Malaysia, Turkey and the U.S. Underline Political Risk

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(Bloomberg) -- Calling early elections is always a gamble, no matter how strong an incumbent’s hold. The 92-year-old Mahathir Mohamad stunned the world by defeating his former protege, Prime Minister Najib Razak, in Wednesday’s landmark Malaysian vote, dealing another blow to complacent emerging-market investors who are licking their wounds from Argentina to Turkey.

As recently as two weeks ago, global investors saw Malaysia as the best growth story among emerging Southeast Asian markets, in large part because of Najib’s “stability rules” and his close ties with China.

Park that thesis. To make sure foreign (hot) money doesn’t just flee, Bank Negara Malaysia declared special post-election holidays for the rest of the week, shutting the onshore money, bond and stock markets.

Investors were caught off-guard elsewhere. In Turkey, even though political risk has been mounting steadily since November, they didn’t price in their concern until this month. The Turkish lira is now down 11.5 percent on the year, despite being among the cheapest emerging-market currencies.

Part of this is positioning. The dollar began the year weak, luring investors to emerging markets. As the U.S. currency rallied and Treasury yields rose, they had to reduce risk and rebalance to the benchmark.

In the past, when emerging markets tumbled, the U.S. partied. One could even argue that the 2013 taper tantrum helped trigger a multi-year bull run in the S&P 500 Index. 

That rotation isn’t happening now.

A case in point: S&P 500 companies delivered a stellar first-quarter earnings report card with an increase of almost 25 percent, beating already sky-high estimates of 18 percent at the start of the reporting season. Since April, however, the benchmark U.S. index has largely been range-bound, gaining just 2.2 percent.

Optimists could argue all of this is a buying opportunity — that even Argentina, which called on the International Monetary Fund again following the peso’s slide, is being treated unfairly. Its foreign exchange reserves are still higher than during the taper tantrum and the Great Financial Crisis.

But the fundamentals no longer matter much. Federal Reserve rate hikes aside, there’s just too much political kabuki. Why did Malaysia’s Najib and Turkey’s Recep Tayyip Erdogan call for early elections? Why is U.S. President Donald Trump pulling out of the Iran nuclear deal now? 

When investors are scared, they see the glass as half-empty. Are American firms’ best days over now that Trump has started a trade war with China? As for emerging markets, the quality of their new bonds has deteriorated.

So sit tight. It may be that the best we can hope for is range-bound trading. 

©2018 Bloomberg L.P.

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