NN IP sees Turkey contagion as limited but other concerns weigh on markets
Turkey’s economic problems and escalating tensions with the United States have dominated the headlines in recent days, causing a spike in risk aversion among investors globally and knocking confidence in emerging market (EM) assets. In the middle of this turmoil, NN Investment Partners (NN IP) has reduced its equity exposure to neutral. The Multi Asset team has also identified other factors than the Turkey crisis that may weigh on equity markets going forward, including a fading support from earnings momentum, weak sentiment, flow and technical indicators and other geopolitical risk factors like trade policy and the Italian budget discussion.
A key source of the rise in risk aversion was the European Central Bank (ECB), which highlighted the extent of several banks’ exposure to Turkey. Higher risk assets declined and spreads widen globally. The banking sector also clearly suffered on the ECB news. However, the sector’s exposure to Turkey remains limited to a few banks in Spain, Italy and France and it should be manageable.
But there are several other sources of concern for investors. A new bipartisan draft bill on Russia has been introduced in the US Congress, increasing the chances of a second round of sanctions that will be more draconian than the first. In addition, the risk of an escalating trade war between the US and China or Europe can pop up any time. The fact that we are getting closer to the US mid-term elections will make the outcome less predictable.
Further, equity markets are losing the tailwind they enjoyed by the better-than-expected second quarter results, especially in the US and Japan, while other geopolitical risks are still present: Budget discussions in Italy, escalation of the trade war, Iran sanctions and Brexit. The positive impulse from macro data has faded recently as the global economy has moved from an acceleration into a consolidation phase, although the absolute level of the data remains nevertheless at a healthy level.
NN IP has reduced risk in its multi-asset portfolios by downgrading equities from a medium overweight to neutral, although it keeps a small overweight to EM equities for the moment.
Ewout van Schaick, Head of Multi Asset at NN Investment Partners, explains: “Turkey’s balance-of-payments and credibility problems are not widespread in the rest of the emerging world. Argentina is the only country that also has large external imbalances, but here the government has a good reputation and has stepped up its macro adjustment efforts with the backing of the IMF.
“The rest of the emerging world is in a relatively good shape and not necessarily vulnerable to serious contagion from Turkey. Particularly relevant here is China, which has managed to reduce its financial system risk in the past years and that has just started to ease economic policies. Also, the depreciation of the renminbi, which caused some market nervousness in past months, seems to have stopped, taking away a negative factor for EM FX and could help all EM assets to recover in the coming months.
“Fundamentals for EMs broadly continue to be robust while repricing will allow for more appealing valuations to emerge. EM debt remains an attractive investment in the medium term. Tail risks have increased, however, and we are cautious in the short term given the escalation of risks in key EM economies.”
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