IShares MSCI Turkey ETF: Macro Outlook 2019
Summary
- Weak economic fundamentals between high inflation, GDP contraction, wide fiscal deficit, and political instability highlight challenges of investing in Turkey.
- Turkish Lira has stabilized in recent months but remains vulnerable to renewed depreciation and represents main risk for ADR investors.
- TUR is a good option for investors seeking to gain exposure to local equity market and macro themes but is highly speculative given economic uncertainties.
iShares MSCI Turkey ETF (NYSE:NASDAQ:TUR) is a single country exchange traded fund that tracks the performance of a basket in Turkish stocks. Turkey has been a curious case among emerging markets, always seen as representing enormous potential but more recently plagued by political instability. Occupying its unique place at the crossroads of Europe, Asia, and the Middle East; Turkey was making progress to officially join the European Union until the process largely abandoned since the election of President Recep Tayyip Erdoğan in 2014. The current government has been criticized for perceived human rights violations with turmoil accelerating since a failed coup d'etat attempt in 2016. Following years of strong growth over the past decade, the economy has become more volatile with GDP expected to contract in 2019. This article highlights some of the current macro themes and risks investors should be aware when looking at TUR.
iShares MSCI Turkey ETF monthly price chart. source: finviz.com
Turkey Economic Outlook
GDP is projected to contract by (-0.4%) in 2019 according to the OECD forecast, before a potential rebound to 2.7% in 2020. These numbers are in stark contrast to a growth rate that averaged over 5% since 2010. GDP growth was as high as 11.1% in 2011 at the peak of the commodity bull market and emerging market sentiment. Looking at the projections below, the fall in private consumption by 4.1% this year is set to have a very real impact to the real economy and is already effecting the labor market as unemployment approaches 13%. Gross fixed capital formation, the investment component of GDP, is set to fall 5.6% in part due to pullback from global investors given the greater instability and political environment. With the current pace of a still early-stage recession, the bearish case for Turkey can very well envision these estimates being revised lower.
Turkey GDP Forecasts. source: OECD country report
The possibility of rebound in 2020 will require effective and transparent monetary and fiscal policies, which itself requires a leap of faith. Some of the measures introduced to support the economy and raise revenues have been a cut to natural gas tariffs balanced by a hike in cigarette taxes. The broader concern is the credibility of government policy and direction. In July of last year, President Erdogan named his son-in-law Berat Albayrak as Turkey's Finance Minister, a move that had the appearance of nepotism even if Albayrak was seemingly qualified as a former CEO and the then-acting Minister of Energy and Mining. The pattern over the Edrogan's administration has been a consolidation of executive powers and deterioration of governance indicators which is a key factor in sovereign credit rating. S&P and Moody's have each downgraded Turkey since 2016 to a current (B+, outlook stable) and (Ba3, outlook negative) respectively. Fitch has taken a more constructive view with the highest rating among the major agencies but maintains a negative outlook, rating Turkey BB. Fitch made the following comments in its last downgrade back in July 2018.
Economic policy credibility has deteriorated in recent months and initial policy actions following elections in June have heightened uncertainty. This environment will make it challenging to engineer a soft landing for the economy.
Summarizing the main themes in the economy, a key consideration is the evolution of Turkish Lira currency.
- 2019 economic recession - GDP is expected to contract pressured by weak domestic demand/consumption and falling investment rates.
Turkey economic activity. source: OECD country report
- High inflation - Inflation ended the year 2018 at 22% compared to the Central Bank target level of 5%. The expectation is for the consumer price index to trend towards 15% by the end of 2019, based primarily on weaker economic conditions and a wider output gap in combination with tighter financial conditions. A large part of that forecast is dependent on a stable currency to hold down prices of imported goods. A return of financial market volatility and renewed pressured on the Lira would fuel inflation higher, undermining the forecast.
Turkey consumer price inflation. source: tradingeconomics.com
- The Wide fiscal deficit reached 2.4% in 2018 compared to an average around 1.2% since 2011. The government is targeting a 1.6% deficit this year through austerity measures and cuts to public investment. Regardless of whether the targets can be reached, the fiscal tightening pressure will be painful for the economy. Lower oil prices currently will also pressure the revenue side of the budget. The consensus right now is that the targets will be difficult to reach. There have been rumors of potential need for financial support from the IMF, but this has been dismissed by the current Finance Minister as unnecessary. Recurring fiscal deficits at wider levels of GDP implicate rising public debt; another bearish sign for the Lira.
High interest rates - The Central Bank has had to deal with surging inflation, with their policy response increasing the monetary reference rate aggressively to 24% in January 2019 from 8% in Q1 2018. The impact of higher rates over the past year has been a noticeable slowdown in domestic credit and loan growth with consumer credit actually posting a contraction of 1% year over year in January. This will continue to pressure consume dynamics and investment demand. 
Turkey Monetary Rates and Country Loan Growth. source: Central Bank Turkey
- A Wide Current Account Deficit was likely the main reason the Turkish Lira first came under speculative attack since 2017 as it reached 5.6% of GDP in 2017. The Central Bank, in coordination with the government, is targeting a current-account-deficit-to-GDP ratio of 3.3% for 2020 and a more manageable 2.6% in 2021. The weaker currency along with weaker economic growth will considerably slow import demand and improve the figures from the net export side.
Data by YCharts
Overall, the economic outlook for Turkey remains very complex with a number of uncertainties and policy execution risks. The Turkish Lira depreciated about 28.2% in 2018 but staged a recovery in the second half of the year. The Turkish Lira has appreciated (an impressive) 33% since reaching a low against the Dollar at an exchange rate of 0.1451 ($TRY 6.89 per USD) in August 2018 to the current level of 0.192 ($TRY 5.22 per USD). The recent strength has been based on a cooling perception of political risk even as the macro indicators worsened. Thus far the government and Central Bank are confident current economic weakness is contained and are projecting a quick recovery by next year. On the other hand, any under-performance of expectations or revision lowers to forecast represents renewed pressure on the Lira.
iShares MSCI Turkey ETF
TUR is composed of 56 holdings with relatively good diversification across sectors, especially compared to other country-specific ETFs. The financial services sector stocks represent 28.3% of the fund, followed by 17.2% in industrials, and 15.5% in basic materials. TUR has an expense ratio of 0.59%, in-line with other iShares MSCI family ETFs, while the stated 12-month trailing dividend yield is 4.03%.
TUR ETF top 10 holdings and sector exposure. source: ycharts.com
Among the top 10 holdings that together represent 62% of the ETF, 7 are listed on a U.S. exchange in some form although only 4 have any meaningful daily liquidity. The common theme has been heavy losses in 2018, even as 2019 has thus far staged a recovery along with world equity markets and improved emerging market sentiment. The ETF is down 36.3% over the past year largely related to the currency depreciation over the period among the economic weakness.
Turkey Stocks trading on a U.S. exchange. source: ycharts.com / table author
Turkcell Iletisim Hizmetleri A.S. (NYSE:TKC), commonly known as "Turkcell" with a market cap of approximately $6 billion is up 22% YTD 2019, is the 5th largest holding of TUR with a 7.04% weighting. The telecom service provider has benefited in recent years from the emerging middle-class consumer driving wireless subscriptions and mobile data growth. The company has about 80% of revenues from Turkey and highlighting the important exposure to local themes.
Akbank TAS (OTCQX:AKBTY) and Turkiye Garanti Bankasi AS (OTCQX:TKGBY) are among the largest holdings of TUR and are the largest banking institutions of the country. The currency crisis of 2018 deeply affected the financial sector given banks' relatively large exposure to foreign currency debt particularly in U.S. Dollar. The graph below tracks the normalized 1-year return of iShares MSCI Turkey ETF along with the Turkish Lira to U.S. Dollar exchange rate and the main U.S. traded Turkish ADRs.
Other Turkey stocks in the ETF traded over the counter on a U.S. exchange include Koc Holdings AS (OTCPK:KHOLY), Turkiye Halk Bankasi AS (OTCPK:THBIY), and Arcelik AS (OTCPK:ACKAY) although all appear to be thinly traded, which augments liquidity risk.
Data by YCharts
Takeaway
The macro outlook suggests Turkish equities remain an extremely speculative investment with a number of complexities and unique risks. Investors here are really betting that there's upside in the currency. The bullish case will rely on the belief that the government can effectively manage the economy around this recession. My view is to take a bearish stance on Turkey equities and the Lira at current levels, with more downside likely.
This article was written by
15 years of professional experience in capital markets and investment management at major financial institutions.
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Comments (6)
The problem could come from a weak europe, since it export large portion to Germany and
UK. Just my opinion.