Turkey: Have equities discounted enough?

Pity central bankers in emerging markets. The politicians want low rates (Growth!) Investors like them high (Carry!) In Turkey, though, the groups suddenly agree. Both want a stable currency. So the central bank had full freedom to crank rates up to support the collapsing lira, down 5 per cent in this month alone. A 475 basis point increase in the overnight rate later, the lira has not risen. More cranking to come.

What happens to Turkish stocks? It is unlikely that analysts will have had such a large rate jump in their models. Credit Suisse, for example, had about 7 per cent earnings per share growth for this year, after a 13 per cent drop last year. Those forecasts will go into the bin, and every sector will need re-evaluation.

A simple-minded contrarianism could be dangerous here, however. The temptation would be to snap up the companies hammered by a falling lira. Shares in Aksa Enerji, Turkey's second largest electric utility by market capitalisation ($590m), have fallen 64 per cent in dollar terms over one year. It suffers from rising natural gas prices as the lira falls with gas comprising three quarters of its input. Moreover, the company has substantial leverage with over 100 per cent net debt to equity, two-thirds of which is in US dollars and the rest in euros. But what happens to electricity demand in a new, slower-growing Turkey? Not to mention that the company's free cash flow was already negative.

On both the short and the long sides, one challenge will be to find enough Turkish ideas to hold in a portfolio without taking a strong view on banks, which constitute 55 per cent of the MSCI Turkey index. And if investors find a play, they will have to endure heavy volatility for a while longer. There is only so much Turkcell (defensive, 7 per cent of the index, and a relative outperformer this year) you can carry.

It may be best to simply move on. Investors may have already given up on Argentina - but it is not in the MSCI EM index. Turkey makes up less than 2 per cent of it. Will a bigger market be tested next time?

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