Turkey's stockmarket rally has come to a sudden halt

After a 53% surge last year, Turkey's stockmarket has suffered an abrupt reversal. On Monday it slid by 4.2%, the worst daily performance in 17 months. One reason was a report questioning the rally in banking stocks, which account for over half the index.

Credit Suisse warned that new consumer protection laws would crimp banks' income. Meanwhile, some had been expecting a credit-rating upgrade to investment grade, a major milestone for an emerging market, from Moody's, but this failed to materialise.

This setback should remind investors that equities have come "too far, too fast", says Tim Ash of Standard Bank. The price-to-earnings ratio is now above the ten-year average. The index is vulnerable to shifts in global risk appetite because foreign investors dominate it, while the economy is also unusually dependent on foreigners' whims. Banks' external debt is high and rising; they've been turning to the wholesale market for funds. Throw in a recent rise in bad loans amid a recent economic slowdown and "further gains in banking stocks would be hard to justify".

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

The current account deficit has decreased, but only to 6.5% of GDP. So Turkey is in debt to the rest of the world and has to borrow from abroad to fund growth. That leaves it vulnerable to external borrowing conditions, especially if the deficit is financed largely with short-term capital flows such as stock or bond investments, rather than longer-term capital flows such as foreign direct investment.

Short-term financing covers almost 80% of the deficit in Turkey's case, says Hurriyetdailynews.com. So money can easily flow out of the economy in the event of further global jitters, implying a rise in interest rates to make the lira more appealing, slowing growth further. Given this, and scope for global sentiment to sour, steer clear of Turkey for now.