Dear All,
Just back from third visit from Turkey and I wrote this report on the visit. Michael McKenna did a great job editing this!
Online version (best): Turkey: Lost or found?
- Turkish election risk premium currently priced too high
- China investing heavily in Turkey as Silk Road ramps up
- Fed rate hike delay boosting emerging markets
Turkish assets may be cheap at present, but investing isn't about following
the crowd – it's about getting ahead of it. Photo: iStock
By Steen Jakobsen
As I write this, I am heading back to Denmark after my third trip to Turkey this year. En route, I find myself wondering: why are Turkish assets so cheap?
In a world of depressed yields and expensive equity valuations, Turkey offers plenty of opportunities. Reading international analyses of Turkey, they all mention political risk as the key negative factor and of course the November 1 election is set to be a "critical test"...
Isn't the lesson to be drawn from elections in 2015, however, that the risk premium added on their behalf is too high?
Life goes on
The common denominator for the elections held so far in 2015 seems to be that when the voting is over, life continues unchanged. Even the populist parties seem to fall in line, either directly in a weak coalition or indirectly as supporters of same.
The other lesson, of course, is that incumbent governments tend to weaken but remain in power, not because voters condone their policies or results but because of a lack of real alternatives.
In other words my basic theorem that politics have (and should have) close to no impact on economics while in a low growth, hope and inflation environment seems to have been validated so far. If this premise is true – if elections rarely change the dynamics of business and the economy – we should expect a substantail relief trade after the November 1 vote in Turkey.
Let me stress that at the time of this writing, the polls in Turkey points to a "hung Parliament" which is probably the best result investors can hope for.
Turkey and the Silk Road
Another macro theme that could improve Turkish economic conditions remains the Chinese Silk Road. Turkey will be a big beneficiary of this ambitious programme and as we get deeper into 2016 it should start to show up as investment in railroads, ports and infrastructure ramps up.
The Chinese, of course, do not put premiums on politics and as such are already investing heavily in Turkey while the rest of the world is "thinking about it".
Source: Pippa Malmgren (@DrPippaM)
The tactical investment case
The key to any improvement in Turkey will have to be external factors improving mainly through a slightly weaker USD and the "delay" of the feared-by-emerging-markets Federal Reserve interest rate hike.
Surveys show that the majority of analysts now see the second half of 2016 as the starting point for Fed hikes. The Fed's pause has created a clean technical setup for a tactical long play into year-end.
USDTRY peaked at 3.05/3.06 during the dramatic selloff in August/September:
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Source: Saxo Bank
Long TRY versus USD with a stop loss of 3.0700 is the catalyst/stop loss for an opportunistic play here.
(Another thing to look at here is the real effective TRY rate as measured by the central bank using 2003 as a base; this supports the premise that TRY is cheap when looked at through an inflation-neutral lens.)
Source: The Central Bank of the Republic of Turkey
The more risk-tolerant investor could go for the two-year government bond or even venture into the banking sector where major player Garanti Bankasi just retested its long-term price and valuation low.
Garanti Bankasi five-year chart (in USD):
Source: Bloomberg
The Turkish bond market is paying 11% for two-year government bonds with an inflation rate just shy of 8%, leaving a rich "real rate" of 300 basis points.
Domestic factors still pose some risk
Turkey's domestic factors will remain unchanged to slightly worse in the rest of 2015. The inflation rate spillover/transmission from the weaker TRY should peak in October/November making a 8.2/8.3% inflation print likely before it comes back down.
Overall, I see 7.5% inflation for 2015 and 6.0% for 2016.
Gross domestic product growth should come down after the surprise Q2 print as the Turkish economy is running in a sub-par fashion around 3.0% (versus a 5% potential GDP growth rate).
With no reforms and no new mandate expected from the upcoming election, I expect Turkey to grow by 4.0% in 2016.
Let me end by comparing Brazil and Turkey, two countries which came "online" in emerging markets and have experienced similar development...
Brazilian, Turkish indicators:
Source: Professor Steve Hanke (@steve_hanke)
This table shows how Turkey is leading in GDP per capita but also in unemployment and relative poverty while both nations remains low debt-to-GDP nations.
(One notable difference is that Brazil is, a net commodity exporter while Turkey is a net importer...)
Countries like Brazil and Turkey remain important for the future of global growth due to their demographics, their rising middle classes and their ability to catch up on wealth.
For now, Turkey is certainly not lost and it has been found – at least by me – but I hasten to add that it's so far a "tactical" rather than a long-term position.
I remain optimistic, however, that in the long term Turkey could join the "Champions League of economies" where it belongs. As in sport, however, first it needs to get in shape.
Trade recommendations
- Short USDTRY at 2.9100 with a stop loss at 3.07*.
- Long two-year Turkish government bonds at 11.0%.
- Long Garanti Bankasi at 7.60 with a stop loss at 5.00.
(*All trades should be closed if USDTRY trades above 3.07)
The Turkish economy is not in top form quite yet, but a bit of training (and some much-needed reforms) could see it rise to the top of the EM pile. Photo: iStock
— Edited by Michael McKenna
Steen Jakobsen is chief economist and CIO at Saxo Bank
Med venlig hilsen | Best regards
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