Markets weren’t pleased with the results of Turkey’s election.
Incumbent president Recep Erdogan, whose ultra-expansive policies have yielded 45% annual inflation and halved the lira’s value over the past two years, won more than 49% of the first-round vote. That made his victory over reform-minded challenger Kemal Kilicdaroglu all but certain in a runoff two weeks from now.
The
iShares MSCI Turkey
exchange-traded fund (ticker: TUR) slid by more than 7% on Monday. The lira fell half a percentage point against the dollar.
With good reason. Erdogan, at age 69 and after 20 years in power, seems unlikely to abandon his unorthodox belief that high interest rates cause inflation, rather than combating them. His erosion of civil liberties and wink-and-nod attitude toward Russian sanctions have wilted the enthusiasm of European investors who used to offset Turkey’s chronic current account deficits.
The Turkish central bank’s net foreign reserves are at a record low of –$68 billion, says Blaise Antin, head of sovereign research at TCW. “Erdogan will either have to adjust interest rates higher or let the currency adjust lower, and it’s unlikely that he’ll raise interest rates,” he says.
Yet investors who don’t mind playing with some fire may find ways to make a quick buck in Turkey.
One way is through the country’s hard-currency bonds, most of which are yielding between 9% to 10% annually, Antin says. Chances of default look low, even with five more years of Erdogan. “There are other single-B sovereigns out there that offer higher yields, he says, referring to Turkey’s credit rating, one notch into junk. “But they don’t have Turkey’s strong repayment history, favorable public debt ratios, or diversified economy.”
The Turkish lira could also be a profit engine, for a while. Over the past half year, it’s settled into a slow, smooth decline that is more than offset by local interest rates.
Aaron Hurd, senior currency portfolio manager at State Street Global Advisors, figures his firm has earned 10% annualized on lira investments this year: 15% interest carry minus a 5% currency loss. Forwards contracts are currently pricing in a 30% devaluation over the next year. “If the lira goes down 29% over the next 12 months, I still make money,” Hurd says. “That adds some comfort.”
The presumed Erdogan victory actually strengthens the lira outlook in the short term, Antin adds. Markets expected a market-oriented Kilicdaroglu administration to remove the props Erdogan employs for the currency, like forced purchases by state-owned banks. “The market was expecting to see a 15% depreciation over the summer, but Erdogan likes the image of stability that comes with a less volatile lira,” Antin says.
His caveat is that such parlor tricks probably can’t last much beyond this year. Then the lira could lurch downward again.
A sinking currency and galloping inflation aren’t always all bad for stocks either. Turkey’s intermittent equity rallies can be explosive. The market doubled in value in the second half of last year as local investors decided it was their least bad option for defending their savings, says Steven Schoenfeld, CEO of Market/Vector Indexes.
An amazing shrinking lira can be a boon to Turkey’s robust export sector, he adds. While the stock index is dominated by domestic-facing names in banking, energy and telecoms, some exporters have wildly outperformed. Shares in industrial conglomerate
Koc Holding
(KCHOL.E.Turkey) have surged fivefold over the past two years. Automotive power
Ford Otomotiv Sanayi
(FROTO.E.Turkey) has tripled. “You might want to underweight Turkey, but not zero it out,” Schoenfeld concludes.
None of this makes Turkey’s election good news. A financially stable country, anchored in the West, positioned to thrive as Europe near-shores its formidable industrial base, would be better for Turks, and the world at large.
Bold investors may find silver linings, though, so long as Erdogan holds off the next market calamity. That could be a while yet. James Jeffrey, a former U.S. ambassador to Ankara, now chair of the Middle East Program at the Wilson Center, adapts the famous saying about Brazil to his old turf: “Turkey is the country of the future economic collapse, and always will be,” he quips.
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