The blame game

Much has been written about his authoritarian style, paranoid outbursts, attacks on the media, questioning of the independence of the central bank, going for vote-winning growth, weakening political institutions and appointing family members to government positions, but the Turkish president is not new to controversy. And he’s not the only one. Political risk is on the rise globally.

As David Jane outlined last week, there are a number of weaknesses to the Turkish economic model, especially in an environment of rising US rates. Nevertheless, a political weapon, in the form of US sanctions, was the trigger for the recent crisis.

Developments in Turkey have put paid to two contemporary assumptions. One, that politics isn’t relevant to financial markets anymore and, two, that contagion is something of the past. Both are emerging as resurgent risks, as we exit the risk-dampening period of QE, and both are very relevant to Turkey, and emerging markets generally. More precisely, the risk baton has been handed from central banks back to politicians, and rightly so, if you believe that power should be vested in elected bodies (a wider question perhaps).

But do politicians have the solution? For many years, disgruntled voters responded in a passive way, generally by not voting, but as new voting opportunities arose in the form of important referendums and new leadership styles, voters have felt more empowered. In this sense, there is a new energy to politics, but politicians have much to do.

In the more fragile emerging markets, there is a growing constraint to political progress due to the economic backdrop. In the more democratic countries, politicians are increasingly dogged by formal investigations (Trump in the US, the PT and the PSDB presidential candidates in Brazil) or internal tensions (the UK’s two main parties, the Italian coalition, the Indonesian ruling party, etc.), reflecting a disharmony and feeding a mistrust of politicians.

Generally, there are no signs of moving towards a more harmonious political environment. ‘Utopian’ Sweden has seen apparently coordinated attacks ahead of September elections, while the Italian bridge tragedy, far from pulling disparate groups closer, has led to heightened tensions within the coalition, and between the coalition and the EU. Maybe the passing of the US mid-term elections in November will see political tensions drop but, with few quick fixes out there for longer term issues like inequality, it looks like the blame game is here to stay.

We have written on the survival of the fittest being an increasingly dominant theme, with higher interest rates providing a less forgiving environment but, in addition, we are starting to see a more active sanctions policy from the US, which is more effective against ‘weaker’ countries. This policy, alongside escalating trade tensions, reflects the US flexing its economic, rather than military muscle. Importantly, it adds to the momentum for the survival of the fittest.

A question we frequently ask ourselves is what does this mean for markets? Well, they are scrambling to price political risk. Markets got Brexit and the US election wrong, both the outcome and the anticipated response from markets. Meanwhile, the consensus at the beginning of this year (based on a search through January’s emails) was that a soft Brexit would be the most likely outcome and that trade tensions would abate. So far, the reverse has happened. What all of these assumptions have in common is that the consensus has consistently backed the status quo, incorrectly.

Perhaps the lesson is that the market has been consistently behind the political curve but longer term history has taught us not to take conviction positions around political risk. Instead, we continue to back the stronger economies and companies. A big part of this is ensuring that they are not exposed via their debt levels.


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Source for information: Miton as at 21/08/2018 unless otherwise stated.

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