Turkish assets were battered this year, leaving them with exceptionally cheap valuations. Companies with battered valuations are often well placed to rebound sharply. And history shows that badly dented markets returning to the mean is a powerful source of investment returns. But low prices do not necessarily imply high value. During such market conditions, we often align our thinking to one of the axioms of value investing guru Howard Marks: The most important thing – above all else – is the relationship between price and value. This phrase captures what we are concerned with very accurately, and today, when looking at the Turkish market, we ask ourselves: what value is in the price?
Turkey’s woes came from a number of directions – excess debt, an overheating economy, rising inflation, war on its borders and, not least, President Erdogan’s authoritarianism, which left investors questioning the independence of the country’s key institutions: the legal system; the central bank; and the press.
Of emerging market economies, only Argentina’s currency and asset markets have done worse year to date.
Turkish authorities are trying to undo some of the damage they caused. Fiscal stimulus and an ever widening current account deficit pushed the envelope too much last year with the central bank ultimately found wanting when tested. It took bond yields to blow out to some 30 per cent and the currency to collapse for the central bank to stop the rot.
But when it finally acted, it did so decisively, hiking rates 625bps. Along the way, it recovered some much needed credibility. The currency has since stabilised, while bond yields have retreated somewhat.
As a consequence of the policies, we think it’s likely that Turkey will slip into recession over the next twelve months. This should bring the country’s current account back under control – the deficit has already shrunk sharply. Assuming that both the finance ministry and central bank stick to prudent economic management, and that the banking system avoids any contagious large scale deterioration in asset quality, it seems possible that Turkey will avoid having to impose extensive capital controls to stem further capital flight.
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