Last updated on February 28, 2022
Dave Fishwick joins the podcast to make the argument for investing in the Turkish lira after it dropped half its value versus major currencies.
The appeal is not just the value but the carry, resulting in the equivalent of 30% to 40% annual interest income. To Fishwick and his team, the trade is not only contrarian but an example of the type of idiosyncratic idea that has no correlation to other parts of the portfolio.
The conversation is not limited to Turkey but expands to the U.S., China, and other emerging markets during the second half of the episode.
(This podcast was recorded in person at the iConnections conference in Miami. The acoustics were not ideal and there is some background noise as a result. Apologies for the inconvenience.)
Content Highlights
- The macroeconomic policy experiment in Turkey, where the country’s central bank took the highly unorthodox step of combating a sovereign crisis by reducing interest rates. The Turkish lira went into freefall as a result (2:24);
- The lira looks attractive on a real basis, but the real appeal comes in the so-called carry, an often-forgotten part of foreign exchange markets. How this works (3:29);
- Some background on the strategy by the Central Bank of the Republic of Turkey, which is on the surface frightening. But therein lies the appeal (5:22);
- Why buy the Turkish lira when the CBRT is cutting rates while the Fed is raising rates? (11:07);
- If the CBRT succeeds with this experiment, could other emerging market countries follow its example? The strategy is not unprecedented… (13:15);
- Background on the guest (16:19);
- Fishwick’s view on current markets. The market has re-rated asset classes, despite upbeat economic news (18:43);
- The present situation may appear bizarre, but it not without parallel. Why it’s hard to be bearish for the longer-term (21:48);
- Other areas of the world that are interesting for investors, especially contrarians (24:11);
- There are “some similarities” with what happened the last time the Fed entered on a sustained interest hiking campaign (2004 to 2007), but many differences. The key? Watch the inflation data, though the Fed’s record on engineering soft landings is poor (27:05).
More Information on the Guest
Transcript
Nathaniel E. Baker
Here with Dave Fishwick of MMG investment management, we are speaking live in person, the first in person interview, by the way, I’ve done it since COVID. So it’s been more than a couple of years, everything else has been over zoom. And I heard Dave speak here in Miami at the iConnections conference. And he raised a very interesting idea that caught my attention immediately for being contrarian. And I wanted to pin him down about this and ask him more about it. This idea is Turkey. So let’s start with this. Dave, tell me what it is about Turkey that you like. And then we’ll take it from there.
Dave Fishwick
So in Turkey, particularly over the kind of the latter stages of last year, but also, during the course of the year, there’s been something of a macro economic policy experiment, which is the reasonable convention as if you have an exchange rate crisis, a sovereign crisis, you raise interest rates, to try and hold that and improve the situation, the Turkish Central Bank, after several firings of the head by the president adopted an alternative approach was actually to reduce interest rates into this kind of led to the Turkish Lira going into pretty much freefall, against a lot of currencies. Now, this has been kind of interesting over a number of years. But the context for us in looking for these types of ideas, is there’s a lot of conventional things you can do playing in major markets, having some kind of informational edge or insight into that is, is pretty tricky. So we run a kind of macro portfolio, looking for idiosyncratic ideas that aren’t necessarily highly correlated with other positions we would have on in portfolios. So in Turkey, you’re talking about an exchange rate that kind of nearly halves, there’s an awful lot of understanding and knowledge about the problems that Turkey has high inflation, and a lack of credibility around policymaking. At the same time, though, with an exchange rate that looks pretty attractive, on a real exchange rate basis, you get paid somewhere between 30 and 40% per annum to own this thing. So the kind of the trade is essentially not necessarily saying we know better than the market does about inflation, and definitely the Turkish Lira is going to rise. But if it doesn’t go down an awful lot, you’re going to do pretty well. And again, relative to the kind of the obsession with the Fed, and is the s&p overvalued and so on, here’s an idea that is independent, no questions about Turkey.
Nathaniel E. Baker
Yeah, that’s why I like it so much. So you say, expressing this idea, you mean buying the Turkish Lira versus
Dave Fishwick
versus say, the euro, or the euro, you get paid, you know, the euro, obviously, interest rates are zero, but you’re getting paid when we put the trade on something like 35% per annum versus the euro. So again, over the course of last year, even with Turkish Lira weakness, relative to the euro, because you had that carry, actually you didn’t lose that much on the trade. So often in foreign exchange markets, people forget about carry. And in a world where most developed countries have zero interest rates, there isn’t any carry. But something like Turkey, you’re getting paid an awful lot of cabinet carry per annum to take this thought sort of thing on
Nathaniel E. Baker
interesting. And so the Turkish Lira has it has been kind of in freefall, I don’t even know what it is exactly.
Dave Fishwick
13.65 against the dollar. Yeah. So got 18 something before they announced a change in policy, which was about protecting lira, Turkish Lira deposit holders, kind of guaranteeing them that they wouldn’t lose money here.
Nathaniel E. Baker
Okay. Because one of the things they did I mean, they they cut interest rates, right. I mean, yeah. Which was, which is if you’re trying to strengthen your currency, that’s exactly opposite of what you
Dave Fishwick
Yeah, do. Right. So the whole thing is, is kind of based around Islam and the view about what interest rates mean. And so you have got an alternative view here. It’s going against the convention, where tend the tendency has been for emerging markets when the currency is weak, to raise interest rates to try and make it more attractive. Effectively, what they’re saying is, we want to let the Turkish Lira do what the Turkish Lira wants to do, and we’re going to set interest rates for the domestic agenda. Now that’s kind of red rag to the foreign exchange markets bull. And so it’s, it’s, you know, it’s a pretty frightening thing. I think importantly for us, that kind of it’s frightening piece is part of an integral part of our investment approach, which We’re looking for things that are a little scary. Yeah. Because we think that kind of behaviorally emotionally, investors demand to get overpaid in situations where they’re frightening. And I can tell you having had exposure to the thing as he was in freefall, it is pretty frightening. Yeah. So intuitively, you kind of think, yeah, I’m attracted to them, because I can understand why other people won’t do it. And I can understand why you get paid so much to take it off. Exactly.
Nathaniel E. Baker
no risk, no reward. What can you tell us about the geopolitical situation in Turkey? And how dangerous is that? How explosive is that? Could that worsen? And yeah, yeah, these
Dave Fishwick
these are kind of ever present. And again, I wouldn’t, you know, sitting in a London office, or sitting here in Miami, claim, I have some kind of information or edge or insight relative to that. So I just tend to concentrate on what the exchange rates done, the narrative about how risky and how dangerous it is, and that carry that I talked about that starting valuation. So there are risks associated with Turkish politics, or the geopolitics of Turkey’s position in the world. And again, kind of the policymaking framework and the experimental nature of that. So I think those are obvious risks. But again, it kind of goes back to your investment philosophy. You know, if there are obvious risks that people have rehearsed, and there’s a narrative around them, it’s not like you can get something from left field on there’s necessarily, it’s possible to be more bearish than than the market is, yeah, about these things. But it’s not like it’s a major, major surprise. Yeah. Right. And so the major surprise would be if things remain tricky. But actually, the exchange rate doesn’t really go anywhere, in which case, you’re picking up 3% per month.
Nathaniel E. Baker
That isn’t healthy carry. Now, how about the Turkish economy has been doing
Dave Fishwick
so ironically, I think that’s actually not doing too badly in a growth sense, where it’s got a problem is on the inflation side. So the inflation, courtesy of imported energy costs, but also, obviously, the exchange rate effect, the current rate of inflation is looking like it’s kind of in the 40s. So this is a problem for a longer term buy and hold on the Turkish Lira. Yeah, which is the real effective exchange rate is, is deteriorating the whole time because of that inflation differential. But at a time when US inflation, European inflation’s not zero anymore. Those kind of higher rates of inflation, which can come down and will naturally fall as we go through the course of this year due to base effects, whilst problematic needn’t necessarily be a major problem, because the exchange rate, the nominal exchange rate has fallen so far, that even with that higher inflation, the real effective exchange rate is actually looking still pretty cheap. But it’s not the sort of thing that are you want to sit there for three years holding this if the inflation doesn’t become a control.
Nathaniel E. Baker
Interesting. I’m curious about other other securities associated with Turkey. I mean, if you’re, you know, the, if you’re talking about the currency, the obvious other one would be the sovereign debt. Do you look at that?
Dave Fishwick
Yeah, we’ve looked at it. But I just in this case, it’s pretty clear that the nature of the risk you’re taking on is about the exchange. So historically, we took on Turkish sovereign debt in 2007. So we’ve been running the strategy for 20, odd years, in 2007, you had one of these exchange rate crises, and the two year bonds went up to yield north of 20% or so. So we have exploited these situations in the past, looking at the debt, also via the equity market. Sure. So where you often have these exchange rate issues, and then you raise interest rates, that hurts the P multiple on the Turkish equity market. So the banks and various other assets don’t enjoy that rising interest rates, this occasion has been difficult different, because as you said, they cut right now. So they actually the Turkish equity markets conferring reasonably well. So on this occasion, we’re just electing directly to play the exchange rate as it is. But you can play these things in other circumstances via their via the other asset classes as well. Obviously, you, you introduce more degrees of freedom and more various factors that can impact the outcome. So this is a very direct trade just about the exchange rate. If you’re introducing profits, risk economic risk via the equity market and the sovereign debt and inflation risk, then obviously, it’s a kind of slightly different element.
Nathaniel E. Baker
You mentioned before the Turkish central bank coming off of this loosening thing, where what is the current discount rate?
Dave Fishwick
So the interest rates are in the mid teens, okay? So not very high, but against an inflation rate of 35 40%. Plus, you know, you’re sitting on what look like deeply negative real rates, but they’re not alone there. So if you kind of think about the developed world, we have negative relative to the measured rate of annual inflation today, we have deeply negative real interest rates and one of the challenges intellectually we would say is, why would you want to buy the Turkish Lira They’re cutting rates in an environment in which the Feds raising rates and kind of caterers, paribus as an all other things being equal, that’s an entirely valid point. Sure. The issue is, what happened before has taken you to levels of valuation and extreme that mean, even if you’re in a world in which emerging markets in general, are pressured by rising US interest rates, we still think that Turkey can do well. But I can’t emphasize enough the main thesis is that carry it’s not a view that everything’s going to be fine in Turkey. It’s just the starting point is so good.
Nathaniel E. Baker
And currencies being so liquid you can get out of that trade at any time. Absolutely. Yeah. The sort case, but are they raising rates now? And
Dave Fishwick
no? Oh, so what they’ve done is to stop reducing, okay, it’s so interesting, when you kind of look at these currency crises, you see a gradual buildup of tension and pressure, then they made the announcement about removing the central bank governor. Oh, right. And then another central bank governor got removed as well. And then an ally of the President, and not a sympathizer with this experimental strategy was my governor. So then they cut interest rates more than the market expected them to. But now what they’ve said is they expect that the easing cycle maybe over Okay, now, that still leaves you with with negative rates. But clearly, the exchange rates behavior was causing some stress. So policy has been mildly adapted to reflect that kind of stress. Okay. But it’s it is highly unconventional, relative to the playbook that you see another. So again, South Africa, J raise rates, right, their exchange rates been a bit weak, inflation’s misbehaving slightly, nothing like turkey. And so the playbook has been stuck to in in large parts of the emerging world, not not in the case of Turkey. But the central bank is aware of the issue, and just doesn’t really believe that the kind of classical view about inflation management via interest rates is the right way to go. And we shall see. Yeah,
Nathaniel E. Baker
I wonder if they if they’re successful, if you see other, you’re going to see other emerging market countries try the same route.
Dave Fishwick
Yeah. So you can go back all the way to the Asian crisis, actually, you know, and I was working in Australia at the time, and their model. And so when the Asian crisis hit, the Australian dollar was weak, historically, the response to that would be to raise rates to try and defend it. But actually, they ease monetary policy into the Asian crisis. And the whole yield curve sat below that of the US. And the exchange rate to all of the heat and the previous worry have been, but that is the soft exchange rate, depreciating exchange rates, cause you elastic inflation problem, but in this case, because the Asian crisis was a deflation shock for Australia, you didn’t end up with the inflation. Okay, so the the challenge for the turkey situation is that they’re doing this against a backdrop in which you’ve got global supply constraints, and measured inflation and a lot of places is not doing this. It doesn’t feel like a deflationary shock. Yeah. So it’s going to be it’s going to be a pretty tasty path for them. So and again, so this is one of those trades that are uncomfortable, and you can see why other people don’t want to do that. But that’s where the the pricing is. That’s the attraction and the trade. Yeah. And challenge comes
Nathaniel E. Baker
opportunity. All right, Dave fishway, thanks so much for joining us. I want to take a quick break and come back and ask you some more questions about your background, and how you ended up at your current state of your career. But let’s first take a break. If you’re a premium subscriber, you do not get the break, don’t touch the dial. And to become a premium subscriber, you can go to the website, contrarian pod.substack.com. And sign up. We’ll be right back. I welcome back everybody here with Dave fishwick of MMG investment management, CIO of mg. Here in Miami speaking live. And Dave, you Yeah, this is a segment of the show where we ask our guests a little bit more about themselves, how they got to this stage of their career. I know you’ve been at NGO for a little while to me last year, LinkedIn. Yeah. Tell us about that. How you how you round up here.
Dave Fishwick
So So I joined the Prudential of the UK insurance company, largest insurance company in the UK back in the 1980s, directly from college, where I had done an economics degree and I was I got a job at the Prudential in a group of people doing macro strategies and was kind of asked to forecast European economies. And from that the group used those interpretations of the Outlook to think what that might mean for asset markets. So it was a relatively conventional first job instantaneously. I kind of thought, well, this is pretty daunting. My job is to be better at forecasting the German economy than the rest of the world’s conventional wisdom. And pretty quickly, it kind of dawned on me that this was this was really difficult to maintain any kind of systematic edging. So I’d actually then kind of developed our own thinking around what really happens in markets and whether it is all about economics or whether other dynamics, influence markets, and we kind of major a lot on emotions and behavioral psychology. And I spent time down in our Australian office. And due to the time difference had quite a lot of time to do some reading around the behavioral psychology stuff. And then that interested me. And then I going back to the UK in the late 90s. And we implemented a macro strategy that emphasized the the the emotional dynamics of markets, and, and which you can use in a lot of ways a lot of momentum strategies work on the basis of that. But we chose what was the kind of contrarian stand against bubble stand against silly busts in the sense type of strategy?
Nathaniel E. Baker
Hmm, that’s really fascinating. So this kind of begs the question what your views are then now because I mean, talk about the divorce between markets and economics. Right now, we’re in a situation here, certainly in the US where we have healthy economic growth, the economy’s in good shape, low unemployment. housing market is great. But the markets are kind of going a little nuts here. And it’s all presumably all because of the Fed and the Fed raising rates. But but this seems to be and you could argue that equities are overvalued, I know, you’re not necessarily an equities guy. But what is your view here on this on this disconnect that we’re seeing?
Dave Fishwick
So the reality is that, you know, the heart of everything that we try to do is a view about valuation in absolute terms, and relative terms. And what I would say is that the impact of the Fed and other central banks around the world taking cash rates to zero is that it’s allowed the valuation of everything else on the planet, to look good in relative space. So it’s a rationale that causes a rewriting of assets. So if you think about the s&p 500, it’s done well from two forces, one is entirely sustainable and real, which is tremendous profits growth, which sets the US hour apart from a lot of countries who have not had net profits growth. But what you’ve also had courtesy of the interest rate effects has been a fall in what investors would look at as the what rate of return do I need. So if interest rates are six, then the kind of 6% return on the equity isn’t enough to get you interested, when interest rates to zero, you can look at that and go Well, I don’t need as much return to justify buying the s&p as I used to. And so on the back of tremendously good profits, company news, and effectively a kind of risk situation associated with interest rates, that makes it assets attractive, you’ve seen the market rewrite, as well as get great news. Now, what’s happening now, ironically, for markets is sometimes good economic news can be bad for your valuation for your rating. So if the Fed funds rate were to rise to 300 basis points, all of a sudden that comparison of valuation of the equity market versus the cash has to adjust. So if I’m looking at the s&p Today, I’m kind of thinking it looks dangerously priced, not not not catastrophic. In the the economic news is good. But ironically, a continuation of good economic news is likely to cause interest rates to readjust. So as you think about it, and price earnings ratio space, the E gets good news, but the P E gets bad news. So effectively, the yield on the market must rise to reflect the improved rate of return available on cash. The same applies for the bonds. So the equities looked attractive relative to the bonds. But if the bonds have to reflect a higher interest rate regime, then that relative valuation argument no longer exists. So it’s harder work. There are parallels to this. So I remember 1994 Well, the Fed raised interest rates 3%. During that calendar year, the s&p had 40% profits growth, but when nowhere, it’s because effectively the valuation of the market had to adjust to those higher interest rates. And then after that, you’re set up for higher returns both on the cash and on the equity. Right. So you don’t you don’t have to tell a bearish negative story about the the US equity market to be a bit cautious about what might happen to as the valuation has to adjust. And the end story is you’re moving to an environment of prospectively higher return, but the market needs to weaken to create that situation.
Nathaniel E. Baker
What about if bonds become more attractive? I mean, already the two years now? I haven’t looked at it was 1.2, I think,
Dave Fishwick
yeah. And it was 505 or up to 165. So that that kind of pressures, yeah, the valuation on the s&p all other things being equal. If you ignore profits for a minute, the weight the price that you’re going to put on those profits has to adjust to the fact that the bonds are competing and now offer higher return. So the ratio, the price earnings ratio, the s&p has to adjust to that. The good news for America, the US in particular, which is less true in other other parts of the world, is that the EBIT? i What are companies are companies making money is looking tremendous. And so as a consequence, it’s hard to be too bearish in a sustained way, about about US equities that but there is a valuation adjustment that needs to occur, should the Fed funds rate go up? Yeah, now you can get bearish around if inflation turns out to be definitively not transitory, and causes a problem. And interest rates have to go up in a slightly more aggressive, chaotic way. In which case, then you’re talking about you need to slow the economy. And so equity markets historically have a problem when the central banks and the Fed is raising rates targeting slower growth to cool the inflation. And that kind of hurts the profits outlook. And so they’re both the valuation and your view of the economy, take a hit, and they can get a little bit messy. And if you throw in all the kind of emotional psychology stuff that I focus on, then you can see while you get some ugly See, huh,
Nathaniel E. Baker
very interesting. Wow. Okay. Thanks for explaining that. Is there other any other areas of the globe? That you you’ve you find interesting opportunities right now?
Dave Fishwick
Yes. So So interestingly, again, it’s very interesting being here in Miami for me because, understandably, investors, US investors, particular kind of US centric as entirely understandable. But right now, the second economy, biggest economy in the world, in China, they’re cutting interest rates, right. So it came in terms of is this a global phenomenon, it’s actually a kind of Western developed world phenomenon, where interest rates have been cut to zero need to rise. So the Chinese have been doing things to cool certain bubbles, and regulate the tech side and the housing side. And so you’ve got a very significant economic bloc, moving in the opposite direction, which is now you kind of easing up a bit and trying to encourage more activity. And parts of Asia have also been hit, and so on. So there are bits of the kind of global perspective and other areas of the world that I think offer some interesting opportunities. And I’d throw emerging markets into that as well.
Nathaniel E. Baker
Okay. Yeah, with any particular emerging rather than targeting some of the kind of commodity
Dave Fishwick
based areas. So Brazil’s had a bad time. Yeah. And again, there are some places where there are legitimate economic concerns, and it’s right to view them as risky. But you always have to kind of have a look at well, how much am I getting paid? Right? So the US is a great place, but you don’t get paid very much I’m invested in elsewhere, you get obvious and visible risks, you can go and get paid? Well, although
Nathaniel E. Baker
the Chinese government is cutting rated as a central bank, the PBOC is cutting rates and us is raising that’ll be an obvious trade there long us short RMB.
Dave Fishwick
Absolutely. You know, again, all other things being equal. The difficulty with this type of analysis is that the US is so meaningful for the world economy, that if the US has a good time, that often is as good if not better for some other countries in the world. So the Europeans will actually kind of be rejoicing about very strong US demand growth, because it helps them out a lot, of course, and you’ve seen this in the past, I mentioned 1994, it is possible to as the US tightens policy, but you’ve got very strong economic growth that helps out Europe sufficiently in that environment, the dollar didn’t go up, it actually went down, because the because this growth benefit was felt so significantly, in a shocking way over in Europe. And so actually, the Dollar weakened into that environment. Yeah,
Nathaniel E. Baker
essentially, you mentioned 94, which I was a little young to be paying attention to these things at the time, but remember, oh, six very well. 2006. Yeah, another year where the Fed was tightening, and another year where the economy was in very good shape, but the equities didn’t do much. Yeah. What happened after that, which was, oh, 708 and Oh, nine? Well, yeah, disaster, obviously have different housing markets and all that other leverage and stuff. Yeah. Is there no concern that the Fed does,
Dave Fishwick
there are some similarities to worry about? So he kind of, you know, the financial system associated with housing and leverage was, was as we found out an issue courtesy of the Fed kind of going after some inflation. So it’s a good example of what I said about the kind of potentially messy things so Ben Bernanke had taken over from Alan Greenspan. And they were raising rates effectively at every meeting by 25 basis points, and then inflation kind of misbehaved a bit. And they kind of got into a difficult situation where their credibility is under attack, if they were because they were looking for what they called a plateau. They’re trying to find what we think we’ve adjusted rates enough. Let’s see if we can stop here and then the inflation data misbehave, and you had what I would call an episode where the s&p was weak risk assets were weak. As Ben Bernanke he was forced into raising rates slightly more than you might want to do. The end answer was actually it was all kind of okay. Yeah. So there wasn’t an ongoing inflation problem. But there was a leverage housing problem, which then revealed itself in 2017 to 2008. But you can see how that can, you know, it’s a problem again, so if your monthly inflation data if your monthly employment data is kind of too strong for comfort, and questions of the speed at which the Feds doing things, life can get chaotic. And you can see why the emotions can end up running highs. So it’s a very tricky game to pull it off. And without without upsetting anything at all. Have they ever? I don’t think they ever had you know, they’re talking about engineering, soft landings, they always and never surprising markets. Well, to some extent, you have to kind of surprise mark. Now the economic system is permanently surprising. So the Fed just has to do what the Fed needs to right. And not worry about. Yeah, communicate. Yeah.
Nathaniel E. Baker
Gosh, it’s so interesting. Wow, what a crazy time. Cool day fishwick. Thank you so much for joining the contrarian investor podcast od today on such short notice here in Miami. In closing, maybe you want to tell our listeners how they can find out more about you more about the firm. Imagine you have a website.
Dave Fishwick
Yeah, so MMG has a website where we’re based in the UK and run a very wide range of assets. We have about $400 billion under management, a range of different products. But yeah, we have a an episode blog, which you can see online as well, where we’re kind of discussing many of these things such as Turkey and what’s going on in market. So should things get interesting anyone to look us up. You can have a look at that episode blog. Do you want to look at my colleague, Eric Lanigan, okay. He’s, uh, he’s been tweeting and as an author and writes lots of stuff about all of the stuff that I’ve been talking about. Very good.
Nathaniel E. Baker
Awesome. Dave Fishwick. Thank you again for joining us. Thank you all for listening. We look forward to speaking to you again next time. And that’s it for today. Thanks.