tension he even suggests that the fight might spread to neighbouring schools as gang culture is rife. Watching this on TV, parents pull their kids out from all the local school. Why? they don’t really need the reason, just the fact that their darlings have the smallest chance of being hurt is enough. Meanwhile, an enterprising guy opens a book on the fight, offering odds. People who have no clue about the antagonists are betting on the outcome. Seeing there is money to be made, big online betting sites get involved. Adverts appear extolling how much money can be made betting on the fight and an old man with ‘The End is Nigh' on a placard is spotted wailing outside the school. He's interviewed on TV as an expert on the upcoming global destruction. Finally ‘Phyghtchain' is ICO’d. The crypto coin backed by the physics of fight. Ten minutes after it launches someone in the centre of the scrum notices that the two scrapping kids have vanished, having been called home for their tea.

Well, that’s what it feels like, and pretty much encapsulates the anatomy of the past few EM crises. If you had faded the noise you would have made a lot of money.

Turkey has been firmly at the centre of my geopolitical radar for years, but the failed coup and the onset of the Putinisation of Erdogan had me shorting Turkey faster than a butcher on Boxing Day (26th Dec, for my non-UK readers).

The concerns being that Turkey was going to be a massive problem in the overlap of every sector of global politics. Add this to the price of coffee in Bodrum cafes and it looked like an obvious short. Yes, I do use a bit of coffee PPP as an indicator for when a country moves from EM to DM, usually through UM (Upstart Market, where they think they can charge alpine prices for emerging levels of service) and Turkey went UM very quickly in the early naughties.

The problem with starting the ball rolling on shorting Turkey was the yield. Yield is like a hill in the road. To get over it you need enough momentum in underlying price to overcome the drag of yield gravity. if you are paying 10+% of your returns away hoping for a move that is greater than that to pay you off, in a world where if you manage to make 5% as a fund money manager you are a hero, you need a really strong belief that you are going to get a big move your way. And this is where momentum comes in. If you travel fast enough up that hill of price then you will make it successfully to the other side in profit. While things grind along slowly it may not be worth the risk.

Until the day comes when something triggers the tipping point and the yield is no longer enough to pay for the risk in price moves. This is what happened with Erdogan's policy announcement that high interest rates were bad and weren’t going to be used to defend the currency. Boom. Momentum meant that prices were moving far faster than the yield could compensate for. Who cares about 16% p/a interest costs when you are getting 5% moves in a day? As momentum explodes the relative return of carry is diminished.

Those long of the carry trade were underwater and the risk-reward was seriously changed. Japanese yield hunters were finally triggered out of their positions (normally the last out) and the resulting sharp moves were what sucked in media attention and anyone thinking there was a buck to be made. Why has everyone piled in? Well… Well, a good question to ask is why are you selling TRY now rather than selling it a year ago at much better levels? The answers I hear back are that ‘this time is different’. Deficits, Balance of Payments, screwed up policy, political isolation and a rising US dollar and global rates.

So which bits of that are new?

Deficits and BoP are cited every time there is an EM sell-off, but we know from experience that investors are tarts enough to be bought off by high yield once things stabilise.

The screwed up policy and political isolation - these are based on Erdogan and I concur it is a long-term mess, but the balance of monetary policy position has shifted with the 300bp rate hike on Wednesday. The political situation is a very good reason to be concerned in the long-term but it isn't anything new to us.

Rising US rate and a strong dollar - This generic EM wasp spray is brought out every time there is an EM crisis. As seen in 2014 and 2016 it never ends up killing EM. It is also important when reading articles on the amount of dollar debt out there, to consider who owns it. EM dependency on US-based lending is waning. If EM issue USD debt and buy USD debt then as rates rise, yes, the borrowers suffer but the lenders gain. Often it is the same countries or companies who are both long and short - most of it is intra-China. So whilst I agree that higher US rates and a stronger dollar don't help matters it certainly isn't responsible for the chaos.

QE unwind? Money was cheap and it was easy to park it in high yield. But the reduction in liquidity is reflected in rates and a move in rates is yield differential and though US rates may be 2% higher than last time, Turkish rates are higher still. It’s a great back-fit story but it isn't the trigger or the ‘now’.

So, as with an old wedding cake being recycled for the first christening, we have the old baked reasons to sell Turkey re-iced with some new ones.

Turkey is still a tinderbox and Erdogan’s positioning in the world will have to be resolved before we can see any long-term improvement but I do not see this event as THE blow-up. EM blow ups are more like dud fireworks. They explode in your face when you go back to wonder why they hadn’t gone off. Early 2014 may be a good case in point to follow. We had maximum noise before Turkey ended up as the best performing EM of the year.

I do not see Turkey acting as a catalyst for a contagious event. It is an easy sensationalist game to play and Ambrose Evans Pritchard is at it already, quoting the head of the IIFF  but the world is now smart enough not to clump all ‘EM’ into the one fund-box it used to.

With noise at such levels and every macro tourist flocking to Turkey, I have turned my shorts into Turkish longs looking for momentum to fade and the weight of the carry costs tied to the ankles of TRY shorts to drag them, spluttering, underwater.


Robert in Chicago said...

I have never traded Turkey and probably won't now either, but I love this post, just for the entertainment value and for the opportunity to appreciate a job very well done. All hail the King of Market Metaphors!

Polemic said...

Thank you, Robert. Much appreciated.

Al said...

Is the EU protectionist? Consider Turkey.

'Protection' or 'protectionist' is one of those words that can alternatively have a warm, fuzzy connotation and at others, a decidedly nasty or 'Trump-like' meaning to the common ear. In terms of the EU's relations and stalling with possible Turkey membership, for me it has warm, fuzzy connotations but, of course, that can engender the opposite feeling about me to those of a different persuasion.