Trouble In Turkey

The demonstrations that escalated into a political crisis in Turkey over the weekend remind us why emerging markets continue to present extra risks for the international investor. In one day, Monday, June 3, the Turkish stock market plunged 10%, the most in a decade; and Turkish bond yields experienced the largest surge on record. Investors, including Cumberland, headed for the exit.

Until May, Turkey had one of the strongest-performing equity markets in the world. Last year the iShares MSCI Turkey Investible Market ETF, TUR, gained 63+%. By mid-May this year an additional gain of some 15% was registered, in sharp contrast to the underperformance of most emerging-market equity indexes. The Turkish economy grew at a rate of 9.2% in 2010 and 8.8% in 2011, slowing dramatically in 2012 to 2.2% as much of Europe entered recession. The OECD projects growth to pick up this year to 3.1% and to 4.6% in 2014. In 2012 Turkey’s credit rating was raised to investment grade. It looked as if Turkey would continue to outshine its European neighbors.

However, the Turkish equity market had three vulnerabilities. The first was the huge run-up in prices. A market correction was becoming increasingly likely, even though valuations did not look excessive. The second was the heavy concentration of financial firms in the Turkish market, accounting for 50.9% of the holdings in TUR. This means TUR is very sensitive to financial developments impacting the banking sector. This vulnerability became evident in the latter half of May as financial markets reacted negatively to uncertainties about the future moves of the US Federal Reserve and the Bank of Japan. By the end of May TUR had slipped 4.7% during the month. The turbulence in the bond market on Monday, noted above, contributed to the equity market’s sharp fall that day.

The third vulnerability, political instability, surged to the forefront over the weekend, and that was decisive for us. What started as a relatively small protest by environmental groups over plans to eliminate one of the few remaining green areas in Istanbul, escalated dramatically in reaction to an excessively heavy response by the authorities and insensitive rhetoric on the part of Prime Minister Erdogan. Eventually, more than ten thousand demonstrators gathered in Istanbul, and protests spread across the country as the issue became the conflict between the increasingly authoritative and Islamist tendencies of Erdogan’s government and more liberal elements who see threats to Turkey’s commitment to maintaining a secular state.

This conflict within Turkey has geopolitical importance. Turkey, a member of NATO and important ally of the United States, has a strategic location between Europe, the Middle East and Asia. It shares a border with Syria. The civil war in that country presents significant dangers to Turkey. Iran and Iraq are also on its border. It is not only global investors that will be closely watching developments in this country.

We do not know how this will turn out. Yesterday, June 4, Turkey’s Deputy Prime Minister Bulent, took a more positive approach, apologizing to the victims of an “excessive use of force” at the initial rallies which were “rightful and legitimate.” The President, Abdullah Gul, also was constructive, saying that the protest “message” had been “received”. The Turkish markets settled down somewhat today with the TUR ETF regaining a bit of yesterday’s losses while global markets declined. The Turkish economy and equity market still looks attractive to us over the long run if the country can resolve this cultural conflict. For the time being, we prefer to watch from the sidelines.

BY Bill Witherell