July 17, 2016

INSPIRING THE NEXT GENERATION OF LONG TERM INVESTORS AND WEALTH CREATORS

Turkey flies the coup

Turkey coup

View this email in your browser

July 17, 2016

Forward

TURKEY FLIES THE COUP

The S&P 500 reached a new all-time high this week, but after Friday’s sensational events in Turkey, it would be hard to start today’s letter anywhere else.

Just before market close Friday, reports began circulating of Turkish tanks entering the streets. Twitter, Facebook and YouTube were suddenly throttled. Soldiers set up roadblocks at major bridges and airports while fighter jets and military helicopters buzzed closer overhead, prompting initial speculation around a potential terror threat. However, it soon became clear that a coup d'état attempt was underway.

After reports of gunfire in the capitol of Ankara, military officials took control of a state-owned TV network and claimed to be in control of the government. However, Prime Minister Binali Yildirim insisted on another station that the coup attempt would soon be put down. Turkish President Recep Tayyip Erdoğan, on vacation in the south of Turkey, was forced to phone into CNN Turk via his iPhone’s FaceTime feature, urging citizens to take to the streets. The populace responded, swarming tanks and confronting gun-wielding soldiers, daring them to repeat the Tiananmen Square massacre live on Periscope and Facebook Live.

Within hours, it became apparent the uprising would likely be unsuccessful, although coup supporters continued to shell certain locations, including Turkish parliament during a live emergency session. While it appeared to have a significant number of sympathizers within the nation’s military, the coup was quickly denounced by all major political parties in Turkey, as well as all foreign governments including the United States. While Washington has been at odds with Erdogan’s increasingly authoritarian rule, surely it could not condone a non-democratic coup in a NATO country and risk destabilizing Europe’s only buffer to the Middle East proper. While Erdogan has increasingly invoked Islam as part of his autocratic rule, he is seen as occupying middle ground between the country’s feuding secular and religious factions. If it learned nothing over the last decade, the U.S. has accepted it is best to tolerate a tyrant rather than risk sparking a civil war, especially in the Middle East.

Erdogan eventually returned to Istanbul as the dying embers of the uprising were extinguished. Coup-supporting soldiers were arrested by civilian police. Total deaths reported as of Saturday afternoon reached 265, a mix of civilians, police and soldiers. Nearly 1,500 were reported injured.

Erdogan’s response to the coup, which he claimed included an assassination attempt, has been characteristically swift and uncompromising. Nearly 3,000 soldiers and military officials have been arrested so far, including the commander of Incirlik Air Base, which the U.S. uses to carry out airstrikes against Islamic State in Syria. More than 2,700 judges accused of having supported the coup have been removed from power. The President has pinned the blame on supporters of powerful opposition cleric Fethullah Gulen, who has lived in exile in the Pennsylvania Poconos since 1999. Gulen denounced the attempted coup, calling accusations of his involvement highly irresponsible.

Erdogan has for years suspected plots within the powerful Turkish military, which has the second largest standing army in NATO, to overthrow his rule. He has arrested hundreds of military officers during his 13 years in power, but now appears justified in his paranoia. Atop the tomb of Mustafa Kemal Atatürk, the founder of the Republic of Turkey, is a message to the military to forever protect Turkey’s tradition of secularism from religious extremists. Apparently a faction within the government felt the time had come to fight back against Erdogan’s increasingly oppressive rule. However, the uprising is likely to backfire, emboldening Erdogan to further crackdown on dissidence. Erdogan went so far as to label the coup a “gift from Allah,” prompting unfounded speculation that he orchestrated the uprising as cover for further silencing the opposition. Inevitably, Saturday brought the first accusations, from Turkey’s Secretary of Labor Süleyman Soylu, that “the U.S. is behind this coup."

The response in financial markets Friday afternoon was predictable, if not more muted than one might have expected. The Turkish Lira fell around 4% versus the dollar, while a U.S.-traded ETF tracking Turkish shares fell around 2.5% as markets closed. Long-term the coup attempt and subsequent political crackdowns in Turkey will add another dose of uncertainty to a region that can hardly tolerate it. Turkey had recently become a more willing partner in U.S.-led offensives against the Islamic State, which is losing significant ground in Iraq. Turkey had agreed to accept a larger influx of Syrian immigrants as part of its flirtation with membership in the European Union. Erdogan’s government had even recently begun to reconcile its differences with leadership in Russia, Syria and Israel. Now, the Turkish regime is likely to cast a more skeptical eye toward the United States and its Western allies, harming a fragile cooperation that was the developed world’s best hope of resolving the disastrous state of the Middle East.

The coup’s failure was likely the short-term outcome for financial markets. The question now is just how ruthless Erdogan’s retribution will be. He has two ways forward: 1) build consensus with opposition parties on a new constitution, or 2) call snap elections, which would almost surely produce a resounding victory for his AKP party that would serve as a powerful mandate to further consolidate power. Political experts believe the latter route is more likely, with distrust between the Muslim and Western worlds continuing to grow. Further geopolitical discord can hardly be seen as having a stabilizing effect on the global economy.

Forward

U.K. COMMERCIAL PROPERTY FOR SALE

Last week we focused on troubling redemption halts in U.K. property funds in the aftermath of the Brexit referendum. While not necessarily being harbingers of another global financial crisis, the developments were at the very least symptomatic of a distorted risk-taking and liquidity environment. The worry was that if investors maintained a desire to raise cash despite markdowns, it could cause forced selling within the U.K. property market that would add further pressure onto a fragile banking system. Well, it took less than a week for those forced sales to begin taking place.

On Monday, a frozen Aberdeen Asset Management fund reportedly hired a broker to sell $136 million London office building, 10 Hammersmith Grove. On Wednesday, Standard Life and Legal & General joined the property fund sales rush , offering multiple buildings for sale in order to rebuild liquidity positions.

MSCI conducted a full study on what the Brexit may mean for the London property market. They found London’s office market has about 30% exposure to non-domestic tenants “who might decamp completely or shift some of their workers to Ireland or the Continent.” However, it believes the reduction in cost of London commercial operations created by the sudden depreciation of the pound may lessen the incentive to relocate.

The ultra-low interest rate environment around the world has boosted once again the attractiveness of real estate investments , raising the possibility of another bubble. The good news, however, is that while British banks have more than 65 billion pounds ($84 billion) of exposure to domestic commercial real estate, post-crisis efforts to strengthen balance sheets and retrench from commercial property markets may prevent systemic destabilizing impairments within the financial sector.

Forward

BANK OF ENGLAND'S (BOE) SURPRISE INACTION

The U.K. finally found someone interested in leading the country through the tenuous post-Brexit period. Pro-Remain Tory MP Theresa May was tapped by her party to become the second female Prime Minister in British history after her top challenger, the pro-Leave Andrea Leadsom, bowed out of the race in the name of national unity. Although May supported the campaign to remain in the E.U., she is seen as being flexible and pragmatic enough to effectively negotiate the kingdom’s departure from the bloc.

News of her appointment sent both British stocks and the pound soaring, with the FTSE 100 technically entering a bull market after rallying 20% off its post-Brexit lows. While the pound staged its first meaningful bounce since the Brexit vote, the currency remains at multi-decade low, prompting opportunistic dealmakers to see once-in-a-generation M&A opportunities in the U.K.

Adding significant fuel to the pound’s turnaround was the Bank of England’s (BOE) surprise decision not to raise interest rates at its July meeting. Amid the post-Brexit turmoil, BOE governor Mark Carney took the unusual step of explicitly promising stimulus. By the time the meeting rolled around, futures markets had priced in an 80% probability of a hike. However, in an 8 to 1 vote, the BOE’s rate setting committee decided to keep rates unchanged at 0.5%. While central banks rarely express currency-driven motivations for monetary policy decisions, it would be hard not to see the BOE’s inaction as driven by worries over the pound’s swift collapse. And with initial Brexit shocks subsiding and the new government indicating no hurry to trigger Article 50, Carney retains flexibility on future policy. The BOE maintained a dovish tone in the release by indicating the strong possibility of a rate cut at the August meeting.

Forward

ITALY MOVES CLOSER TO REFERENDUM

In last week’s letter we also talked about urgent concerns over Italian banks in the wake of Brexit. E.U. anti-bailout rules prevent the government from giving the financial system a much-needed cash injection , and the Italian people aren’t happy about it. Anti-establishment candidates in Italy’s nationalist Five Star Movement swept to surprise mayoral election victories in Rome and Turin in late June. With the country’s lawmaking body paralyzed as the result of an archaic political system, Prime Minister Matteo Renzi pledged two years ago to revise Italy’s constitution. Brexit only added a bit of urgency to that process, with Renzi saying Italy’s referendum on a new constitution will take place on either October 30 ^th or November 6 ^th. If the referendum fails, he has said he will step down as Prime Minister, paving the way for new leadership to potentially seek an “Italeave” or “Quitaly” vote.

Swirling winds of change in the E.U.’s fourth-largest economy is the next brick in Europe’s tall wall of worry, but it’s far from the only concern. The Portugese and Spanish banking systems desperately need a bailout. On Tuesday, a vote of the European Council found that governments in Portugal and Spain did not try hard enough to get their deficits below 3% of GDP, which could prompt the first-ever E.U. fines over deficit levels. The decision to fine any European country in the current economic climate would be ill-advised . If European banks continue down this road, Germany may be forced to reluctantly lead a continent-wide effort to recapitalize the banking system. And while they’re re-writing the rules, why not address immigration standards in such a way that would prevent the U.K. from leaving and slow the rise of Marine Le Pen’s National Front party in France?

While the E.U. contemplates its future, yields on 10-year government bonds in Germany and the Netherlands entered the negative-rate club for the first time ever.

Forward

Link

FINANCIAL SECTOR POTPOURRI

If an economic crisis happens, but nobody acknowledges it, does it really make a sound at all? Leading up to the Brexit referendum, global banks warned that if the U.K. voted to leave the E.U. they would likely be forced to locate many jobs to E.U. countries. The people voted to leave, so banks have made no secret of the fact they’re preparing contingencies to move jobs to the continent. According to the U.K. Treasury, those public pronouncements are “not helpful.” U.K. officials are apparently pressing JPMorgan and other banks with U.K.-based operations not to speak about potential job losses . Last week they were forced to sign a half-hearted, non-binding statement of intent saying they would try to keep jobs in London, but exchequer officials believe its tone was not optimistic enough. The banks don’t much seem to care, with UBS investment bank chief Andrea Orcel telling Bloomberg Tuesday that “most probably we would need to consider moving a … significant percentage of its 5,000-strong London workforce” to an E.U. country.

Speaking of the banks, JPMorgan (JPM), Citigroup (C) and Wells Fargo (WFC) kicked off earnings season this week. JPMorgan posted stronger-than-expected results on an increase in trading revenue and reduction in costs, causing shares to initially rally more than 2.5%. Citi shares rose by a similar margin after its earnings topped estimates . Wells Fargo (WFC) was not so fortunate , its shares falling modestly after in-line earnings as its steady lending-driven business model was more significantly impacted by low net interest margins.

JPMorgan CEO Jamie Dimon announced his firm’s decision to give its lowest-paid employees, bank tellers and administrative staff, a raise in a New York Times op-ed . Starbucks CEO Howard Schultz, in a letter to employees Monday, announced his company would do the same . Both expressed a desire to do their part in combatting income inequality, but economists suggest there might be a more business-oriented motivation. As a labor market tightens, demand for competent low-skilled workers often exceeds supply. In the case of JPMorgan, greater automation had led to a smaller labor force at bank branches, putting greater productivity demands on its workforce. If it wanted to maintain a strong customer service experience, the company likely had little choice but to entice its workers with a higher wage.

When pieces of major financial regulation are passed, banks usually get years to comply. The Volcker Rule was passed in 2010, leading most of Wall Street to make preparations for the new reality by beginning a gradual exit from proprietary trading operations. However, some firms decided to hold onto lucrative operations for as long as possible, hoping the additional extraction of revenue would outweigh any losses created by hasty selling. U.S. banks got a one-year extension last week to comply with a Volcker Rule ban on investing in private equity and hedge funds, but Goldman Sachs and Morgan Stanley still face the tall task of exiting billions of dollars worth of positions without getting ripped off.

When CalPERs announced its decision to dump its entire hedge fund portfolio in late 2014, it was supposed to be a death knell for the industry. When several other large pension funds followed suit, the narrative went that the hedge fund model would surely bleed out. But while performance has been lackluster in the last 18 months, it appears the industry’s death has been greatly exaggerated.

New data out this week shows the appetite for hedge funds remains as healthy as ever . Pension fund allocations to hedge funds increased 4% year-over-year, with the top 10 biggest institutional investors increasing their exposure to the asset class by 10%, or $183 billion. A pan-European survey of 116 institutional investors conducted by Dutch firm NN Investment Partners in March also found 52% of respondents said they favored investing in hedge funds over the next six to 12 months. While hedge funds aren’t for everyone, on the whole institutional investors appear to value the diversifying and risk management properties of well-built alternatives allocations.

Forward

Link

CHINA'S TOUGH WEEK

It wasn’t a great week for China. The government’s belligerent South China Sea claims were rejected by a Hague tribunal , although Beijing refused to accept the legitimacy of the ruling . It’s refusal to abide by international law puts the communist power at odds with the United States at a time when it is demanding monetary policy coordination to help with a soft landing. China’s Q2 GDP held steady thanks to record stimulus, but the government’s stimulus efforts are producing diminishing returns . Also, China is responding to rising defaults among zombie companies by simply ignoring them.

Forward

HERBALIFE'S $200 MILLION PYRAMID

Herbalife reached a deal with the FTC preventing it from being labeled a pyramid scheme, causing the stock to rally nearly 20%. But while the company’s business model is allowed to go by any other name, the settlement wasn’t as sweet. In addition to paying a $200 million fine, Herbalife will be forced to overhaul its marketing efforts. The company will be forced to stop misrepresenting how much its members are likely to make, while distributors will no longer be rewarded primarily for recruiting rather than sales. The stock is up nearly 70% since Bill Ackman famously announced his short position, but he said he will remain short as the new “fundamental structural changes will cause the pyramid to collapse.” Carl Icahn, meanwhile, took a victory lap on the other side of the trade, with Herbalife rewarding his PR contributions by raising his ownership limit from 25% to 35%. Right now he owns around 18% of the company.

Forward

IMAGE OF THE WEEK

Turkish soldiers lay down their arms after unsuccessful coup attempt. (Gokhan Tan/Getty Images)

Forward

QUOTE OF THE WEEK

"I still believe, and more strongly than ever, that we're looking at a long-term bottoming process in interest rates here."

- Jeffrey Gundlach this week on a DoubleLine client conference call

Forward

FURTHER READING

Former Port Authority Chairman and current RNC finance committee chairman Lew Eisenberg talks economy, election on “Wall Street Week.”

Forward

Buybacks pump up the stock rally , but there’s no need to fear the buyback-boosted stock market.

Japanese messaging app Line (LINE) rises in IPO , offering hope for a skittish tech industry, but unicorn valuations are nearing a reckoning .

Nintendo adds $7 billion to market cap on PokemonGO success.

Fresh from a record default, Puerto Rico plots bond-market return .

U.S. data point to stronger economy .

Low interest rates are dooming financial companies to a slow death .

Behind the bond-stock disconnect is a big and risky bet on the central bank safety net .

Forward

SkyBrief is for general information purposes only and is not intended to provide investing, accounting, tax or legal advice and should not be relied upon. You should consult your own investment, legal and/or tax professionals regarding your specific situation. Under no circumstances should any SkyBrief material be used or considered as an offer to sell or a solicitation of any offer to buy securities or any other instruments or interests, whether or not sponsored or managed by SkyBridge. Any such offer or solicitation can and will be made only by means of a prospectus or explanatory memorandum of each such investment or other applicable document, only in jurisdictions in which such an offer would be lawful and only to individuals who meet all application investor suitability and sophistication requirements.

UNSUBSCRIBE

Learn more about SkyBridge

Website

YouTube

Copyright © 2016 SkyBridge Insights, All rights reserved.

You are receiving this email because you opted in at our website.

Our mailing address is:
SkyBridge Insights
527 Madison Ave
21st Floor
New York, NY 10022
Add us to your address book

Want to change how you receive these emails?
You can update your preferences or unsubscribe from this list

http://us10.campaign-archive.com/?u=7b1ee360b7c4521c3dae8caed&id=ccf820b3ef