Turkish Stocks Most Expensive Since 2003 Imperil `Crowded Trade'

The highest Turkish stock valuations in seven years and slowest profit growth in the emerging markets are signs the nation’s longest stretch of equity outperformance since 1997 is ending.

The MSCI Turkey Index trades for 2.2 times net assets, the highest since February 2003 relative to the MSCI Emerging Markets Index, data compiled by Bloomberg and MSCI Inc. show. Earnings in the 20-company Turkey gauge will rise 7.7 percent next year, the smallest gain of 19 major developing nations, according to analysts’ estimates.

Turkey’s fastest economic expansion since 2005 and record- low interest rates spurred mutual fund managers to make Turkey their largest “overweight” holding and sent price-to-book ratios to a 10 percent premium over emerging markets, from a 45 percent discount two years ago. Citigroup Inc. and Morgan Stanley say stock pickers are too optimistic and slower profit growth will limit gains after the MSCI Turkey index outperformed the emerging markets benchmark for six straight quarters.

“It’s hard to go any lower on interest rates and the economy is going to decelerate after its V-shaped recovery,” Andrew Howell, Citigroup’s emerging-market equity strategist in London, said in a Nov. 19 phone interview. “Investors are now pricing in much more of a rosy scenario for Turkey than they’ve tended to in the past. The risk is that they’re disappointed in the near term.”

Stock Swings

Howell lowered his “overweight” recommendation on Turkish stocks to “neutral” for the first time since May, saying in an Oct. 28 report that increased foreign inflows have made the market a “crowded trade.” The MSCI Turkey gauge advanced 27 percent this year, more than double the 11 percent gain of the MSCI emerging-market index.

Turkish stocks are known for their sizable swings, with the MSCI Turkey index having rallied 86 percent last year after tumbling 52 percent in 2008 and increasing 41 percent in 2007. The Turkey gauge fell 0.3 percent to 982,428.6 at 5:40 p.m. in Istanbul today, while the MSCI emerging-market index advanced 0.3 percent.

Turkey’s economy is set to expand 7.8 percent in 2010, compared with 10.5 percent in China, the fastest-growing major economy, according to forecasts from the International Monetary Fund. While China will grow 9.6 percent next year, the pace will slow for the Mediterranean nation to 3.6 percent in 2011, below its annual average of 4 percent since 1980, based on the Washington-based IMF’s October projections. Turkey’s economy shrank by 4.7 percent in 2009 as China’s grew 9.1 percent.

IMF Bailout

Turkey was bailed out by the IMF in 2001 after a banking crisis forced the government to borrow more than $40 billion to recapitalize more than 20 failed lenders. The IMF agreement ended in May 2008 and Prime Minister Recep Tayyip Erdogan says he aims to finish repaying the fund by 2012.

Turkey’s slowing economy and a central bank requirement that lenders raise their reserve levels will curb profitability at lenders such as Turkiye Is Bankasi AS and Yapi & Kredi Bankasi AS that account for 60 percent of the MSCI Turkey index’s market value, according to analysts’ estimates compiled by Bloomberg.

Turkey’s central bank increased the level of lira reserves that banks must deposit on Nov. 12 to 6 percent from 5.5 percent and said it may boost the level further because the economy is in danger of “overheating.”

Isbank, Yapi Kredi

Profits at Turkish financial companies jumped 32 percent during the past 12 months as the economy rebounded and a surge in government bond prices increased the value of lenders’ holdings, data compiled by Bloomberg show. The bond rally may falter as inflation forces the central bank to lift its benchmark interest rate next year, Citigroup said on Oct. 28.

The central bank probably will raise its benchmark interest rate by 150 basis points, or 1.5 percentage point, to 8.5 percent by the end of next year to combat inflation, according to Citigroup.

Isbank, Turkey’s biggest-listed lender by assets, may increase profits 1.9 percent next year and Yapi Kredi’s will climb 5.3 percent, according to analysts’ estimates compiled by Bloomberg. That compares with predictions of 23 percent growth for companies in the MSCI Emerging Markets Financials Index. Both Turkish lenders are based in Istanbul.

“Turkey’s banks are an area to be careful in,” Ivo Kovachev, an emerging-markets money manager at JO Hambro Capital Management Ltd. in London, which oversees about $8.5 billion, said in a Nov. 19 phone interview. “They’ve been winners because of good fundamental reasons, but this situation is changing.”

Borrowing Costs

Philippe Langham, who runs the $660 million RBC Emerging Markets Fund, said the outlook for Turkish banks is “very positive” because borrowing costs have declined and they’re better-capitalized than peers.

The average yield on Turkish corporate bonds has dropped to 5.28 percent from 18 percent two years ago, according to JPMorgan Chase & Co.’s CEMBI Broad Turkey Index. The average Tier 1 capital ratio, a measure of financial strength, for banks in the MSCI Turkey Financials Index is 17 percent, compared with 12 percent for lenders in the MSCI emerging- markets index, Bloomberg data show.

Turkish share valuations are about 20 percent too low, based on a model used by Credit Suisse Group AG that ranks countries using price-to-book ratios and returns on equity, a measure of how well management reinvests profits, Sakthi Siva, the Zurich-based bank’s emerging-market strategist, wrote in a Nov. 22 note.

Fund Flows

Emerging equity mutual funds have boosted their holdings in Turkey to the biggest “overweight” position on record, a sign bullish managers have already bought into the market, according to Citigroup’s Howell, who cited data for the end of September compiled by EPFR Global, a Cambridge, Massachusetts-based research firm.

Company analysts are lowering estimates for Turkish profits, cutting their growth projection for the MSCI Turkey Index to 7.7 percent from 19 percent at the start of the year, according to the average of about 475 estimates compiled by Bloomberg. Growth estimates for the MSCI emerging-market index have slipped to 16 percent from 21 percent in January, the data show.

Stock Picking

Turkey’s current-account and budget deficits make the lira vulnerable to declines, eroding returns for overseas equity investors, according to Morgan Stanley strategist Jonathan Garner. The IMF predicts a budget shortfall this year amounting to 3.5 percent of gross domestic product and a 5.2 percent current-account gap. China will have a budget deficit of about 2.9 percent and a 4.7 percent current-account surplus. The lira rose 6.7 percent against the dollar in the past six months.

“It is one of those markets that we would recommend reducing exposure,” Garner said in a Nov. 23 phone interview. He downgraded Turkey to “underweight” from “equal-weight” on Sept. 21.

JO Hambro holds Turkish shares that aren’t in the MSCI index, including Turk Traktor & Ziraat Makineleri AS, a maker of farm machinery, and Yazicilar Holding AS, the Istanbul-based holding company with stakes in beverage and automotive businesses. Turk Traktor, based in Ankara, is valued at 9 times reported earnings and Yazicilar trades for 7.6 times, compared with 11.3 for the MSCI Turkey index, according to data compiled by Bloomberg.

“I’m looking at smaller, more dynamic companies,” said JO Hambro’s Kovachev. “Stock selection is important.”

To contact the reporter on this story: Michael Patterson in London at mpatterson10@bloomberg.net.

To contact the editor responsible for this story: Gavin Serkin at gserkin@bloomberg.net.

Bloomberg reserves the right to edit or remove comments but is under no obligation to do so, or to explain individual moderation decisions.

Please enable JavaScript to view the comments powered by Disqus.