Will This Country Be The ‘Silk Road’ Of The 21st Century?
The Bosphorus River, which divides the eastern and western sections of Istanbul, is also thought of as the dividing line between Asia and Europe. Indeed, that location has enabled Turkey to develop strong trading relationships in every direction.
As the global economy rebounded from the 2008 crisis, Turkey’s fast-growing role in world trade helped the country lure massive sums of foreign money, which led to 9% GDP growth in 2010 and again in 2011.
#-ad_banner-#Then, the Turkish miracle abruptly ended. Inflationary bottlenecks appeared in the economy, eventually leading central bankers to boost interest rates to nearly double-digits. And the frenzy of investments led Turkey to run large trade deficits, leading economists in 2013 to categorize the country as one of the “Fragile Five.”
Adding insult, local trading partners, such as Egypt and Syria, saw their economies collapse amid political upheaval. And Europe, which had been making overtures about an eventual Turkish entry into NATO, dimmed its ardor for the country, and the prospects of an imminent NATO entry have since vanished.
Fast forward to the third quarter of 2014, and the Turkish economy is growing at just a 2% pace, which economists believe will mark the bottom of the cycle. Meanwhile, inflation is another concern, hovering just below 9%. The bleak current environment may explain why the Turkish stock market is among the cheapest in the world: According to Bloomberg, the Borsa Istanbul 100 index trades for just 10.3 times projected 2015 profits.
In just the past few months, a series of events have played out that will help the Turkish economy stabilize in coming quarters and perhaps boom in coming years.
Though Turkey has expressed concerns about Russia’s increasingly expansionist tendencies, the country has maintained an official stance of neutrality. That may help explain why Vladimir Putin recently announced a desire to build a natural gas pipeline to Turkey in lieu of a planned pipeline to the Europe Union, which looked increasingly less likely as tensions worsened between Russia and Europe. Russia is also promising to send that gas to Turkey at a 6% discount to current market rates.
Lower gas prices would be a clear help. The country already spends $55 billion a year on energy imports, equating to 6.5% of GDP. Of course much of that energy tab is related to crude oil as well. And the sharp plunge in oil prices will also yield a solid windfall for the Turkish economy. According to Turkish finance minister, Mehmet Simsek, every $10 drop in the price of oil has reduced Turkish import costs by around $5 billion.
The savings are helping Turkey in a pair of important ways:
First, it helps the country tame a large trade deficit, which is one concern that global investors have expressed in recent years.
Second, it will lower inflationary pressures, enabling the Central Bank to end its rate hike campaign and begin to cut interest rates. It will be a slow process, likely taking place over a number of quarters, but by 2016, the Turkish economy will no longer be restrained by this interest rate headwind.
By the time that scenario plays out, do you think the Turkish stock market will still be trading for around 10 times forward earnings? If Turkish corporate growth rebounds in tandem, then the answer is no.
As it stands, market analysts think Turkish profits have already bottomed out this year and will rise a solid 14% in 2015. It’s too soon to speculate on 2016 profits, but that’s not how you should be thinking about emerging markets like Turkey anyway. Instead, focus on the longer-term dynamics. And few countries possess the infrastructure and regional positioning that Turkey has.
Meanwhile, European governments are realizing that they may have erred in pulling away from this dynamic economy. A delegation from Brussels arrived this week to seek ways to strengthen ties. That’s welcome news in Turkey, which still aims to become one of the top trade-oriented economies.
Agreements with Russia, Europe and its own Middle Eastern backyard may help Turkey to be the “silk road of the 21st century.”
Risks To Consider: The battle with ISIS has had only a tangential impact on the Turkish economy thus far, but if the conflict expands, then it could destabilize the Turkish economy.
Action To Take –> The best time to invest in any emerging market is when economic growth has bottomed out and inflation rates have peaked. That appears to be the case in Turkey, as rates should move slowly lower in 2015, right at a time when other economic headwinds start to abate. Economists think the economy will grow around 3% this year, rising toward the 4% mark in 2016. Looking out into the later part of the decade, Turkey is capable of 5%-to-7% annual GDP growth, a rate that the U.S. and European economies may never see again. Measured against the current low price-to-earnings ratio, that makes this a great time to further research investing in Turkey.
The best way to invest in Turkey: iShares MSCI Turkey ETF (NYSE: TUR), which carries a 0.61% expense ratio. The fund has a 43% weighting in Turkish banks and another 25% spread across consumer and communications firms. The fund has delivered a mere 4% annualized gain over the past five years, underscoring the country’s recent economic challenges. But that recent relative underperformance (to developed market indexes) may set the stage for eventual outperformance, considering the zigging and zagging nature of emerging market returns relative to the U.S. and Europe.
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