In a slower world, Turkish stocks may shine

Published 13.10.2011 00:00
Updated 14.10.2011 08:55

It's 10 p.m. on a weekday evening and Istanbul's cosmopolitan shopping street, Istiklal, is buzzing with youngsters checking out the latest fashions and phone models. In the noisy bars that dot the district, Turkish beer flows freely.

The contrast couldn't be starker with the slumbering commuter suburb of Beylikdüzü, an hour from the city center. But

cranes and half-built apartment blocks looming out of the dark point to manic construction activity during daytime hours.

Both pictures offer clues to why Turkey's stock market may attract increasing interest as global economic growth slows and weak banking systems in the developed world crimp portfolio investment there.

In a country where per capita incomes are up 40 percent since 2001, consumer hunger for goods and services is explosive. The $735 billion economy grew 8.8 percent in the second quarter of 2011, faster than India's and more than four times the pace of the euro zone. Loans, corporate profits and sales of cars and electronics are still rising at double-digit clips.

Turkey's stock market has lost favor this year, caught up in a general investor exodus from emerging markets and hit by worries that the local economy could overheat and head for a crash. That pushed foreign investors' share of the market to a seven-year low of 62 percent, compared to almost 80 percent a year ago.

In May, foreign investors went underweight Turkish stocks for the first time in three years, a Bank of America/Merrill Lynch poll showed.

But Dilek Capanoglu, chief investment officer for emerging markets at RCM, part of Allianz Global Investors, recently raised its Turkish portfolio allocations back to overweight relative to benchmark equity indexes.

She reckons that at a time when the world is slowing, Turkey is a better place to be than many other developing markets. Like most economists, she expects Turkish growth to cool rather than suffer the kind of bust that characterized the country's economic cycles throughout the 20th century.

And softer U.S. and Chinese economic outlooks may prevent oil prices from rising much above the $100 mark for now -- a boon for Turkey, which imports 95 percent of its energy needs.

"Domestic demand is so strong that even if we have a slowdown globally, Turkey will continue to grow, though at a slower pace," Capanoglu said, adding: "An environment where you have oil prices coming down is a good environment for Turkey."

Capanoglu is not alone. Turkish stocks rose 3 percent last month in dollar terms, while emerging market equities as a group fell more than a tenth. That has helped the Turkey index trim year-to-date loses to 11 percent, while MSCI's EM equity index is down 23 percent.

The explanation is that a slowing world economy tends to be bad news for countries reliant on external demand, such as South Korea, where exports make up almost 60 percent of gross domestic product, or Poland with 30 percent. Both these markets suffered huge outflows last month.

In contrast, Turkey's export-to-GDP ratio is just 16 percent, while 70 percent of GDP comes from household consumption.

Analysts at Morgan Stanley advised clients last month to raise allocations to Turkey at the expense of Czech and Russian stocks, which are more closely correlated to world growth.

"What you have in Turkey is a good growth story that's relatively less dependent on what's going on in developed markets," says Namik Aksel, who oversees almost 3 billion lira ($1.6 billion) at HSBC Asset Management in Istanbul.


Not everyone is a fan of the Turkish market. Some predict the country's economic growth will slip along with global growth to as low as 1.5 percent in 2012 from an estimated 8 percent this year. That would bring Turkey's expansion close to the rate of the euro zone and carry risks for banks, which comprise 54 percent of the stock index.

But it is the current account deficit -- a record 10 percent of GDP -- that causes the most unease among investors, by making Turkey vulnerable to a balance of payments crisis should investment flows reverse dramatically. And equity returns have taken a huge hit this year from the lira's roughly 16 percent fall against the U.S. dollar.

Julian Thompson, who manages $600 million in emerging market equities at AXA Investments, cut Turkey allocations earlier this year and has no immediate plans to buy, even though the current account deficit is expected to shrink next year.

"You are talking of a country that will run a deficit of 6 percent at least," he said. "The combination of weak external growth and domestic growth is not great...For me to buy, Turkish stocks need to be very cheap and they are not there yet."

Yavuz Uzay, head of Turkish equity research at Renaissance Capital, agrees. He notes bank shares currently enjoy a 17 percent premium to emerging market financials on a price-to-book-value basis, while historically they have traded at a 9 percent discount.

"Things are marginally negative in terms of outlook but the banks are trading as though everything were fine," he said.


But many believe a slowdown from Turkey's turbo-charged growth rates could be good for everyone. For one thing, the current account gap should shrink next year to more manageable levels as import growth eases.

Slower economic growth would also benefit the financial sector, Morgan Stanley analysts argue, citing Turkish authorities' recent relaxation of stringent reserve ratio rules for banks that were brought in to curb 40 percent-plus annual credit growth.

Those red hot rates should ease to around 20-25 percent in 2012, analysts predict -- still enviable levels for any country.

Capanoglu of RCM has increased her weighting for Turkish banks, seeing them as a play on still-robust consumer demand.

"Loan growth for next year is still going to be good. Turkish banks have very high return on equity and we have reached a point where net margins are higher than the emerging markets average," she said.

What of the weak lira? Although it worries some fund managers, others are moving to capitalize on the competitive advantage that a cheap currency can bring.

Julian Mayo at Charlemagne Securities is overweight Turkey and especially likes companies such as white goods maker Arcelik and airports operator TAV, which may see gains from the lira's depreciation in the last several months.

He reckons that with the lira down some 20 percent versus the euro this year, TAV will benefit as more foreigners fly to holiday in Turkey rather than Spain or Greece, whose membership of the euro has prevented them from enjoying such currency benefits.

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