Stock trading in Turkey on Friday 9th September was up an impressive 37% for the year making this stock market the best performing stock market compared to other global markets. Given that most regions are still underwater in 2022 – including North America, Europe and Emerging markets as a whole – Investors may be wondering what’s behind the Turkey rally.
Let’s start with the facts. Turkey is currently facing record-high inflation, with consumer prices rising a staggering 80% in August compared to the same month last year. President Recep Erdogan, who enjoys unorthodox control over the country’s monetary policy, responded by cutting interest rates to 13% from 14% in July.
This is not the expected way to counter inflation, as you probably know. To combat rising prices, policymakers are usually at central banks to lift, rather than lower borrowing costs, which can have the desired effect of slowing demand. The US Federal Reserve’s interest rate, for example, has been raised four times so far this year, with another hike all but guaranteed after the Labor Department report showed annual inflation remained at a 40-year high in August. Earlier this month, the European Central Bank (ECB) implemented the largest rate hike in its history, raising it to 0.75%.
But Erdogan from Turkey is different. He would prefer to keep the economy running unabated and so the policy rate is currently down about 600 basis points (bps) from August 2021 and a whopping 1,100 bps from June 2019.
Trying to beat inflation in a low interest rate environment
Trying to beat inflation is, in my opinion, the main factor behind Turkey’s rapid stock rally. Turkish investors appear to be pouring money into the country’s stocks to beat inflation, perhaps without heeding fundamentals. Monetary policy is currently being relaxed, government bonds are not enough. (Declining interest rates tend to cause bond prices to rise and yields to fall.)
Again, here are the facts: The yield on the 10-year Turkish bond is currently trading at around 10%, well below the 80% inflation rate. A number of Turkish stocks are now up over 100%, 200% and even 300% in US dollar terms despite historically high year-to-date inflation. Where should a Turkish investor invest his money?
Not only local investors are involved. In the past, foreign investors made up a small minority of all investors in Istanbul-listed stocks. However, according to Bloomberg, many of them ramped up their purchases of Turkish stocks in August at the fastest pace since November.
Extremely low valuations for financial stocks
Another catalyst for the rally could be that Turkish stocks are currently incredibly cheap on a price-to-earnings (P/E) basis. According to JPMorgan, Turkey is currently the cheapest market in the entire CEEMEA region (Central & Eastern Europe, Middle East and Africa). That’s especially true for Turkish banks and financials, which ended August at an extremely low P/E ratio of 2.2 compared to a recent peak of 6.0 in early 2021.
Turkish banks have been in the news in recent months, with at least five of them agreeing to take over Russia’s Mir payment system after the country pulled out of SWIFT (Society for Worldwide Interbank Financial Telecommunications) in response to its invasion of Ukraine . Although Turkey initially criticized Russian President Vladimir Putin for the move, it has refrained from imposing sanctions on a country that resembles the US and Europe. In early August, President Erdogan predicted that paying Turkey in Russian rubles for imported Russian energy would be a great source of financial support for both countries.
He wasn’t wrong. Many Turkish banks had a phenomenal June quarter. Yapı Kredi — the country’s fourth-largest bank — reported net income of $1.3 billion in the first half of 2022, an increase of about 180% from the same six-month period last year. Yapı Kredi rose 96.08% for the year on Sept. 9.