Not long ago, the economy was booming. Turkey’s GDP sky-rocketed between 2002-2012. The phenomenal growth caught the eyes of investors from all around the world, and a massive flood of cash started flowing to Turkish assets. Now, those glamorous days are long gone. iShares TUR ETF is losing value every day as the Turkish Stock markets’ gains cannot keep up with the flying USD/TRY parity.
iShares MSCI Turkey ETF (TUR) dropped to all-time lows last week, as markets and the Turkish Lira dropped together. Turkish Lira has been struggling since 2013. Tumbling started with Gezi Protests and fastened with the military coup in 2016. The Turkish Lira is on a free fall since the 2018 Lira Crisis. Recently Lira’s losses grew more due to stubborn monetary policies contradicting the laws of economics.
TUR is holding the biggest in Turkey. It has a remarkably low P/B ratio of 0.99 and a P/E ratio of only 7.76. TUR’s holdings are profitable companies, and their operations grew massively in the time frame. Still, TUR investors lost more than 30% this year, and the past is even more depressing. Investors holding TUR for ten years are down 70%. Currency depreciation, anti-democratic administration, and irrational monetary policies crippled the Lira and destroyed the stock market.
Institutional Foreign investors are the fuel for emerging markets. Without them, the stock market can’t bring remarkable returns to its investors. Foreign investors are hesitant to invest in Turkish Markets despite the extremely low valuations, as they can’t make any gains with the falling Lira. Unless there are fundamental reforms that will secure the Turkish Lira, it is unlikely that TUR will be profitable soon. Looking at the last ten years of the Erdoğan regime, it would be a romantic dream to believe the turnaround is going to happen soon.
Falling Lira and The Monetary Policy
The Turkish Lira is one of the worst-performing currencies of 2020. Lira underperformed even the worst-performing currencies. Argentine Peso and Brazilian Real performed better than Lira. Lira lost more than 41% YTD and nearly 50% in the last year.
Lira has devaluated consistently in the last 15 years, but it gained more momentum as Turkey left Lira investors with negative real interest rates during COVID-19. Turkey saw the global cut in interest rates as an opportunity to decrease the policy rates and stimulate the stagnating economy but pushed it a bit too far and hurt Lira investors. As a result, Lira depreciated over 22% in the last three months. Things were getting back on track with the 200 basis point increase in September. The increase gave confidence to investors as investors assumed Central Bank would continue to increase rates. However, Central Bank surprised everyone and kept the interest rate at the same level in October and caused another round of sell-off.
Erdoğan changed the Central Bank’s head the previous year and accused him of the economic downturn as he was reluctant to decrease the policy rates. Erdoğan said: “Inflation is a result of the high-interest rates.” It does not work for countries that heavily rely on exports. Low real interest rates decrease the demand for Lira. Thus, the currency depreciates, and all the exported materials and goods price increases, and it creates inflation. The government knows it very well, but increasing the rates cools down the economy, and it is bad for the popular vote.
Central Bank Is Powerless
Erdoğan restraints the Central Bank from increasing policy rates. Without the interest rate weapon, Central Bank has a limited effect on the Lira, and it is selling FX and Gold to stop the devaluation of the Lira. Since Turkey is struggling to find FX, it is draining Central Bank’s reserves and not sustainable.
Turks lost their fate in the Lira and rushed to FX as the falling Lira forced Turkish investors to hedge. Now, FX positions of Turks are more than 220 billion dollars, and the number is increasing. Real numbers are way higher as many Turks hold their FX savings in banks’ private vaults or their safe boxes at home.
Central Bank’s net FX reserves fell to 21.8 Billion dollars. In 2010 net FX reserves were 63.5 billion dollars. Currently, it is only 1/3 of what it was. On the other hand, the Central Bank was consistently buying after the 2018 Lira Crisis. For the first time, we have seen the Central Bank as a seller on a monthly basis in September by 45.5 tonnes to hold the Turkish Lira.
Erdoğan’s rule has been a roller-coaster ride, fun in the beginning bumpy, to the end. Turkey is in the middle of many disputes, and it causes foreign relations to be problematic with many nations. Various conflicts created way too many uncertainties for investors to bear. There are tensions with the EU, conflicts with Greece about eastern Mediterranean oil reserves. A handful of disputes with the USA, including the lawsuit of Halkbank. Also, there is the growing Nagorno-Karabakh conflict, and last but not least, active military operations in Iraq and Syria. Most of these problems are a result of the regime’s desire to be a key player in the region, and it creates imponderable risks for the investors.
Lack of Foreign Investment
Populist monetary policies scared foreign investors. Many left Turkey, looking for better opportunities. For the first in history, holdings of Turkish citizens surpassed the holdings of foreign investors in the stock market. Although five hundred thousand new investors entered the stock market, the main reason is the fleeing foreign investors exiting Turkish Markets.
Small-Cap Stocks Are Moving the Market
Foreign investors exiting from the big corporations left these Turkish giants on discount. While the biggest banks and corporations were the top losers of the last couple of years, small-cap stocks were the winners. OTC:KHOLF is the biggest corporation in Turkey, operating in every sector. We can see the parallel movement of KHOLF with the stock market until this summer. However, it recently changed with the speculative increase in small-cap stocks. Some of the small-cap companies increased 10-20 times. These stocks moved by pure speculation, and it is not a healthy sign for the overall stock market.
Furthermore, holdings of TUR ETF are only the large-cap, heavy stocks, and most of these companies underperformed the stock market rallied by small-cap stocks. Looking deeper into the portfolio of TUR ETF, we see more than 20% of it is banks. Banks were the worst performers of this year and hurt the performance of TUR. On the other hand, it is a good sign that BIMAS is the primary holding of the ETF. BIMAS had a spectacular year as sales and revenue grew significantly with the COVID-19.
Risks and Recent News
TUR has been losing for the last ten years, let alone creating Alpha for the investors. TUR’s outlook is bearish, and it is not likely to change until the 2023 elections. Until there are fundamental changes in the economic administration, I do not see a bright future for TUR investors in the long run. Still, the current levels of the TUR are risky to short. TUR is trading around all-time lows, and there is some recent news that can boost TUR in the short term. The Head of the Central Bank has changed by Erdoğan, and it was poor news for the markets. However, Minister of Treasury Albayrak, who is the son in law of Erdoğan, announced his resignation from Instagram. Although resignation is not official, it helped Lira and Turkish Markets. If resignation takes place, we can see the recently formed positive outlook to continue in the short run.
Turkey has various geopolitical risks, and it is unbearable for foreign investors. Devaluation of the Lira is continuing, and it is not likely to stop with populist monetary policies. TUR should be avoided by long-term investors until there is a significant change in Turkey’s outlook. Yet, TUR offers good potential for speculative place due to the volatile nature of Turkish Markets. Investors looking for a safer way to invest in Turkey can benefit from high-yield Turkish Eurobonds. They bring around 5% to investors willing to take the country risk. Even during the terrible financial crisis of the 2000s, Turkey made all the payments to its debtors. Hence, I do not see a high default risk for Turkey in the next three years. Still, it would be a better idea for Eurobond investors to choose short maturity Eurobonds to minimize the risk further.