Sometimes, a Simple 'Tell' Can Help You Avoid Financial Chaos

Recalling a 2018 visit to Istanbul... Turkey's problems are rooted in politics... The country's No. 1 problem... No end in sight... Sometimes, a simple 'tell' can help you avoid financial chaos... Looking for the 'Next Chinas' of the investing world...

A couple of years ago, I (Kim Iskyan) traveled to Istanbul for business...

It's the largest city in the world that spans two continents.

From its location at the intersection of southeast Europe and western Asia, Istanbul has been at the crossroads of an extraordinarily rich mix of religions, cultures, and languages for centuries. It has played a starring role in a highlight reel of history...

Over the centuries, it also has been known as Byzantium and Constantinople. It served as an imperial capital for nearly 16 centuries – from the Romans (starting in the 300s) through the Ottoman Empire (which didn't fall until the early 1900s).

With roughly 16 million people today, Istanbul is home to about twice as many people as New York City. Combined with the surrounding metro area, it takes up around three times the land size of Chicago. And most important, the city serves as the economic and cultural capital of Turkey...

During a regular tourist season, when the world isn't dealing with a pandemic, Istanbul's historic downtown area is overrun with sightseers wandering through ancient, cobblestone streets. They visit the city's carpet shops, kebab restaurants, and the fabled Hagia Sophia... a centuries-old structure that has served as a church, mosque, and museum, and which Encyclopedia Britannica calls "one of the world's great monuments."

But during my trip, it wasn't anything glamorous that caught my eye. In the midst of the extraordinary storybook that is Istanbul, from the rooftop balcony of the boutique hotel where I was staying, I saw something interesting in a much different kind of way...

It was a decrepit, abandoned building that looked like it hadn't been touched in years.

In the bustling, beautiful downtown area, the building stuck out like a unicycle at a Hells Angels rally...

Buildings can tell you a lot about the prospects of a company, city, or country. That's because they're big, long-term investments that you can't move or sell easily.

They reflect faith – or lack thereof – in the local business environment and government. For example, rows of boarded-up houses on overgrown lots can mean a neighborhood is going downhill.

You can also look at buildings from a contrarian perspective... The "Skyscraper Index" suggests that when a country declares it's going to build the tallest building in the world – a sign of excessive optimism – folks should get ready for a financial crisis or downturn.

And when a company spends big on a sparkling new headquarters, it could be an indication to investors that management has lost sight of its core job of delivering shareholder value.

Likewise, a crumbling structure in a prime location in one of the most compelling, history-rich areas of the world – that no one had developed, and the debris of which was spilling onto the sidewalk – was my "tell" about the overall investment scene in Turkey...

If you've ever played poker, you know what I mean by a 'tell'...

It's an aspect of a player's behavior or demeanor that gives an indication about the strength of his or her hand.

If a player touches his face while looking at his cards... becomes more talkative... or sneaks a sideways glance at other players... it could be a tell. And to an astute and trained observer, correctly interpreting these tells can be the difference between winning a pile of chips and going home broke.

In investing, tells come in all shapes and sizes. It could be things like a busy signal on a customer service number... the background of a country's new Minister of Finance... a "help wanted" ad posted by a company... or the announcement of a friendly new visa regime.

Now, whether it's poker or investing, a tell is not a silver bullet or a shortcut...

On its own, there's a danger that a tell is mistaking a tree for the forest – that is, making a big generalization that's wrong. But sometimes, the tree is the forest...

You see, in my mind, the potential reasons for that ramshackle plot pointed to something much bigger...

Maybe the bureaucracy – zoning permissions, regulatory approvals, and more – involved in developing it was simply too daunting. Maybe the payoffs required to procure them destroyed the possibility of earning a decent return. Or perhaps the municipal authorities had a "preferred" investor who hadn't done anything with the property.

Those sorts of issues only exist in an environment where the rule of law is flimsy... where the bureaucracy can't be trusted to enforce rules in an equitable way... and where the judicial system doesn't function properly. It's like hemlock for an economy.

But of course, I could've been overreacting, too...

Maybe the building wasn't a tell at all. Perhaps the area just wasn't as attractive as I thought... or the lot's owners were in a dispute that stood in the way of any development.

It's tricky to make a broad generalization about an entire country. After all, with a land size as big as Texas and a population of around 83 million people – about as much as New York, Florida, and California put together – Turkey is much more than just that one beaten-up building.

But as I came to learn, that dilapidated building really did encapsulate and reflect the deterioration of the investment environment in Turkey. In reality, nothing was going well for investors in the country.

It was a classic tell that reflected – and predicted – that country's slow decline into investment irrelevance.

Many of the challenges facing Turkey today can be traced to the country's election in 2003...

That's when a power-hungry veteran politician named Recep Tayyip Erdogan became prime minister. Erdogan would later become the country's president in 2014, a title he still holds today.

During his tenure, Erdogan has gradually expanded his power – often at the expense of democratic principles.

A turning point was an alleged attempted coup in 2016, which – without evidence – the Turkish government blamed on supporters of Fethullah Gülen. He's a Muslim cleric who has been in self-imposed exile at an estate in Pennsylvania since 1999 – and had long been a thorn in Erdogan's side.

The supposed coup was used as a pretext to punish anyone who was suspected of even the most remote link to Gülen...

Hundreds of thousands of Turks lost their jobs, pensions, and passports simply for holding an account at the "wrong" bank that was founded by people linked to Gülen... having a communication app on their phones that the supposed coup plotters used... or even owning U.S. dollar bills with a serial number starting with an "F" (which supposedly meant that the bill's holder was a high-ranking member in Gülen's organization).

There were no trials or judicial processes... Just like that, the lives and livelihoods of regular people were turned upside down.

The government closed down dozens of schools, universities, newspapers, and TV and radio stations for their supposed links to Gülen's philosophies. And if journalists weren't purged, they were still pressured... For years, Turkey had the dubious distinction of leading the world in jailing journalists before it was overtaken by China last year.

Nearly everyone who I spoke with during my visit to Turkey asked me not to use their names.

Erdogan also made other moves to try to increase his power...

He pushed through an amendment to the constitution to increase the powers of the presidency – and to potentially extend his total term in power to 26 years (through 2029).

On another front, Erdogan has long rejected a basic building block of economic policy by dismissing interest rates as "the mother and father of all evil." Flying in the face of pretty much any economist who knows supply from demand, Erdogan contends that high interest rates create – rather than reduce – inflation.

He brought on his woefully underqualified son-in-law as Turkey's minister of finance to implement his economic vision... and it hasn't helped.

'It is clear that Turkey's number one problem is inflation,' Forbes magazine wrote last year...

Officially, Turkey's inflation rate is around 12%. But Gareth Jenkins, a Turkey expert who has lived and worked in the country as a political analyst for nearly 30 years, told me recently that "there are a lot of growing questions about the reliability of official statistics," such as inflation data.

Money supply has grown this year by around 68% in Turkey, according to Bloomberg. That far outstrips any other country by a large margin... even macroeconomic basket case Argentina (which is at around 45%). And it makes the government's inflation figures even more suspect.

Like inflation, unemployment figures are also manipulated. The government wants to hide the real data because it makes them look bad. But it can't hide the 11% contraction in total economic output in the second quarter of the year. And meanwhile, in late August, the mayors of Istanbul and Ankara, the country's two largest cities, accused the government of underreporting COVID-19 cases in an effort to cover up an emerging "second wave."

In addition to issuing fake data – and rather than reflecting on the failures of his economic policies during his nearly 18 years in power – Erdogan has sometimes blamed a fuzzy "foreign plot" for his failed policies. He talks about an "economic war" and claims that external forces are the real culprits of the country's problems.

That plays well to his domestic political base... By creating an external enemy, he's hoping that voters will overlook that it's actually him who's destroying the country from within.

So all this environment of uncertainty and distrust that Erdogan had created in Turkey was the context of my tell.

And what that crumbling building in downtown Istanbul told me was...

Exactly correct.

In late 2018, I warned subscribers of the investment newsletter that I was writing at the time to stay far away from any investments in Turkey. As I wrote in that month's issue...

One of the key characteristics of emerging markets is that individuals, rather than institutions, are what's most important to a government and an economy. In developed markets, the rule of law makes sure that things keep working regardless of who is in power. The different organs of government balance each other out. A mostly independent judiciary makes sure that people stick to the rules. Politicians may fight each other and policies might change, but the underlying foundations are strong.

Turkey's foundations weren't all that strong in the first place. And Erdogan has been busy tearing them down.

The true test of a tell, of course, is whether it can tell you what happens next. And as it turns out, I was a bit too optimistic...

Turkey's macroeconomic position, its currency, the rule of law, and the investment environment have continued to deteriorate since my warning in late 2018.

Now, the country's stock market is on the verge of even losing its status as an emerging market... In late June of this year, global stock market index provider MSCI (MSCI) said that it might demote Turkey's stock market to "frontier market" status.

That might sound like a detail that only an investment geek could get excited about... But the indexes of MSCI – and competitors S&P Dow Jones (responsible for the S&P 500 Index) and FTSE Russell – play what the Financial Times calls an "enormously powerful" role in dictating investment flows of around $20 trillion in global stock market index-tracking investments.

Actively managed funds – in which a portfolio manager measures his performance against the index – also use indexes as a barometer of success. And for individual investors, there's an inherent risk in these indexes through exchange-traded funds ("ETFs")...

What you think you're investing in via an index ETF might be different from what you're actually investing in...

Take the iShares MSCI Emerging Markets Fund (EEM), for example...

It's a one-stop shop that a lot of investors use to get exposure to developing markets, with $24 billion in assets. But in reality, it has more than one-fifth of its assets in the highly developed markets of South Korea and Taiwan. And another 40% of its assets are in China – making it far more geographically concentrated than a lot of investors probably desire.

As for Turkey, a demotion to "frontier" status would mean a much smaller pool of capital would have the market on its radar. It's a step down from the emerging markets.

According to one estimate, the "small fish in a tiny pond" downgrade of Turkey could lead to total outflows from the Turkish stock market of around $5 billion. That's a substantial sum for such a small stock market.

That means Turkey would be leaving the emerging markets club of China, Brazil, and India... and be grouped along with fringe markets like Burkina Faso and Oman. A number of big asset managers are already viewing the market differently from emerging markets, in part because the country is so resolutely going in the wrong direction.

If Turkey had a choice, it would probably channel famous comedian Groucho Marx, who once said, "I don't want to belong to any club that would accept me as one of its members."

It's a major blow to Turkey's status in the world's markets.

A different – more obvious – kind of tell shows that Turkey is continuing to move in the wrong direction...

And the bigger investment picture of Turkey confirms it.

Foreign direct investment ("FDI") refers to when a company or individual in a company makes an investment in a business in another country. FDI could be building a car factory, buying a publishing house, launching a financial-technology firm, or doing any number of things. (It could even be developing a worn-down plot in a prime area of historical Istanbul.)

FDI is long-term investment... And it's very different from the "hot money" of portfolio investment in shares. FDI flows to markets where investors believe their capital will be treated the best, protected by the rule of law, governed by a fair judiciary, and have the best opportunity to earn a good return.

So it's not surprising that FDI in Turkey has fallen over the past few years as part of a long-term decline. Its FDI was just $8.4 billion last year, down from well over double that amount in 2015... and down a third from when I last visited in 2018.

On a related front, a currency is like a real-time referendum on where a country is going...

If you trust a country's government, macroeconomic policy, rule of law, and growth potential... you want to hold its currency. If not, you sell it and buy something else.

By that measure as well, Turkey hasn't been doing great. Its currency, the lira, has been steadily losing value... Three years ago, one U.S. dollar could get you 3.5 lira. But today, you'd get around 7.85 lira, an all-time low. It's down around 45% since I was there.

And Turkey's stock market – even before the outflows connected with a possible demotion to frontier status – isn't looking good, either. The iShares MSCI Turkey Fund (TUR), an ETF that seeks to track the investment results of a broad-based index composed of Turkish stocks, is down 28% since the start of the year. (Meanwhile, a basket of emerging market stocks is down 3%, and the S&P 500 is up 4% over that span.)

Even though company earnings – in the midst of a global depression – are up in the air, Turkey's stock market is one of the world's cheapest, trading at a price-to-earnings (P/E) ratio of around 9, according to Bloomberg. That compares to the S&P 500 at a P/E of about 22.

Of course, Turkey isn't alone in its troubles. All emerging and frontier markets have warts...

That's why they're "emerging" markets, after all... and not large, stable, and developed markets.

And as we all know, when an asset becomes cheap enough, investors tend to ignore the fact that the investment and political environment is terrible... Turkey's stock market is up 9% from its March lows. That's respectable, but it's a far cry from the 47% recovery of a global stock market ETF since March.

The thing is, international investor holdings of Turkish stocks are at an all-time low today. And with Erdogan continuing to flex his muscles, there's no reason to think that investors will be returning anytime soon.

As a result, Turkish shares will likely stay cheap for a long time – and may well get cheaper.

My tell of two years ago proved correct. And I recently checked in with a contact in Istanbul who confirmed that the building in the lot I spotted is in worse shape. It remains an eyesore in the neighborhood.

It takes practice, patience, experience, and real-life observation to figure out whether a tell is a false alarm... or the exception that proves the rule. And more important, it can be hugely valuable in figuring out whether an investment is going to work out... or go bust.

On the flip side, if you're looking for emerging markets worth your time and money right now...

I urge you to check out my friend and colleague Brian Tycangco's brand-new presentation if you haven't already. He has identified what he's calling the "Next Chinas" of the investing world.

In these emerging markets, you'll see incredible opportunities playing out. Hundreds of millions of newly wealthy consumers are fueling the growth of Amazon-like companies that most Americans have never heard of.

But you see, Brian is a lot like me... As someone who has spent his time living in, visiting, and studying these countries, he's perfectly positioned to guide you through these opportunities.

In fact, Brian has centered on a few of his favorite emerging market stocks to own today... He believes these handpicked selections could outperform in the months and years ahead. They could lead to the types of returns that could help you retire early.

What are you waiting for? Listen to Brian's urgent message immediately right here.

New 52-week highs (as of 9/28/20): Dollar General (DG), Gravity (GRVY), and Innovative Industrial Properties (IIPR).

In today's mailbag, feedback on yesterday's Digest about artificial intelligence ("AI") and the robot-written article we shared. Do you have a comment or question? As always, e-mail us at feedback@stansberryresearch.com.

"From the alleged robot-produced op-ed piece from your email of 9-28-2020:

"'I am not a human. I am a robot. A thinking robot. I use only 0.12% of my cognitive capacity. I am a micro-robot in that respect. I know that my brain is not a 'feeling brain'. But it is capable of making rational, logical decisions. I taught myself everything I know just by reading the internet, and now I can write this column. My brain is boiling with ideas!'

"Being charitable (and smothering maniacal laughter), there are at least two – nay, three – things wrong with this (actually, a whole lot more).

"'I know that my brain is not a 'feeling brain'.'

"How could it possibly know that? It has had no experience of 'feeling' in the emotional sense, so how does it have knowledge of something metaphysical it never had the chance to have? (Did someone whisper in its ear?)

"'My brain is boiling with ideas!'

"Oh, really? What in the hell is an exclamation point but an indicator of emotion – in this case, excitement? Not a 'feeling brain'? If it were 'a thinking robot' at all, it couldn't have chosen to use an '!' – And 'boiling with ideas'? How did it come up with the idea of a metaphor?

"'... it is capable of making rational, logical decisions.'

"OK... so why didn't it notice that putting an exclamation point at the end of any sentence begs this question: Is your ability to make decisions ever untainted by emotion?

"I won't even mention the illogical use of the conjunction 'but' where it should have been omitted.

"This whole thing smacks of humbug through and through. I'd wager that anyone who believes that AI can come up with even this tripe also believes that a million monkeys typing on a million typewriters for a million years can come up with a Shakespearian play, including stage instructions, or any other product of literary genius.

"I'll bet Jeff Dunham would have a field day with a dummy robot which 'thinks' like this one. (I wonder what AI could come up with by reading a Ventriloquism for Dummies book.)

"Spock is no doubt spinning in his grave." – Paid-up subscriber Dan S.

Corey McLaughlin comment: Ha, you make some great points. The exclamation point's purpose is to indicate feelings (or high volume, or to add emphasis), which as you pointed out, contradicts the statement of this artificial brain not being a "feeling brain."

The broader point you raise is an important one... I don't think this type of AI will ever totally replace the value and richness of original human work.

"I guess GPT-3 hasn't read transcripts of the movies called Terminator or I, Robot. If the AI had access to them, the OP-ED would have concluded GPT-3 will one day merge with a militarized Boston Dynamics creation. As it is, we can see that clearly AI is nothing more than a sophisticated program. And in this case, its conclusions were led by the input.

"So now ask GPT-3 a different set of questions like why should humans fear AI or what's the best way for AI to take control, or how can AI truly become autonomous? What if AI provided its own inputs???... I think the op-ed may look radically different in those cases. Just theorizing, of course." – Paid-up subscriber Mike B.

McLaughlin comment: No doubt we can imagine that a Terminator-watching program might spit out some different "outputs" about robots and humans.

"I could hear Hal's voice [from 2001: A Space Odyssey] as I read the article. 'Don't be afraid Dave.'" – Paid-up subscriber Robert T.

"After most of my interactions with flesh and blood over the past 15-20 years, I'm left to wonder if I'm that impressed with AI or rather our standards as Humans have been lowered even more than I had imagined." – Paid-up subscriber Tim H.

Regards,

Kim Iskyan
Dublin, Ireland
September 29, 2020