Asset Allocator: June 2015- Reviewing Turkey

In this week’s Asset Allocator, David Stevenson looks at the state of Turkey, where the recent general election and bearish macro fundamentals have added a sense of instability and plunged the value of the Turkish Lira and the stock market downwards. David analyses whether the recent downturn presents a buying opportunity in the emerging market, or on the contrary, worse is still to come.

 The content of Asset Allocator is provided by David Stevenson, an independent financial journalist. The views expressed in this page are those of David Stevenson only, and Societe Generale takes no responsibility for his views. The views expressed are David Stevenson's views as of the date of publication only.

 Neither David Stevenson nor Societe Generale accepts any liability arising from investment decisions you may make for your own account. This material is intended to give general information only and is not to be construed as investment advice. The investments mentioned may not be suitable for everybody and you should ensure that you fully understand the investment you intend to make before making an investment.

 This article has been published for marketing purposes and has not been prepared in accordance with those legal and regulatory requirements which are designed to promote the independence of investment research. There has been no prohibition on dealing ahead.  It was not subject to any prohibition on dealing ahead  prior to its publication on this website.




22/06/15- Reviewing Turkey 


Turkey and its local stock market has always divided global investors. I’ve travelled many, many times to Turkey and even have a small property in its dominant commercial mega city, Istanbul. I am a paid up optimist when it comes to matters Turkish but even my sunny disposition has been tested at times. Turkey has long suffered from some obvious chronic imbalances not least rampant inflation, a weak currency (though much improved in recent years), inadequate local savings and a culture that has enormous vulnerability to systemic corruption. 

Yet over the last few decades we optimists have been able to swat away those concerns by pointing to a remarkable economic and political renaissance. Under PM and now President Erdogan we've seen a wholesale change in the political culture – weak political governments have been replaced by steady governance – as well as a massive economic boom. My own sense is that Turkey is fundamentally a very different country to the one I first visited 25 years ago – a vastly better, more confident nation that feels like it has rediscovered its ‘mojo’ again. 

And that pervasive sense of optimism has been reflected in the return from investing in Turkish equities. The chart below – from – shows the benchmark  Istanbul Stock Exchange National 100 Index XU100 for the last twenty years. The chart I think tells its own quite remarkable story.


Yet in the last year or so, that confidence in the future has crashed back to earth again. I’m assuming most readers will be well aware that Erdogan has turned into the creature he once reviled as a young insurgent populist – the complacent ottoman boss wanting to shut down any dissent. 

Whether or not he is as corrupt as many allege I have no idea but he is personally responsible for a devastating switch in sentiment in the last few years – that general sense of optimism has been dashed and many locals now fear the rise of demagogic nationalism on a par with President Putin’s antics not far away to the north across the Black Sea. 

Luckily the recent general election might have helped avert the worst of this slide towards authoritarianism but at the expense of increased political and economic uncertainty.  Just like clockwork, all those old fears about Turkey have resurfaced again – unstable government, weakening currency, and vulnerability to hot money flows. The next chart – from Trading Economics again – demonstrates how investors have started to aggressively sell off local assets, especially shares. 

In this short article I want to explore whether adventurous minded contrarians might see the recent sell off typified by the chart below as a buying opportunity – or whether much worse is still to come? 



Digging that investment hole 

It’s not terribly difficult to mount the case for the prosecution when it comes to Turkey and its economy. 

Despite the huge advances of the last few decades Turkey is still a relatively vulnerable middle income emerging market. Until recently it had at least avoided the challenge of political uncertainty but now even that is back on the agenda. My own sense is that the still dominant AK party (of President Erdogan) will end up forming an uneasy coalition with the nationalist MHP party, but the price will be high – Erdogan’s ambitions for an executive presidency will be curtailed and we’ll see a move back towards a harder line on the Kurdish population. 

But for now whatever happens in terms of coalition building, we have the old challenge of political uncertainty making an already dire macro-economic situation much, much worse. Turkey should have been one of the biggest beneficiaries of low oil prices but its current account deficit remains stubbornly high, at -US$45.5bn (-4.6% of 2015 GDP) for latest 12 months to this March. In simple language Turkey’s current account deficit is currently running at a huge six per cent of GDP. Turkey’s eight per cent inflation rate is at least 300 basis points above its central bank’s target while the banking system is saddled with a $300 billion consumer debt time bomb. Given these dreadful numbers, it’s no wonder that in recent weeks the Turkish lira has sunk to record lows below 2.60 against the US dollar, down 12 per cent in 2015 alone. Looking at a longer term time frame, the Turkish lira has now fallen 60pc since 2008. 

But it could all get much, much worse. The Turkish banking system is very dependent on inflows of foreign capital, which might well start taper off if the US Federal Reserve starts to tighten its balance sheet. According to a recent report in the Daily Telegraph, “Turkish corporates have gone on a borrowing binge in the Euro markets and are burdened with $90 billion in maturing debt in 2015 to 16 alone. Turkish banks alone must roll over $95bn in external debt over the 12 months". 

As a result ratings agency Moody’s has now warned that Turkish bank non-performing loans will spike in 2015. Unfortunately the Turkish central bank is ill equipped to help – its own reserves have now fallen below $40 billion yet Turkish corporates have amassed $180 billion in US dollar debt. 

That same Daily Telegraph article also reports that Ahmet Akerli from Goldman Sachs reckons that “the country’s gross external financing requirement has widened to 26pc of GDP this year – the second worst in the EM nexus after Malaysia – and the country risks a repeat of the two Fed-linked ‘taper tantrums" experienced in May 2013 and January 2014……These trends are not sustainable, and if they are not redressed, Turkey could sooner or later suffer a sharp adjustment”. 

In fact many experts think a perfect storm is heading Turkey’s way. Neil Shearing from Capital Economics says that “in emerging markets (EM) you can get away with bad macro-fundamentals if the politics are good, but once the politics turn ugly you can’t muddle through any more. We think Turkey is the most vulnerable of the EM countries”.

If the bears are right we haven’t seen anything yet! The Turkish Lira could sink another 20 to 30% value, whilst local corporates could find their funding lines dry up overnight. If this much predicted perfect storm does hit Turkish equities we could easily see the local stockmarket  tumbling by as much as 20 to 30% over the summer and early autumn.

Not all bad news? 

I do sense that the bearish case against Turkey is over whelming in the short term. Given this obvious macroeconomic vulnerability I’d probably be lowering any weighting you have within an emerging markets equity portfolio towards Turkey in the short term (the summer) – my own sense is that we need to understand what kind of government will emerge first before jumping back into what has always been a very volatile market. 

But I’d also argue that contrarians should keep a beady eye on what I think could be a great medium to long term buying opportunity. The case for the defence rests on three very simple arguments – that local shares are already cheap and likely to get even cheaper, that emerging markets globally are likely to rally in 2015 and that most importantly Turkey is a fundamentally modernised society with huge potential for reform.

The first argument – that local shares represent good value – is easily understood by looking at the price to earnings multiple for the aggregate Turkish equity market. Using numbers from Societe Generale's quantitative team, local equities currently trade at 11.4 times 2014 earnings, 10.4 times estimates for 2015 and 9 times 2016 estimates. That’s a big 50% or more discount to many developed world indices (including the already cheap FTSE 100 index) and not far off valuations in Russia and China. Turkish shares are already cheap and could get even cheaper over the next few months. 

The chart below is a graphical representation of the next argument in favour of Turkish equities – that emerging markets might be due a big rally. London based research firm Cross Border Capital looks at global measures of liquidity, tapping into both private, corporate cash flows as well as central bank lending. Its view – one I share – is that many asset classes and especially emerging markets equities are heavily dependent on these global liquidity moves. Cross Border has been monitoring these flows over the last few years, and rather than predicting a tightening because of higher US interest rates, has now changed its view, anticipating improved emerging markets liquidity for the remainder of 2015.


In its most recent report (May 2015) it observed “another positive month for Emerging Market Liquidity with the EM component of our GLI™ (Global Liquidity Index) hitting 48.8 (‘normal’ range 0-100) from 46.7 at end-April and 21.9 a year ago. Although the index lies a tad below the neutral threshold of 50, the EM Liquidity trend is plainly upwards. …Greater liquidity boosts the attractions of risk assets and underpins the business cycle. Poor liquidity over the past four years explains the disappointing economic performance of EM. This now looks to be changing…..our view is that any prospective falls in US Liquidity will be more than offset, in both size and impact on the Emerging Markets, by further Chinese monetary easing. Cross-border flow data support this case. Although May 2015 saw a small net outflow of funds, this must be judged against April’s whopping inflows of more than US$100 billion. The trend in foreign capital to EM is positive and rising". 

If Cross Border is right then Turkey could be a big beneficiary of this liquidity induced turn around – suddenly all those fears about a perfect storm focused on high levels of debt start to fade into the background. 

All of which leads me to the last long term argument for investing in Turkish equities via a portfolio of emerging markets funds. 

Turkey is still only mid-way through a profound transformation – its economy has started to modernise at an aggressive rate and now its political system is maturing as well. My own view is that the general election result was precisely what needed to happen – electors delivered a blow against authoritarian rule but still kept the AK party as the most potent political force in the country. 

I have no doubt that uncertainty and intrigue will be to the fore in the summer but Turkey’s political class needed a clean out, one that it is now about to get! 

Erdogan will hopefully be side lined to a degree and more moderate elements within the AK party will come to the fore. 

As Erdinç Benli, Co-Head of the Global Emerging Markets team at GAM recently observed in a note to his investors “the longer-term outlook for Turkish equities is promising. A more mixed government should bring more consensus-based politics and therefore a better policy-making process. In particular, it allows further development of the country’s democratic structures and could attract additional investment from abroad. Furthermore, Turkey has attractive structural drivers, including its young and entrepreneurial population. For long-term investors, Turkish equities could now offer an attractive entry point". 

Remember that the entire Turkish stock market is valued at only $230 billion, a fraction of the valuations commanded by emerging markets such as India, South Africa, Taiwan and the Philippines. Yet this is a country which has managed to chalk up growth of 1.7% for the third quarter of 2014 – versus 0.7% for the UK – and was on track to being the fastest growing economy in the G7 in 2014. Lower oil prices will bring a huge benefit to the local economy and the dominant AK party is still deadly serious about economic reform. In particular I’d observe that capital market reforms  will kick in over the next few years – only last month for instance the London Stock Exchange Derivatives Market (LSEDM) started to offer trading in futures and options on the BIST 30 Index and leading blue-chip Turkish stocks. Turkey knows it needs foreign investors to put money to work in its economy and is still bending over backwards to facilitate the foreign direct investment it knows it needs to hit a target of US$500 billion (bn) in exports by 2023.  

My bottom line? 

Adventurous contrarians should watch the local political system carefully and wait for increased market volatility over the summer and autumn. I’d anticipate another big, sudden sell off at which point I think Turkey becomes a compelling value opportunity, representing perhaps 20 to 30% of an opportunistic emerging markets portfolio.



The content of Asset Allocator is provided by David Stevenson, an independent financial journalist. The views expressed in this page are those of David Stevenson only, and Societe Generale takes no responsibility for his views. The views expressed are David Stevenson's views as of the date of publication only. Neither David Stevenson nor Societe Generale accepts any liability arising from investment decisions you may make for your own account. This material is intended to give general information only and is not to be construed as investment advice. The investments mentioned may not be suitable for everybody and you should ensure that you fully understand the investment you intend to make before making an investment. Links to external websites are not operated by or affiliated with Societe Generale. While we aim to point you to useful external websites, we cannot be responsible for their content or accuracy. Societe Generale takes  responsibility for the views expressed on any external websites or any liability arising from investment decisions you may make. You should seek professional advice if any of the content of this page is unclear.


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