The Great Turk Fund

Turkish economic forecast gives grounds for optimism

Originally published in the March 2016 issue

Emerging market investors in Turkish equities have been subjected to a roller coaster ride in recent years. Following 90.0%+ gains in 2009, as measured by the MSCI Turkey Index (€: +92.31%; $: +98.49%), which carried on, albeit more modestly, through 2010, the Index has alternated between significant double-digit rises and falls culminating in a (€ denominated) gain of 35.59% in 2014 and a fall of -23.76% last year.

This pattern of alternating returns has prompted chartists to predict a strong showing in 2016 and while I would agree with this forecast, I believe there are many other reasons beyond simple pattern recognition why one of the world’s most interesting emerging markets will and should attract investor interest this year despite the fact that many positive economic and financial indicators are currently overshadowed by geopolitics.

Let’s start with some basic geography. Turkey occupies some 783,000 sq kms, and is thus significantly larger than any European country. The distance, as the crow flies, from Istanbul to Aleppo in north Syria – the current focus of geopolitical concern – is some 890kms, only 45 kms less than the distance from London to Berlin. In other words, Turkey’s financial centre is not physically impacted by the Syrian turmoil although of course investor psychology necessarily takes account of a much larger range of issues than this one linear fact.

The long-contentious question of an independent or semi-autonomous Kurdish homeland remains a major cause for concern despite (or perhaps because of) behind-closed-doors negotiations between Russia and the US aimed at resolving this issue once and for all. For example, at time of writing, Turkey has become at immediate risk of irreversibly losing its influence over the Azaz corridor area which stretches from north of Aleppo to the Turkish border some 45 kms.

The corridor is now closed and the vacuum this has created appears to be filled by the Kurdish Syrian militia forces, the YPD, militarily backed by Russian air power and the Syrian government forces. What concerns investors is Turkey’s likely and probably immediate reaction. Does it want to engage in a war against the YPD which is backed by the US, the Russians and Syrians? This is not a strategy Turkey can pursue successfully in reality. The only option Turkey has is to accept this fait accompli of a Syrian Kurdistan developing alongside its borders if we are to believe (what many think in Turkey, apparently including the government) that such a decision has already been taken by Russia and the US. That said, there is no question that a Turkish/Kurdish accord would be of immense benefit to the country and to its markets.

Even now, and unpalatable though it may be, shares on the Borsa Istanbul have not reacted badly to newsfrom the Syrian war, the suicide bombing in Istanbul and subsequent car bombing in Ankara, and more generally to Turkey’s equivocal stance on the question of Syrian refugees (itself a product of mixed messages from the European Union). Indeed, at a little over six weeks into 2016, the Borsa Istanbul 100 Index was up by some 1.66% by comparison to a fall of -4.33% in the FT-SE 100 Index and -5.58% in the S&P 100 Index.

There are a series of important reasons for this market strength: economic, geopolitical, political and indeed military. Taking the last first it is well to remember that Turkey maintains the second largest army in NATO, after the US and there should therefore be little surprise at the news that defence spending is rising … to the benefit of Turkish arms manufacturers.

Politically, Turkey has entered a period of relative stability following two years of contentious elections which, at the least, sapped investor confidence in the country’s political process and raised questions about the country’s direction of travel: towards more democracy or towards autocracy? Today and foreseeably, President Recep Tayyip Erodogan, has regained the initiative to lead Turkey into the EU and it appears that issues such as the plight of the Syrian refugees are beginning to help that dialogue and, in so doing, are providing a fillip to the market.

Turkey shares borders with eight separate countries: Bulgaria and Greece to the west, Iraq and Syria to the south and Armenia, Azerbaijan, Georgia, and Iran to the east. The current commercial spotlight is on Iran since the lifting of sanctions on the Rouhani regime following the resolution of the international argument about the country’s potential ability to develop nuclear weapons. As the BBC reported on 16th January this year, “lifting the sanctions will unfreeze billions of dollars of assets and allow Iran's oil to be sold internationally.”

The Turks gain two key advantages from this move. Already Turkey’s substantial cement, construction, steel and transport corporations, to name only a few sectors, are actively engaged in developing and rebuilding Iran’s aging infrastructure and there are more contracts on the way. At the same time, the return of Iran’s vast oil reserves, estimated in 2014 at 150 billion barrels, to international trade has already increased downward pressure on oil prices whose current low level is in turn daily reducing Turkey’s current account deficit given this is largely a reflection of the country’s (growing) requirement for imported energy as its economy grows.

Speaking of the Turkish economy, there has been a recent tendency for (foreign) analysts to under forecast growth and thus to contribute to what my team perceive to be a serious undervaluation of the Turkish stock market. 2015 was a case in point. Forecasts came in at 2.5% whereas the reality is much closer to 4.0%, a big number by comparison to the EU as a whole and the Eurozone in particular.

This impressive growth rate is predicted to continue. According to the OECD, Turkey is expected to continue to be one of the fastest growing countries within the OECD membership through 2016. Also, the Turkish government announced its Medium Term Programme (MTP) and hinted at a 4.5% 2016 growth expectation.

A further boost to growth is likely following the anticipated signature, in a couple of months, of a deal between Israel and Turkey for the development of a gas pipeline designed to exploit Israel’s substantial natural gas resources and to deliver these to the Turkish mainland via the Turkish port of Ceyhan in the south-east of the country.

So there are a lot of strong pluses for investors looking at Turkey even though, to many in the outside world, these are overshadowed by the Syrian crisis and uncertainty about the fate of the Kurds. That said, the team at Bruegger Invest, who run The Great Turk Fund, continue to be surprised by thefact that, by many metrics, shares trading on Borsa Istanbul are severely undervalued even by comparison to the weak emerging markets segment as a whole.

For example, a comparison of the MSCI Turkey Index, to the overall MSCI Emerging Markets Index, points out the fact that Turkish dividend yield is, denominated in euros, at end-Feb analysis, 3.32%, compared to 3.01% (MSCI EM Index). At the same time, the P/E on Turkish equities is some 22% lower than emerging market averages.

While I have never been a great believer in lumping ‘emerging markets’ together into one catch-all category, it is reasonable to see these comparative figures, plus Turkey’s economic growth forecasts, as grounds for considerable optimism. And for a range of reasons, only some of which are listed in this article, my own forecast is the Turkish market will rise by some 25% through the course of this year.