Jules Rimmer has been in investment banking for 32 years, most of it with a focus on emerging markets. Today he is a freelance journalist
A crisis is temporary by nature, but Turks redefine the term to convey a sense of permanence. Turkoparalysis best embodies the feeling investors have of hectic but still economic activity. The economy has struggled for years with skyrocketing inflation, a miles wide current account deficit, a falling currency and a balance of payments emergency. Reasons for surrender are legion.
Then how come the best performing emerging market of 2022 is none other than Turkey? Contrary to forecasts of another year of disastrous returns, Turkey’s XU100 benchmark rose as much as 33 percent in dollar terms and convincingly outperformed its peers, with the MSCI EM index falling nearly 20 percent year-to-date. In a high inflation/weak lira environment, a stock market bounce in local currency terms should come as no surprise, but Turkey’s hard currency return has muddled expectations.
The outperformance was mainly recorded in the summer months with a ~50% rally in the overall index, the main engine of which was a 160% rise in the banking sector. Volumes skyrocketed, hitting an all-time high of $7.6 billion last week. How can this step be explained, despite the deteriorating economic outlook and all investment logic?
Certainly banks were cheap by any standard valuation measure, but they always have been and that didn’t trigger the five-year high. At around 33 percent, the share of foreign owners in the Turkish market is just below its record low. Regulatory changes imposed by the Central Bank of Turkey forced banks to divest highly profitable CPI linkers and invest in local currency government bonds. As a result, the latter’s yields fell by 1,000 basis points and traded through Eurobonds despite the consumer price index being anywhere between 80 percent and 150 percent, depending on who you trust.
Analysts cited these circumstances as possible explanations for the startling rise in share prices. There were other left-wing proposals too: perhaps the hand dab of the Turkish sovereign wealth fund? Retail investors capitulating to crypto and swarming into stocks? However, the likely cause is more mysterious.
Turkish investors who, for legitimate or other reasons, move their assets abroad and reinvest in the stock market have long been a strong factor in asset prices on the Istanbul Stock Exchange. Brokers colloquially refer to them as “the mustaches”. One of them, who rose to fame as The Dude, is said to have been responsible for huge swings in stocks in 2016.
Come summer 2022 and the talk on the spot was of a different shadowy figure. According to market commentators, a speculator placed a series of heavily leveraged bets on single-stock futures in bank stocks in July. These contracts are not particularly liquid. The trades – which started with the smaller banks and initial positions of just TRY 100-200mn – created a bottleneck as arbitrage players exploited the gap between futures and cash.
The derivatives glut coincided with a period of relative stability for the lira, as Turkish President Recep Tayyip Erdoğan negotiated swap deals and loans with the Saudis and the Russians, and Turkey’s outsized base of retail investors desperately chasing the bandwagon.
If rumors are to be believed, the lone punter’s exposure has grown to TRY 20bn, which translates to around 2-3bn paper profit. In a market characterized by regulatory vigilance and overseen by an obsessively panoptic Treasury and Central Bank, these moves simply could not go unnoticed. The approval could be considered at least tacit, if not explicit.
Authorities are quick to shout economic sabotage when the market falls, but have seemingly been fine with it as long as the direction of asset prices is higher. There are hardly any constitutional limits to Erdogan’s power; A freely traded lira is the only thing beyond his control.
The government always welcomes relief from economic pressures, whatever the source. Allowing punters to skim the scum from a bank rally might have softened criticism of the AKP’s astonishingly doltish mismanagement of the economy, if only for a moment.
However, late last week there were signs that even the central bank was uncomfortable with the resulting bubble, and the minimum collateral required for margin positions was raised by 30 percent. Local brokers, who made it easier to execute so-called mustache trades, also increased margin requirements. Suddenly momentum faltered and bank stocks saw continuous limit declines.
Exiting a heavily leveraged position will be more difficult than entering. The cumulative effect of the market turmoil is to deter international institutional investors. The potemkinization of the stock market means that stocks do not reflect economic fundamentals, volatility is forbidding and Turkey only has a 37 basis point weighting in the MSCI EM, money managers can easily afford to ignore the circus.
The outperformance of the Turkish market is an optical illusion. Keep your distance.