iShares MSCI Turkey ETF: Tracking The World's Cheapest Market

Summary

• Once a quarter, I conduct a review of market valuations around the globe.
• Turkey is currently the cheapest market in the world by many measures.
• Turkey is cheap for many social, geopolitical, and economic reasons, including inflation, currency depreciation, and questionable central banking practices.
• This said, demographic and economic trends are strong, the economy is well-diversified, revenues are growing, and many public corporations have remained profitable despite the inflation.
• Deep value or contrarian investors may wish to consider a position in this out of favour market.

Manakin/iStock via Getty Images

Introduction

Each quarter, I conduct a review of market valuations around the globe using data from MSCI. The purpose of the exercise is to rank the countries of the world from cheapest to most expensive and track these relative valuations over time. The process is often instructive because I’m able to use the data to home in on ETFs that track specific geographies, as well as individual companies within countries of interest.

For the past two years, Turkey has consistently been one of the 10 cheapest countries in the world. In the most recent assessment, the country’s valuations fell to the bottom of the barrel, making its stock market the cheapest globally. For North American investors, the iShares MSCI Turkey ETF (NASDAQ:TUR) is one way to gain exposure to the country.

While there are many reasons for Turkey’s low valuations, I have still chosen to take a position in TUR. My average price is roughly $19.00, and the intention is to hold the position until the country’s valuations and prospects improve. This investment idea is not for fair weather investors, as the ETF carries many social, economic, and geopolitical risks, but patient deep value investors may realize gains in this unloved country over time.

Global Valuation Summary

MSCI’s latest data has been summarized in the table below. The valuation metrics that MSCI tracks include the dividend yield, price-to-earnings ratio, forward price-to-earnings ratio, and price-to-book ratio. From there, I have ranked each country by each individual metric and taken an average rank of all four to determine which countries are most vs. least expensive. Dark green represents the cheapest five countries, with light green indicating the next five cheapest. Meanwhile, red reflects the five most expensive markets, and yellow represents the next five most expensive markets.

Sources: Author’s table pulled from MSCI Index Data as of 06.30.2021, ETF Database ETFs, and ETF Database Countries.

As you can see, Turkey is the cheapest market globally. It ranks first in terms of forward PE and PB, while ranking third for current PE and fourth for dividend yield. Turkey’s low valuation profile is followed closely by Pakistan (PAK), Russia (RSX), Greece (GREK), and the United Arab Emirates (UAE). Other relatively cheap markets include Austria (EWO), the Czech Republic, Malaysia (EWM), Brazil (EWZ), and Egypt (EGPT). Deep value investors attempting to diversify away from North America may wish to look at the ETFs which track these beaten-up geographies. For full disclosure, we have also invested in GREK and have written about that investment here on Seeking Alpha.

It is also worth noting that nearly all stock exchanges (although oddly enough, not Turkey) have much higher valuations than they did a year ago, 18 months ago during the Covid meltdown, and compared to their long-term averages. This means the table above does not capture how over or undervalued a specific market may be versus its historic range.

Why is Turkey Cheap and What Are the Risks?

Turkey is facing a host of economic, social, and geopolitical challenges. On the economic and social front, inflation is running hot, and has been an issue for the country since 2018 when the inflation rate reached over 25%. Though CPI dropped back down in 2019 and 2020, it is once again on the rise and reached 17.5% in June 2021.

Source: Turkey’s annual consumer price inflation index via Trading Economics.

Unfortunately, in my opinion anyway, President Recep Tayyip Erdoğan has made the inflation problem worse. He believes that high interest rates actually cause higher inflation, and dislikes when the country’s central bankers raise rates to deal with the price pressure. In March, Erdoğan sacked central bank governor Naci Agbal after only four months on the job for hiking interest rates more than expected. Agbal was replaced by Sahap Kavcioglu, who holds similar views to Erdoğan. Agbal’s firing represents the third time Erdoğan has dismissed a central bank chief since mid-2019. The revolving door at the central bank casts significant doubt on the institution’s political independence and has further eroded investor confidence in Turkey.

The inflationary pressure, Erdoğan’s unorthodox inflationary view, and the country’s central bank drama have depressed the value of the Lira. 10 years ago, one Lira could purchase USD$0.618. By contrast, today the Lira can only purchase USD$0.115.

Source: Lira to USD exchange rate via XE.com.

This high inflation and persistent currency depreciation have caused negative ripple effects throughout the Turkish economy. Capital flight is a particular problem as domestic money leaves the country and international money stays away. The chart below, provided by Trading Economics, illustrates this point, showing that foreign exchange reserves in Turkey have fallen from a high of nearly USD$120,000 million in 2014 to USD$59,000 million. Though this is an improvement versus late 2020 when foreign exchange dipped to USD$40,000 million, the situation is far from rosy.

Source: Turkey’s Gross Foreign Exchange Reserves via Trading Economics.

A falling Lira also poses significant solvency risks for the Turkish state, which raises taxes in Lira but issues some debt in other currencies, as well as corporations who generate revenues in Lira but borrow abroad. In the absence of tight currency hedging programs, this dynamic can drive companies into bankruptcy and even threaten the financial stability of the state. Though Fitch improved Turkey’s outlook in February to stable, Turkey’s credit worthiness is below investment grade in the eyes of Fitch, Moody’s, and S&P.

Turkey also ranks fairly poorly when it comes to corruption perception, rule of law, and press freedom. In 2020, Turkey ranked 86^th for corruption perception (similar to Brazil), 107^th for rule of law (similar to Iran), and 153^rd for press freedom (similar to Russia). This means transparency in Turkey is low, and legal recourse is difficult. Fortunately, Turkey ranks somewhat better on the Ease of Doing Business Index, coming in at 41^st (similar to France).

Geopolitical watchers will also know that Turkey faces many domestic and international military and political pressures. In 2016, a faction within the Turkish Armed Forces attempted a coup that quickly failed, resulting in mass arrests and strengthening President Erdoğan’s hand. Turkey has had a decades-long domestic conflict with its Kurdish minority, which occasionally spills over into fighting in Iraq, Syria, or both. The ongoing Syrian Civil War has seen Turkey shoulder a massive refugee burden, while also engaging in fighting along its border. Most recently, Turkey volunteered to guard Kabul’s Hamid Karzai International Airport once the Americans complete their withdrawal from Afghanistan.

Moreover, geopolitical relations are often tense. While Turkey is a NATO ally, its relationships with the US, the European Union, and Greece are often tense. In the north, Turkey shares the Black Sea with Russia. To the east, the country shares its border with Iran and Armenia. On the southern border, Iraq and Syria don’t make for the most stable neighbors.

To make a long story short, Turkey faces many economic, social, and geopolitical issues. An investment in TUR or specific Turkish companies is not for fair weather investors, as there are current problems and much that could continue going wrong. On a side note, in 2014 we purchased shares in Alacer Gold, which has since been acquired by SSR Mining (SSRM). The miner operates the Çöpler open-pit mine in eastern Turkey. Since then, we have watched closely as the various dramas in Turkey ebb and flow.

Investment Thesis

So, why invest in iShares MSCI Turkey ETF when the country has so many issues? The main answer is that Turkey is cheap – very cheap. As the table at the start of this article demonstrates, Turkey is the least expensive market in the world today by many measures. Moreover, while many stock markets have seen their valuations climb steeply since the lows in March 2020, Turkey has not. Therefore, in this era of (likely) widespread overvaluation, Turkey is something of a standout. My current plan is to hold, wait patiently for the current situation within Turkey to improve, and wait for valuations to regress to the mean. This waiting could be a long game though, and as with all things in investing, a positive outcome is not guaranteed.

When investing, I try to remember to use the “outside view” instead of the “inside view,” as suggested by Daniel Kahneman in his books, including Thinking, Fast and Slow. Those who take the inside view focus on the specifics of the situation and use that information to predict outcomes. By contrast, those who take the outside view focus on comparing the situation’s characteristics to a broader data set. While taking the inside view is intuitive, Kahneman argues that taking the outside view results in more objective insights and better outcomes.

Applying this to investing, and to Turkey and TUR more specifically, taking the inside view would focus only on the risks outlined above and use that information to draw conclusions. By contrast, those taking the outside view would contextualize Turkey’s valuations and situation within a broader historic valuation picture, and (likely) conclude that as cheap securities generally beat expensive securities, the odds favour TUR.

Source: Seeking Alpha’s Sectoral Breakdown for TUR – July 2021.

Aside from recognizing the simplicity and power of investing in cheap securities as an investment thesis, Turkey has a few positive features to consider too. Demographics and economic growth trends are more favorable than its Western allies or even East Asian peers. The ETF is well-diversified across materials, financials, industrials, and consumer defensives as well.

Source: Author’s table pulled from Morningstar’s Key Ratios tab for Bim Birlesik Magazalar AS, Eregli Demir Ve Celik Fabrikalari TAS, Turkiye Garanti Bankasi AS, Akbank TAS, and Turkcell Iletisim Hizmetleri AS.

Perhaps most importantly of all, many of the ETF’s holdings are growing their top lines and have maintained healthy profitability despite Turkey’s inflationary pressures. The table above summarizes the revenue and net margin trends for TUR’s top five holdings (OTCPK:BMBRF, OTCPK:ERELY, OTCQX:TKGBF, OTCQX:AKBTY, and TKC). These top five holdings comprise 33.6% of TUR, but the top and bottom-line trends are similar for many of TUR’s smaller positions as well.

The importance of growing sales and maintaining profitability during an inflationary period is hard to ignore. Though the market is unlikely to value this fairly while inflation is climbing, when inflation does fall, uncertainty will subside, discount rates used in discounted cash flow models will drop, and the companies within the ETF should see their valuations jump.

Conclusion

Each quarter, I review market valuations around the globe to get a sense of which countries are hot and which are undervalued. Turkey is currently the cheapest market in the world by many measures, and unlike many countries, its valuations have not improved since major exchanges bottomed in March 2020. Turkey’s low valuations are reflective of many social, geopolitical, and economic issues including inflation, currency depreciation, capital flight, and questionable central banking practices.

Though an investment in Turkey via TUR or any of TUR’s components is risky and not for the faint of heart, deep value investors may benefit from a position in this unliked market. The country’s demographics and economic growth trends are strong, the economy is well-diversified, and many of the country’s publicly listed corporations are growing revenues and maintaining profitability in the face of stiff inflation. As a result, I have taken a position in TUR with an average price just over $19.00.

Disclaimer:

The opinions expressed – imperfect and often subject to change – are not intended nor should be taken as advice or guidance. The information enclosed in this article is deemed to be accurate and reliable, but is not guaranteed by the author.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of TUR, SSRM, GREK either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.