Turkey’s economic meltdown could soon resemble the Asian financial crisis of 1997-98 and create contagion in global markets, Hugh Johnson, chief investment officer at Hugh Johnson Advisors, said in an interview.

Citing the origins of Asian financial crisis, Johnson told the International Business Times that what appears to be a “fairly-small problem affecting a limited part of our world sometimes transforms into a significant problem for the global economy.” He pointed out that the Southeast Asian financial crisis of 1997-98 began with instability in the Thai economy, caused by some policy mistakes in that country.

The contagion then rippled across economies in SouthEast Asia and other parts of the world through four transmission mechanisms. Johnson worries that the current crisis in Turkey could spread to the  European Union, the country’s most important trading partner, in a similar fashion.

Still, he thinks there is good news for the U.S investors. “The good news is that it will not end or it is unlikely to end the current cycle -- stock market, economic, interest rates cycle, or the U.S. bull market, recovery, rise in interest rates. It is not likely to be derailed by what’s happening in Turkey even if it spreads," he says.

THE FOUR TRANSMISSION MECHANISMS

Johnson says there are four transmission mechanisms that play a significant role in amplifying a regional problem into a global crisis:  psychological, commodity prices, trade flows and capital flows.

First, the global markets reflect the sentiments of other markets. He says stock market declines in one market, even a small seemingly inconsequential market, can scare investors in the markets around the world. “Stock price declines in parts of Asia can scare investors in the Europe and U.S.” U.S. stocks fell in second week of August as the Turkish lira hit record lows, rattling investors around the world.

The second is decline in commodity prices. He referred to how a decline in oil prices following the Asian crisis caused significant problems for the economies of producers such as Russia. Johnson says the current decline in copper prices is not “good news” for copper-producing countries and companies.

“If the economy of Turkey starts to deteriorate, which it clearly is, it could carry with it negative implications for lots of other substantial parts of the world,” he says.

Regional economic problems can be spread across the world through trade. For instance, U.S. exports declined in the third and fourth quarters of 1998. “We had a real problem with exports because of the problems in import / export destinations such as Southeast Asia,” according to Johnson.

The fourth transmission mechanism is capital flows. The flow of capital from Southeast Asia to the U.S. financial markets declined during the Asian crisis and put upward pressure on interest rates in the U.S.  Although Turkey represents only 0.9 percent of U.S. stocks and bonds held by foreigners, the EU has a much bigger exposure at 35.8 percent, he says.

U.S. STOCKS OVERVALUED, CORRECTION WELCOME

Johnson says the good news is that the Turkey crisis, even if it spreads, “will not end or it is unlikely to end the current cycle — stock market, economic, interest rates cycle, or the U.S. bull market, recovery, rise in interest rates.”

He sees a correction of 10 percent on the U.S. stock market, which he says is already modestly overvalued -- about 2.5 percent above what it should average in the current quarter; and 0.1 percent below what it should average in the fourth quarter.

“If Turkey or the global trade situation leads to a decline in the stock prices that would be a welcome event because it would move the stock market — the S&P 500 — to a level which is modestly undervalued and would make more sense,” he says. “Right now I’m not doing any buying primarily because of valuation concerns and my concern that the events — whether Turkey or global trade conditions — will set off a possibility of a correction. So, I’m not doing any buying but I’m not doing any selling either. I’m not reducing any equities in my portfolio yet.”

GLOBAL GROWTH IMPACT

Johnson says the global markets will get more affected if protectionism and trade disputes intensify.

IMF forecasts global real GDP growth at 3.9 percent this year and next year and Johnson noted that it has not changed the forecasts even as trade tensions escalate.

According to him, the trade tariffs will certainly have an impact, reducing global growth by 2 percentage points in an extreme situation. “But right now I’d say by 0.2 - 0.3 percent, i.e., from 3.9 to 3.6 percent.”

If the contagion spreads to the EU, then Johnson sees an impact of 0.3 - 0.5 percent on global GDP growth and a real hit to earnings and stock markets.

Johnson says that if trade tensions escalate and in an extreme case of a global trade war where there’s the imposition of 25 percent tariffs on all goods across the board, with every country, the impact on the global economy will be significant. “That means that instead of the global economy expanding, my guess is that the global economy may contract but that’s only if you get to that extreme,” he says.

He added: “The American president is emotional enough to try to do that but he’ll have real resistance or problems with Congress so I don’t expect that to happen. But that’s the worst case scenario. And that’s not impossible but it is improbable.”

POLITICS BEHIND CRISIS

Johnson thinks the Turkey crisis is about politics and that it can be resolved very easily. “What’s created the crisis in Turkey is some very stubborn politicians and it's very disturbing that the politicians – Erdogan on one side and Trump on the other side – are focused so much on themselves and not on sensible outcomes.”

He thinks this will end and there could be a negotiation away from the headlines. He says that confidence in investing in Turkey has been eroding for a long time because of the leadership and policies which cannot be changed in a short time, just as it couldn't be done in Thailand.