Political kabuki? Markets don't care

Although yesterday's market action was relatively uninspiring ( US equity volume was some 20% below its 4 week moving average), Monday nevertheless yielded fascinating insights into how the forces of autocracy can sweep away institutions in even apparently flourishing democracies.   But enough about the kabuki theater of the Republican convention...what about those purges in Turkey?

While the speed and scale of the Turkish round-up certainly suggests that the list of detainees was not completely drawn up from scratch, most markets simply couldn't give a tinker's damn about what is now apparently seen as an idiosyncratic, one-off event in a non-core country (economically, at least.)  After all, when Softbank starts throwing around cash like a sailor on shore leave (or at the very least, a corporation whose home currency has appreciated like Billy-O), there are bigger fish to fry.

While the Softbank/Arm deal would certainly appear to confirm that not everyone is running from the UK like the plague, by the same token it's hard to say that selling off national champions at knockdown international prices is really a sign of strength.  In any event, given that it's to be an all cash deal to the tune of 24 billion quid, one might reasonably express surprise that  GBP/JPY didn't rally harder on the day.


Taking a step back, it's remarkable, really, that something like the VIX is back to where it was a year ago despite what could easily be construed as a laundry list of potential risks.   In addition to those cited in the "5 bricks" post a couple of weeks ago, we can add to the list the instability in Turkey, yet another apparent terrorist attack (this time on a German train), and a US presidential election with quite possibly the worst slate of candidates in history.


Maybe that's just it though.   There is so much potential turbulence out there that large investors are being overly cautious...which perhaps explains the widespread underperformance of both long-only (vs benchmarks) and hedge fund (vs cash) investors across a range of disciplines.   Sure, the "boy plunger" approach of buying every sell-off that's barely large enough to call a dip has worked....kind of.  But naturally, that's no way to run an institutional portfolio and it's no way to make money over meaningful periods of time.

So here we are, with nearly enough bricks to build a wall of worry to the sky, the global political situation possibly the most depressing it's been in seventy years, and few investment professionals generating much if any alpha.  Oh, and we're entering one of the least liquid periods of the year.

It seems a natural environment to tread softly and pick one's spots carefully.  There are likely to be opportunities at some point, and it would be good to be in a position to take advantage of them.
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checkmate
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July 19, 2016 at 8:31 AM ×

Desks manned by 12 yr old HFM's seasonality factors in play. Pop and crash equally available for the weeks ahead.

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checkmate
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July 19, 2016 at 8:32 AM ×

Sometimes you have to let the children play.

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Unknown
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July 19, 2016 at 9:40 AM ×

Perhaps one reason for GBPJPY not rallying harder could be that Softbank had already bought all the GBP for the deal in the run up to the announcement.

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Anonymous
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July 19, 2016 at 11:59 AM ×

DId Erdogna remove the head of CB? We will see in a few seconds.

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Bruce in Tennessee
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July 19, 2016 at 12:35 PM ×

"Monday nevertheless yielded fascinating insights into how the forces of autocracy can sweep away institutions in even apparently flourishing democracies."

Oh? 8 years of executive orders decimating the coal industry, creating Solyndras, empowering a Fed that is clueless and has sacrificed the common man for the elite, massive sovereign debt...and this isn't an autocracy?

Probably should stick to economic comments, MM.

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checkmate
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July 19, 2016 at 12:50 PM ×

The distinction between 'Autocracy' and 'Democracy'.
Do you get screwed by one man as opposed to a collective. Colour me cynical.

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Macro Man
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July 19, 2016 at 1:02 PM ×

BinT, The funny thing is that you're the one that does the writing, you're the one that decides what you want to write about. The amusing thing about American political debates is that adherents of neither side can recognize how shit they are, and nobody has a sense of humour....

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abee crombie
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July 19, 2016 at 1:18 PM ×

Meanwhile Europe paused right at 150 day. Cant buy a bid. EEM however looks to be breaking out.

From DZ last week

Now just to be clear, I have always believed that aggressively accommodative unconventional monetary policy was the right prescription for the US economy from 2008–2014 (and I argued many times that it should have been far more aggressive in the early stages). When the economy enters a state like 2008–2009, some serious medicine is in order. With an unemployment rate of 10, 9, 8, or even 7 percent, along with little evidence of future inflation risks, aggressive treatment is in order. That is a time for coddling, not for tough love. But as we approach 5 percent unemployment rates (and below), the mission has largely been accomplished. The game no longer requires the reviving of broken animal spirits. And if we keep pushing, as seems to be happening, the game will devolve - and animal spirits will rise to the point of frenzy. With many trophies on their shelves, players begin to believe they can't possibly lose. So they start to do stupid things.

Honestly, I fear we are now entering a phase that looks a lot like the late ’90s. To be sure, I always thought this monetary policy experiment would lead to a ’90s rather than a ’70s outcome (recall my old “stocks are for lovers, gold is for haters” mantra from many years ago). But now we are coming to the late ’90s part of the playbook. We just had our 1998-style EM and commodity crisis. And the Fed has responded with much easier policy - even in the face of a strong US economy. Of course the Fed didn't cut rates three times as was done in Q4 1998. But they basically took the three rate hikes that were priced in from the beginning of 2016 and whisked them away - the same diff in my opinion. The basic storyline is that the Fed, as in 1997–1998, has been setting policy for a while now in order to backstop non-domestic headwinds — Greece, China, and now the UK. In my opinion, these "crises" are the modern day equivalent of the 1997–1998 events in South East Asia and Russia.

In sum, I now see us in a time very much like the post-1998 period. EM has been beaten down but is now backstopped by the Fed. And US risk assets are bubbling up because this backstop is inappropriate for the US economy. However, I should add at least one caveat to this comparison. The rise of anti-globalization and populism was not part of the late ’90s/early ’00s storyline. With that added wrinkle I am much less excited about the magnitude of any bubbling up in US risk assets. Instead, I think the post 1998 EM trade bounce trade looks far more interesting. Furthermore, the risks with populism are generally moving in the right direction for EM economies.

In many ways I think about the late ’90s trading analogy like this. In early ’99, after the EM dust settled, the Nasdaq was 2000, and the Russia 12.75 6/28s were being offered at seven cents on the dollar. The "committee to save world" sent the Nasdaq to 5000 as developed market animal spirits went loco!!! But those guys backstopped EM. Within 2 years the Nasdaq was below 2000 again!! And of course the Russia 28s moonshot to a 175 dollar price by 2003 and never looked back - paying you a 12.75% coupon every year! Now, I know EM is not that distressed, but there are double-digit annual yields all over LATAM as well as Russia. And the backstop is in. I am happily heading over to the EM world and away from the mania stage developing in US risk assets. I don't need any Yellen-Bernanke participation trophies on my shelf. Good luck trading.

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Anonymous
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July 19, 2016 at 1:27 PM ×

"Melania Trump Plagiarizes Michelle Obama"

http://bluevirginia.us/2016/07/tuesday-news-20

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washedup
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July 19, 2016 at 2:12 PM ×

@abee - I get the analogy to the late 90's and have thought about it a lot in the last couple of years - bottomline, EMs are more leveraged now, and a much bigger part of the global economy than they were in the late 90's, so the impact of a rising dollar would be a lot more problematic compared to then. I think to match the global financial conditions of late 90's period we would need a weak US and a strong EM to keep the dollar suppressed - possible, but thats a bit of a change from the meme of the last couple of years. Also, what does DZ mean by 'the risks with populism are moving in the right direction for EM economies'?

More than anything I feel like this is a market looking for a narrative rather than the other way around.

@MM/Left any thoughts on the late 90's comparison?

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Macro Man
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July 19, 2016 at 2:25 PM ×

Exactly 17 years ago, Bund yields closed at 4.77%. They are currently -0.025%. I really don't see how you can make anything but a superficial comparison. The structure of the global economy has changed (eg, China into WTO), the structure of the financial system has changed, the monetary regime has changed, and underlying growth in most of the world has changed.

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henner
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July 19, 2016 at 2:54 PM ×

Morgan Stanley sellside summer strategy....
main line of thinking is less growth => no hike until mid 2017, lower rates, lower dollar, positive for EM. so classic momentum chasing

call me old-school but I'm not buying expensive US stocks and go long bonds on these levels...


Credit: We continue to favour credit, but lower our weight to
US corporates, given a large YTD rally, late-cycle readings
from our models and our US credit team’s caution. We raise
exposure to securitised credit, which we see as well suited to
a ‘quality and carry’ theme.

l Rates: We raise our strategic allocation one notch, reflecting
a tug-of-war between our below-consensus economic forecasts,
lower Fed path and rate strategy forecasts versus very
poor long-run valuation and cycle-model readings.

l Equities: We raise EM above Europe and Japan, which remain
our least-favoured markets. US stocks remain most favoured,
as we see their valuation premium justified by superior earnings
trends, better shareholder returns and easier 2H comparisons
(see Easier Comps from August, June 17 2016).

l EM > DM: For the first time in several years, we see the next
6-12 months as relatively favourable for EM over DM, with a
Fed on hold and EM growth meeting expectations (compared
to large misses in DM). We raise exposure in EM equities and
EM local rates (currency-adjusted).

l Cash: The above results in our cash weighting falling from
+4% to +1%.

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Booger
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July 19, 2016 at 3:03 PM ×

MM, one thing is still the same, the Fed still shit their britches anytime there is sign of turbulence and take hikes off the table. This makes them in practice repeat, serial bubble blowers.

Unlike in 1998 though, there has not been a systemic event (LTCM) from EM troubles. Arguably, there is a stock bubble and certainly a bond bubble already. I wonder whether we are near the top for the S&P for this cycle.

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Bruce in Tennessee
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July 19, 2016 at 3:43 PM ×

MM,

You are correct, in that I am the one who decides what to write. But where we are now isn't exactly funny. The NSA combs through data 24/7 now on the entire population, and you write snarky comments about autocracy? Yes, Trump is an unknown quantity, but LBJ did the same thing in the 1964 election with Goldwater. Look it up. If Goldwater was elected, we had advertisements that it would lead to certain nuclear war.

We don't have great candidates this go around, I'll grant you. But I am certain Bill and Mrs. Clinton are corrupt, and I don't think even those who will vote for her feel good about her ethics.

Do the sides of the Brexit vote now clap each other on the back and say,"Well that was a jolly good dust up! Let's just forget about the vote and the consequences, and get on with partying..."

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Tallbacken
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July 19, 2016 at 3:49 PM ×

Great post MM. One thing that really jumps out over the past few months is how bearish of vol the VIX market has been (really since March) and how cautious and "pale green light at best" the actual U.S. equity market has been. VIX spot is low, so is put-call skew and VIX positioning has been quite bearish VIX long before we got these fresh SPX highs.

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abee crombie
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July 19, 2016 at 4:08 PM ×

@ washed I think he might be referring to events in Latam where they seem to be rejecting socialism ... agreed US Dollar is important. But in a world starved for yield, carry monkeys will flock to EM as long as it isnt getting worse, imo

fwiw I think you can try to make comparisons of S&P now and in the 90's but I dont think its the correct time period. No retail today. but we are both in late stages of a lengthy bull so anything that can give an edge is worth to look at. the divergence in performace of different sectors/countries is the most notable for me

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Maelstrom
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July 19, 2016 at 5:19 PM ×

Closed out our XIV position today that was put on during the Brexit Monday. I, and our models, agree with you that VIX is too low given the global maelstrom. Tough to walk way from the 20% contango though, however, definitely not the time to be sitting in long VOL either in my view. Still holding the Spooz we bought during the same dip. I hate it though.

Re: Political discourse on this or any blog. I've never understood taking a hardline stance on what are obviously complex and difficult topics. There are three sides to almost every coin and yet comments quickly turn into the kind of closed minded, the world is black and white, and my view is the right view, opinionated garbage that my grandfather defaults to when talking about immigration. I always expect more from what should be an analytical group biased toward rational and critical thinking. What is it about politics that makes one close their eyes and their mind? Given the state of our country, and especially the shit quality of our candidates, a sense of humor is the only thing we have left to keep the tears away. The next generational roll off can't happen fast enough.

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checkmate
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July 19, 2016 at 5:48 PM ×

RE the Fed and rate hikes I think it's been pretty much a case of Triffin’s dilemma’
Bretton or no Bretton.

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Anonymous
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July 19, 2016 at 6:39 PM ×

re maelstorm:
have to say i humbly disagree regarding vol- yes contango high but mid-dated vol way to low- even if we get a breakout to 2200 and above vol will reset higher i think.
there is complete belief in Cbs here but price is news and leg lower will find its own narrative- cny,earnings,banks,fed etc etc
vvix also marching higher -10 off lows and given range of asset prices- seriously pick a number- and vol looks big MINE.
SS

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Maelstrom
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July 19, 2016 at 8:24 PM ×

@Anon 6:39

I actually agree with your assessment and believe we're likely to see a move high in short order (seriously most of the barrels in the hold are powder kegs, a single match could set any one of them off). However, in trading VOL we make most of are bets going short. In order to go long we need VIX to cross specific historic low bounds (check) and contango to settle below 10%. Simply a rule to increase our hit rate. Best of luck to you.

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Polemic
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July 19, 2016 at 8:40 PM ×

Well Turkish Lira has shot up this afternoon as the Erdogan purges race beyond military and judiciary with vast swathes of teachers and ever university dean in the country being rounded up and shown the door. But 3.04 is diddly squat. Turkey exports tourist facilities and toilets and some nuts. And Fridges ( no one made the Arclik joke I see). But at the moment a Brexit is measured higher than a failed military coup and autocratic takeover, judging by GBP?TRY which is still lower than it was Pre Brexit. This is a mispricing of risk.

Turkey is potentially heading off down a path towards a Venezuela or Zimbabwe.

the last time Turkey was in the news to this extent was Jan 2014 when, together with South Africa, it was driving global markets as it was seen as the bellwether for EM in general during that EM worry phase, which of course came to naught. Back then every global stock market was following the path of USDTRY. But now? Looking at US markets they really don't give a damn. Too much inward attention on Trump, unicorn pricing and Pokemon Go. But folks, what is going on in turkey is more serious shitlike than any other serious shit stuff coming from there.

If the US markets can panic over Greece, Italian banks, DB cocos, high yield oil stocks and all gthe other crap that has still left markets at all time highs, then I suggest they panic over Turkey too. But is that it? Because we are near all time highs hte market is very reluctant to panic because all the past panics were obviously soooooo wrong they wouldn't be stupid enough to panic over Turkey now? "No siree we ain;t gonna be caught out by that little trick again. Panic? us? never nope never.

which could be really ironic that the biggest signal to potential global risk is flashing like a submariners crash claxon and this time everyone is ignoring it. Because anyway, even if theirs nuclear war it will only increase the chance of CB accommodative policy. yaaaaawn

hey ho .. Funny old world ..

'


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washedup
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July 19, 2016 at 8:42 PM ×

One interesting thing that distinguishes the upcoming fed meeting from the previous 5 or 6, is the utter lack of an even semi credible excuse for a hold - I get it that no one (including your truly) expects one, but I am most intrigued to see what they come up with as a reason - I half expect them to invoke turkey and the terror attack in nice, but perhaps I am missing something, because…

1. Stock market making all time highs instead of threatening to break down - check
2. Inflation expectations stable instead of worsening - check
3. Crude - basically doing nothing - check
4. EM - supposedly on the mend as evidenced by equity/bond inflows - check
5. "Global Developments", i.e. China - nary a peep - check.

So - what will they use?

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Leftback
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July 19, 2016 at 9:23 PM ×

@Maelstrom, thanks for the discussion. Models and gut feelings saying vol is too cheap. 12 y-o vol sellers have been known to make mistakes when left in charge of the vol desk during the Summer. We have about 12 catalysts for a possible sell-off (China, Deutsche Bank, Italian NPLs, NIRP, UK GDP), none of which matter, b/c, like, Janet Yellen. This kind of logic has failed in the past.

@washed, how about the Fed uses as the excuse a 5% drop in the markets that occurs in the next week, then they decide not to hike, and the market gains most of it back again as 12 y-o HFMs sell vol and Buy the Dip. Too cynical? Nah.

The dollar may have completed a consolidation phase and moved on to the next phase of its bull run. EURUSD weakness is most likely to drive the greenback higher (it's almost a mathematical certainty). Next up, the commodity unwind....

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Polemic
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July 19, 2016 at 9:25 PM ×

well LB .. that proves my theory. No one in the US gives a monkey's about Turkey. You even have UK GDP ahead of it.

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Sigma
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July 19, 2016 at 9:35 PM ×

My friends, you are all sitting on short positions and refuse to get it that the trend is up.

Look at the price action in XLF, MCD, PM, JNJ, LQD - they all tell that the direction is up no matter what the news is.

Forget about the FED. Why would they risk further flattening of the curve and the possibility of an iversion? They may hike when 30y is above 2.50% but it will take ages until we get there. Leave to trade that event to your kids.

The belly is the free money at these levels.

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Anonymous
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July 19, 2016 at 10:12 PM ×

Think 12HFM & Sigma has it on the SPX until the US economy turns, which may not be for a while. I also think we need some geniue euphoria before we get a sustained downturn.

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washedup
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July 19, 2016 at 10:43 PM ×

@Pol - what do you see as the contagion channel for the turkish 'incident' to spill over, though? TRY is simply not big enough in anyone's portfolio, neither are turkish stocks. It could have tumbled the sentiment domino like jan 2014, but as you pointed out, it didn't, and that's that.
I am definitely in the camp that just because ignoring geopolitics has worked for the last 30 years (really since the start of the Iran-Iraq war) doesn't mean it will keep working, but this market would treat an earnings fraud disclosure from a minor landesbank with greater horror than, say, an accidental nuclear missile launch in a haphazard direction from N. Korea.
There is financial markets, and then there is the real world - never the twain shall meet, till introduced by a hit to the face by a frying pan.

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Polemic
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July 19, 2016 at 10:46 PM ×

You hit the nail on the head. This isn't financial contagion until someone notices, say a German bank with Garillions out to Turkey, but it is a political unbalancing. Remember Ukraine? Think like that ..

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Sigma
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July 19, 2016 at 11:46 PM ×

You know what happens when everyone is looking for a black swan?

If you are so bearish then go long duration. As I said, the belly is the free money now. These political risks will not materialise anytime soon anyway.

Alternatively, you can go long bonds and stocks, and some other crap along with them. This is what is called the risk parity. It made enormous money this year...

As a matter of fact, I am starting to look to for a retirement house now in France or Spain. It became so easy to make money now that I can simply put a robot that buys stocks and bonds on any dip, meanwhile I spend my time sipping martini on the beach

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Anonymous
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July 19, 2016 at 11:56 PM ×

re sigma: every downtick doesn't have to be a black swan- a garden variety 10% pullback is neither here nor there point being made here is that sentiment in this market is very fickle and if price rolls it will find its own narrative and snowball...looking for blackswans i am not but neither do i have my head too far up my backside . have traded far too many market cycles to know that when people start talking regime change and this time its different because blah blah blah....watch out

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checkmate
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July 20, 2016 at 8:35 AM ×

Purging the intellectuals. Where have I heard that one before ! Erdogan is nothing more than a dictator in the sense that he is treating the country like it is his personal 'house to clean'. Frankly, I find it impossible to see a good outcome to such a situation. Any market glad-handing will turn out to be bucking a longer term trend for investment outflows.

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Gnome of Zurich
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July 20, 2016 at 10:33 AM ×

Can someone please explain me why the market should panic about the events in Turkey? If the coup succeeded, we would be in a much worse situation with a certain islamistic uprising against the secular military and a civil war that could turn the country into another Syria.

But it didn't happen. No we still have an elected, although somewhat autocratic leader from a religious party in power that is preventing a radicalization of the islamistic hotheads.

But anyway, people have record amounts of cash in their funds and are loaded up on put protection, so this stock market rally may well continue to year end and spark a phenomal performance chase.

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