Time to buy the Turkish Lira!

Turkey - political chaos, impotent central bank, dire current account and inflation forecasts, all time low sentiment, brutal sell off in Turkish asset classes, Argentina economic crisis - Time to buy the Turkish lira!

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The past 3 months in Turkey:

(1) Increased Political Risk

Since the June 24 Parliamentary and Presidential elections everything has been a disaster for Turkey.

Politics, both domestically and internationally have not gone well. The new parliamentary cabinet announcements, namely the appointment of Erdogan’s son in law Berat Albayrak as finance minister were met with a lot of skepticism.

There has also been growing concern over Erdogan’s expanded executive presidential powers namely his control over central bank appointments and policy. His outspoken views on the economy have really spooked investors.

Erdogan’s relationship with the western world has become much more strained over recent months. The public spat with Trump over the release of the US pastor Andrew Brunson and tit for tat trade sanctions have led to further aggressive selling of Turkish assets. 

(2) Lack of Cohesive Central Bank Policy

The post-election central bank is now viewed as impotent. It may want to increase interest rates to cool the economy and spiraling inflation but pressure from Erdogan has prohibited it from doing so. The last time interest rates in Turkey were increased was on June 7 (pre-election) at the scheduled Monetary Policy Committee Meeting. One year repo rates were raised by 125 basis points to 17.75%. This proactive central bank action was in response to an inflation report showing that prices rose by 12% in May from a year earlier (note that Aug YOY inflation is 18%)

Central Bank Governor Murat Cetinkaya had a lot of political support at this time from the now ex Finance Minister Mehmet Simsek. I remember Cetinkaya and Simsek being in London at the end of May reassuring investors that the central bank and finance ministry would be ready to act if necessary. They were true to their word. The interest rate hike announcement on June 7 saw the lira strengthen from 4.58 to 4.46 intraday versus the US dollar.

Since June 7 there has been no further rate hikes despite a brutal sell off in Turkish assets. The USDTRY rate has rocketed to a high of 7.10 mid-August and closing yesterday Sept 7 at 6.41. In just 2 to 3 months the lira has been obliterated and confidence in the government and central bank shattered.

(3) Change in the Finance Ministry

During these past months the change in the finance ministry has been a big cause for concern. Ex Finance Minister Mehmet Simsek was well liked and understood by international investors being an ex-Merrill Lynch banker himself. To replace him with Erdogan’s own son in law, Berat Albayrak does smell of nepotism. Despite Albayrak’s lack of financial experience he has spoken well at times but until now there has been no concrete fiscal policy to tackle the problems at hand. Action not talk is required.

(4) Sentiment towards Turkey at an all-time low

Sentiment and policy expectation of the post-election government and president is now pretty much zero. No one understands why the government has let this situation get out of control. This is not an economic crisis. It is a political crisis. Every global investment bank analyst and economist now paints a very grim picture for the country. There is now incredible negativity towards Turkey.

(5) Brutal Sell-Off In Turkish Assets

The sell-off in Turkish assets over the past 3 months has been staggering. The pain has been felt most in the Turkish Lira. The USDTRY rate has jumped more than 70% year to date (3.75 start Jan to 6.41 Sept 7 close) Most of this move has happened post June elections. Turkish bonds have also been out of favour. The 2 year government bonds started the year yielding 13%, then spiked up to 30% mid Aug and closed Sept 7 at 23%. 3-month Bank time deposits have jumped in 2018 YTD from 14% to 23%.

Equities have witnessed more modest falls. The BIST 100 Index has fell 20% year to date but given that prices are denominated in lira you can also say that stocks have dropped by more than 50% in USD terms YTD.

The true change in real estate prices is very difficult to say right now. What is going on in Turkey needs to be filtered down through the system but I think it’s fair to say that in hard currency terms (USD or EUROS) prices are 10-20% lower this year. The financial situation of the seller could mean that properties change hands at a 30-50% discount compared to early 2018 prices.

(6) Crippling Economic Crisis in Argentina

What Turkey didn’t want at this time was another emerging market country blowing up. Argentina’s economic crisis has seen the peso lose half its value YTD versus the US dollar and interest rates were recently increased from 45% to a staggering 60%. It is begging the IMF for money and quickly. This has increased risk aversion across all emerging markets. Over the past weeks fear in Argentina and Turkey has feed off each other. 

So where does Turkey stand now?

Well first of all Turkey is not Argentina. The situation in Turkey is far different to that of Argentina.

The post-election government in Turkey has simply not come to terms with the urgent fiscal and monetary policy measures needed for the country. Erdogan has also been overly aggressive in his foreign policy notably with the US.

The Turkish Government has shot itself in one foot and then shot itself in the other. Could things have been any worse? There have been countless policy blunders/ lack of action. The July 24 MPC meeting decision not to hike rates had probably the biggest negative effect on the lira. Turkey’s standing in the world has taken an absolute battering. There has been an incredible build-up of negativity in a very short space of time.

The big question is will the government and specifically Erdogan learn from their mistakes and adapt and change? Many people will say no but I don’t think Erdogan is that stupid. Turkey stands on the precipice. It needs to act quickly and decisively to avoid a full blown economic crisis. This pending crisis is self-inflicted. 

MPC Central Bank Meeting Sept 13

Next week’s Monetary Policy Committee meeting is arguably the most important ever. It is really the last chance saloon for the central bank to regain any semblance of credibility and independence. Trust in the central bank is rock bottom. Rates have to be increased plain and simple. If not then the lira will most probably see fresh highs against the USD pretty quickly. Surely Erdogan knows this? The financial markets believe that the Central Bank will raise interest rates but remain extremely sceptical. We have been disappointed so many times over recent months with inept policy action.

I believe that rates will be increased by @3%. It should be 5-8% but I don’t believe they will do that much. My whole point for buying the lira now is that even a relative modest rate hike in this environment will signal a change and acceptance from Erdogan that the central bank has to be left to get on with its job and hike rates.

How sentiment in Turkey can change quickly next week?

Well first of all a rate hike next Thursday is a pre-requisite. Without this all bets are off.

Running parallel with Central Bank action there needs to be a clear fiscal plan laid out by Finance Minister Albayrak. Spending must be reined in. No more talking. Action needed.

Also Erdogan needs to be calmer in his foreign relations. The elections are finished. He doesn’t need to be in ‘election rally’ mode anymore. Promote Turkey to the outside world!

What if next week…?

...Turkey surprised the market and aggressively raised rates. This was then backed up with a new fiscal plan and Trump and Erdogan decided to kiss and make up and Pastor Brunson got released?

All are possible and if Erdogan wants this then they will happen. Trump also can change everything in one tweet! Where would the lira go? Well it will overshoot the other way. It will go straight to 5.00-5.50 versus USD and maybe lower (6.41 Sept 7).

I think that we will get a rate hike next week, there will be efforts made by the Finance Ministry and Erdogan will tone down his rhetoric. The lira weakness this year is 70% politically induced, 30% economic. There is a big political vacuum in the lira that could be largely removed.

Overall I remain sceptical but watch out if some positive news starts coming out of Turkey. Sentiment will change quickly. Turkey has problems for sure but I believe it is more in South Africa’s league than Argentina’s.

Don’t forget Turkey is a key member of NATO. It has the second biggest army in NATO next to the US. Turkey is a key geo-political ally for the West. Turkey has considerable US airbases in its country. Turkey can place great difficulty onto Europe regarding the migrant crisis if it wants to. Germany knows this. Funny that Merkel has invited Erdogan over to Germany later this month.

I don’t fully understand the game that has been going on but it is in everyone’s interest that Turkey gets back on track. Turkey has cards to play in this game and if it chooses to play them well then a full blown crisis can be averted.

What to trade ahead of next week’s MPC Central Bank of Turkey meeting, Sept 13?

I wrote last week, August 31 about where to invest. My idea very much remains the same. Stay short term, stay trading the market, save the investment ideas for later.

Buy the Turkish lira, buy bank time deposits, buy Garanti Bank stock.

Change hard currency into lira now and take advantage of the attractive lira exchange rates. Put the lira into bank time deposits and also some stocks for a general stock market relief rally (bank stocks preferred).

A one month time deposit is now paying 23% annualised rate. That’s almost 2% a month. This is now the same rate as the 2 year government bond. Time deposit rates are simple and easy. Also last week the withholding tax rates on time deposits were cut (0-6 months 15% to 5%, 6-12 months 12% to 3% and 12 months+ 10% to zero).

A stronger lira will give an initial pop to the stock market particularly bank stocks but ongoing lira strength with probably limit further gains for stocks. One will counter balance the other. My preferred stock would be Garanti Bank – (GARAN). It’s halved in lira value from its Jan 2018 highs and down more than 70% this year in USD terms. It’s also the stock that all the international funds will buy on a rally.

If the Central Bank and Government are not responsive next week then trade straight back to USD.

For those people looking to buy real estate now then yes there are some very attractive opportunities around now. I can talk more later about specific projects.

For any questions regarding the spectrum of investments in Turkey please just message me on Linkedin.