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The summer months for global capital markets, particularly the fortnight over mid-August are usually commensurate with low levels of investor activity, low trading volumes, low levels of volatility. We call it the lull of the summer months, where we can afford to have a day or two off from work, as pretty nothing much happens this time of the year. Foreign traders take their 2 weeks off during this period, and international investment managers take advantage of this by booking their summer holidays.
This year is different. We have said ‘this year is different’ many a times so far during 2018, and whilst we were hoping to have an uneventful summer, after geo-political tensions, trade wars, political instabilities, rising interest rates, you name it, have pretty much shaped up and characterised the better part of the year so far, the infamous trade wars have taken an unnecessary called twist. Not that trade wars were called for in the first place, but the twist we have witnessed on Friday and over the weekend, is a new ingredient to already turbulent diplomatic and trading relations between the US and other major global economies.
To date, US president has engaged in head-to-head spats with leaders of China, the EU and Russia amongst many others in relation to the trade wars the US is having with the rest of the world. We have all read about these trade wars, what they mean, but it is as yet cumbersome to quantify the global ramifications of these trade wars, with tariffs flying in from all directions left, right and centre.
But the new twist to the saga, or rather, the new ingredient to this already complex concoction of trade wars is Turkey, which was brought about primarily by a diplomatic feud over the arrest of an American pastor in Turkey. On Friday, US President Trump retaliated by imposing harsh tariffs on Turkey. The Turkish Lira plummeted, as did Turkish assets. Putting it mildly, markets have gone cold Turkey.
It is fair to say that Trump getting into loggerheads with his Turkish counterpart, Erdogan, has the makings of what could escalate into something deeper, as their leadership styles are, being politically correct, my-way-or-the-highway type. It is still early days to see whether either of the two will concede, and at what stage, but what is sure is that, in what is usually a quiet time for investment managers, investors have been reminded that things can turn rough pretty quickly. And whilst traders and asset managers are probably well into their summer vacation, the ones who remained in the office to fill in their shoes are left with a pretty daunting task on how to act in such a scenario.
It is important to point out that the implications in this case are more widespread than headline news indicate. Emerging market assets have sold off. The Turkish lira sold off. Turkish banks were the sectors which were worst hit, and we are aware that a number of key players in the European banking sector have large exposures to Turkey.
Asset managers ought to act rationally and calmly however in such circumstances, and not rush into taking decisions or exiting positions. Liquidity is thin. Spreads have clearly widened. And it would be extremely difficult to find market makers trying to place bids in what is an already fragile market. Exposures should be monitored thoroughly and adequate risk frameworks should be in place before such situations occur so as not to let the situation adversely impact investment portfolios should it all spiral out of control.
Whilst it is a tough investment decision for asset managers to hold on to high levels of cash when markets appear to be in a smooth/quiet transitory phase, it is precisely this exposure to cash which (1) serves as a buffer and dampens the impact of market movements during a sell-off and (2) provides the asset manager with the necessary arsenal to pounce on those beaten down assets which were unjustifiably beaten down. Let’s not forget – cash is a trade in itself, and this concept is quite easily overlooked.
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