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.
Fig.1 - TURKEY - Firmly on the podium of Emerging market underperformers
Year-to-date the Turkish stock market and lira have fallen by 47% and 32% respectively, to 31 October 2018
Pictet Asset Management, Factset, data as at 31st October 2018
So what should we make of this market extreme?
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.
Fig.2 - Decisive action from the turkish central bank has had an impact
Turkish CPI (Year on Year changes) and benchmark 2 year government bond yields.
Pictet Asset Management, Factset, data as at 31st October 2018
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.
The key question is at which point the market starts to recognise value in Turkish assets.
Using history as a guide, we think that’s unlikely until next year – the time to buy following previous Turkish crises has been in the first quarter of negative GDP growth. At present, Turkish equity market valuations are historically cheap at around 5.6 times price to earnings compared with a 10 year historic average of around 9.1 times. We think historic patterns will repeat – that Turkish valuations will return to historic trend, which is why we’ve started to increase our holdings of Turkish equities on a tactical basis.
Fig.3 - Turkish equity markets as cheap as they have been in ten years
Price to earnings ratio, forward twelve months, for the MSCI Turkey Index
Pictet Asset Management, Factset, data as at 31st October 2018
Clearly, any investment that has the potential to undergo a severe inflationary debt crisis and 50 per cent devaluation in 3 months merits close scrutiny. But as Howard Marks says, it is the price you pay for assets that determines their risk and ultimate success, not whether they are high quality. On today’s prices, we believe Turkey could represent a fantastic buying opportunity into 2019.
Christopher Bannon, Senior Investment ManagerJune 2018
About
Christopher Bannon
About
Christopher Bannon
Christopher Bannon joined Pictet Asset Management in 2007 and is a Senior Investment Manager in the Emerging Markets Equities team, specialising in Emerging Europe and Russia.
Christopher joined Pictet in 2007, initially as a risk manager before moving across to the Emerging Equities Research team in 2011 specialising in the energy sector across global emerging markets. Christopher started his career in 2005 with Citigroup, where he spent 18 months on the corporate actions desk.
Christopher graduated from Trinity College Dublin with a BA (Hons) in Mathematics and Philosophy and he holds an MSc in Finance (graduated with Distinction) from Imperial College London. He is also a Chartered Financial Analyst (CFA) charterholder.
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