Financial Insights

Turkey’s “New” Leadership

Turkey’s equities rallied an impressive 22.01% over the last 30 days through June 8th in local currency terms, reflecting investor enthusiasm following the election.  This continues an impressive run for Turkey stocks, measuring 578.82% or 46.64% annualized return for the trailing five years, measured in Turkish lira.  Initially, the market believed President Erdogan would lose to opposition leader Kemal Kilicdaroglu, a candidate vowing economic reform.  Although the reformer lost the runoff, market hopes were not dashed, as President Erdogan unveiled his new cabinet, including new Treasury and Finance Minister, Mehmet Simsek, a former economy chief known for his market-friendly policies.  Many international investors, seeing the market momentum, and policy shift potential, believe now is the time to buy Turkish stocks.  We disagree.  We’re reluctant to add a Turkey-based investment to our International and Global portfolios.  We remain skeptical about a meaningful and sustained improvement in the country’s business climate.

It’s easy to understand why the market welcomes Mr. Simsek.  The hope, of course, is that he’ll forge a more responsible economic policy, including a more orthodox approach to taming almost out-of-control inflation.  President Erdogan, perplexingly believes raising interest rates adds to inflationary pressure. Accordingly, he regularly appointed central bankers who promised to cut rates in the face of surging prices.  Unsurprisingly, this had disastrous consequences.  The annual inflation rate exploded from 8.5% in October 2019 to over 85% three years later at October 2022, before easing back to a still alarming 40% recently.  You can imagine what this did to the lira.  The hapless currency plummeted against the US dollar.  It requires 22 lira to buy a dollar today versus less than 4.5 in June 2018.  Thus, for US investors, Turkey’s optically impressive 578.82% local currency return, mentioned above, translates to a much more pedestrian 29.91%, or 5.37% annualized return in dollar terms, an unimpressive equity result which is below the global index averages for this five-year period.  Looking forward, we understand Turkish investors may need to plow money into local equities, since little else provides an opportunity to beat inflation, but we believe US investors have better options.

True, the country has potential, and we’ve successfully invested in Turkish names in the past.  Serving as a bridge between Europe and Asia, Turkish companies capture significant trade opportunities.  Many well-run corporates thrived, benefiting from a younger, well-educated, skilled, lower cost, enterprising workforce, and an advantaged tax code.  Further, only a decade ago, Turkey’s macro environment was lauded as one of the best in the emerging markets universe.  Leadership provided a stable environment, having a progressive, secular reputation with advanced democratic institutions.  The country was thought to provide a calming hand over the more radical Middle East countries, a characteristic appreciated by the West, especially given the dependence on crude oil from this part of the world.  Confident in Turkey’s economic performance, international investors historically directed significant capital into the country.  Unfortunately, this macro stability deteriorated, and confidence evaporated, much like Kemal’s lead in the polls.  What happened?  Simply stated, the country’s AKP party led by President Erdogan shifted to more authoritarian rule.  This resulted in policy makers at the central bank and other institutions ignoring market signals, resulting in economic mismanagement.  Although many members of the new cabinet show strong free-market credentials, without a change at the top, there is no guarantee leadership won’t again veer away from free-market principles.

Importantly, President Erdogan’s popularity in the West has plummeted.  Eroding the strength of Turkey’s democracy, the AKP party has moved the country toward greater Islamist-based control with less separation between church and state.  Erdogan appears to be using religion and increased military capability to gain greater influence throughout the Arab states of the Gulf.  Examples include Turkey’s direct intervention in the Syrian conflict, growing economic ties to Sudan, and military cooperation with the United Arab Emirates to name a few. Some characterize these developments as President Erdogan’s pursuit of a modern-day Ottoman Empire.  Also aggravating the West, Erdogan positioned Turkey as neutral or maybe better said as pro-Ukraine, but not anti-Russia.  Claiming to support democratic freedoms and sovereignty, in truth, Turkey sees Ukraine as little more than an opportunity to check Russian power and limit Russia’s geopolitical strength, hoping this lifts Turkey’s position of power in the Black Sea region.  While condemning the annexation of Ukrainian territory, and restricting Russia military ship movements through the Black Sea, Turkey is notable in opposing Russian sanctions, purchasing Russia’s advanced weapon systems, and using its NATO power to veto Sweden’s membership.  Turkey clearly does not want to choose sides.  Kemal, by contrast, promised to pivot back to Western Europe and the US, allowing Sweden’s NATO membership, improving human rights, and restoring independence to democratic institutions like a free press.  Considered anathema to Russian leadership, it’s no wonder President Putin was the first to congratulate President Erdogan on his win.

As we all know, Russian equity investors were punished as President Putin, acting on his geopolitical goal of retaking control of Eastern Europe, attacked Ukraine.  Given President Erdogan’s apparent aspirations to become a greater regional power, we’re understandably reticent to get involved.  Although there are many profitable and well-run companies domiciled in Turkey, an attractive stock would not only have to meet our exacting fundamental criteria, it would also have to provide incredibly compelling valuation.  In other words, it would need to trade at a very steep discount relative to our estimate of the company’s intrinsic value, given the higher geopolitical risks.  We characterize these types of investments as “stupid cheap”, but we believe this is necessary to offset the additional, and significant risks inherent in this particular emerging market.  As of today, we do not see any Turkey-based stocks meeting this criterion, and with the country burdened with another five years under President Erdogan, we don’t expect anything to meet our requirements soon.  We’ve been blessed with delivering competitive long-term returns.  Of course, stock selection plays a major role, but the avoidance of poor investments is just as important.

The foregoing content reflects the opinions of Advisors Capital Management, LLC and is subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. Past performance may not be indicative of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns. Securities investing involves risk, including the potential for loss of principal. There is no assurance that any investment plan or strategy will be successful.

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