Market Strategy - Equity Outperformance Set To End - SEPT 2017

  • The recent outperformance of Turkish equities is coming up against rising headwinds and we no longer expect continued outperformance.

  • Following significant gains, the main reasons for being bullish are no longer in place, including technical conditions and sentiment.

The recent outperformance of Turkish equities - in line with a tactical view we put out in February on account of extreme bearish sentiment, cheap valuations, and oversold technical conditions ( see ' Technical Picure Points To Gains Across Asset Classes ' , June 2017) - is coming up against rising downside pressure and we no longer expect continued outperformance. Broadly speaking, monetary tightening since the start of 2017, alongside a more supportive global economic backdrop, has served to bolster investor sentiment and precipitated rising capital inflows, providing a tailwind for Turkish assets. Following significant gains, the main reasons for being bullish are no longer in place, while a recovering oil price provides a renewed headwind.

Break Of Support For The Lira
Exchange Rate, TRY/USD (Daily)
Source : Bloomberg, BMI

Technical conditions are suggesting that the rally is coming to an end. The lira has broken through support ( see chart above), while equities in dollar terms look to have begun topping out having failed to overcome resistance at around 2,900. Furthermore, Turkish equities in USD terms have rallied by over 28% year-to-date, while in local currency terms the uptrend has been even more impressive - suggesting that the rally is increasingly stretched.

Equities Topping Out
Turkey - BIST 100 Index, USD (Weekly)
Source: Bloomberg, BMI

Bearish sentiment towards Turkey has also been reversing in recent months, removing a major tailwind for Turkish assets, and while equity valuations generally remain at a discount compared to emerging market equivalents, they have narrowed from extremes. We have previously argued that we see some discount as warranted in light of the country's deteriorating political and macroeconomic outlook.

Narrowing, But Discount Gap Still Remains
MSCI Emerging Market Index Price-to-Sales / MSCI Turkey Index Price-To-Sale
Source: Bloomberg, BMI

While Turkish equities may continue to outperform in the short term, longer term the country's poor fundamentals will increasingly weigh on Turkish assets. Alongside a deteriorating fiscal position, several macroeconomic imbalances are likely to erode the country's sovereign risk profile in the years ahead. Furthermore, political concerns will remain salient, while questions over the central bank's independence will remain prominent and structurally high inflation is likely to continue.

Primary Balance Deep Into Deficit
Turkey - Central Government Primary Balance, TRYmn, 12mma (IMF definition)
Source: Treasury, BMI

In turn, we see little room from for CDS spreads in Turkey to fall further - as has been the case in recent months - and highlight the possibility that they could start to rise as investors price in greater default risk in Turkey. Already, when we adjust for the higher default risk in Turkey relative to the US, real bond yields are currently around those of the US ( see ' Monthly FX Strategy: Dollar On The Front Foot, EM To Underperform ' , July 6 for a more comprehensive explanation of this measure).