Turkish stocks are cheap – but for a good reason

“I am fully prepared to swiftly destroy Turkey’s economy,” vowed US president Donald Trump last week. Angered by Turkey’s attack on the West’s Kurdish allies in Syria, Trump sent a letter to Turkish president Recep Tayyip Erdogan urging him not to “be a tough guy”. The Turkish strongman responded that he had thrown Trump’s missive “in the bin”.

For all the absurdly theatrical posturing, the reality is that the White House has taken only “milquetoast” measures to punish Ankara, note Keith Johnson and Elias Groll in Foreign Policy. Sanctions against three Turkish officials and the country’s steel industry were little more than a slap on the wrist. Yet with the country’s lira currency already “getting thumped”, it is clear that America could inflict “plenty of economic pain on Turkey” if it wants to.

Repeating past mistakes

Easy credit fuelled a boom that saw Turkish growth hit an impressive 7.4% in 2017. Yet the economy overheated and the good times came to a screeching halt last year when Turkey’s economy tumbled into a financial crisis and recession. The lira slumped by 30% against the US dollar in 2018. This year has only brought more pain, with the currency losing a further 11%. The benchmark BIST 100 stockmarket index is down more than 5% since Turkey’s Syrian offensive raised the prospect of US sanctions. It has fallen by nearly a fifth since early 2018.

Erdogan talks of 5% growth next year, says Laura Pitel for the Financial Times, but the economy will barely grow at all in 2019. The president’s plan is to stoke animal spirits “the way he knows best”: he fired the central bank governor this summer and the new appointee has “slashed 7.5 percentage points” from interest rates over the past two months. More loose money will only lay the foundations for another crisis.

“Turkey’s economy is tanking,” writes Craig Mellow for Barron’s. More easy money will not help the extremely fragile and heavily indebted banking system. The government’s budget deficit could be as high as 8% when you factor in loans guaranteed by state banks, says Cem Karacadag of Barings. Erdogan’s apparent willingness to run the “gauntlet of Western disapproval” is another bad omen. Russia tried a similar approach after it invaded Ukraine in 2014: international investors packed their bags and the Russian economy has struggled ever since.

Very brave bargain-hunters may spy opportunity. On a cyclically-adjusted price/earnings ratio of 8.3, Turkey’s stocks are undoubtedly cheap. Yet with politicians poised to repeat the mistakes that caused last year’s financial crisis and US policymakers debating whether to ramp up sanctions, this market is cheap for a very good reason.