The Turkish Stock Market & Economy Are Very Fragile – Here’s How I’m Playing It

Adem Tumerkan March 7, 2018
Category: Research

 

My father once told me,

“Turkey’s the most beautiful place in the world but it’s run by the most wicked of men.

I never knew what he meant until I was older.

The problems going on in Turkey today are personal for me – that’s my ancestry there.

My father was born in Istanbul. He didn’t move to America until his mid-twenties. 

And I’ve lived in Turkey on two occasions.

My name is as classical Ottoman-Turkish as it gets – Adem Tumerkan (pronounced: Ah-dem Too-mare-eh-khan). 

Before I worked in finance, I was vice-president of my fathers supply chain management business Adam International Inc. (no relation to myself – he named it that before I was born – never understood why). Our customers were all based in Turkey.

So I have a lot of experience working and traveling in Turkey. . . 

It is a beautiful country – rich with history, culture, and delicious food.

They are an emerging market and have a very large, proud, and young population.

Many don’t know this, but the country has the second largest military in NATO – right behind the U.S.

 

Besides all this, Turkey’s geo-politics are a mess.

Their history is plagued with coups, corruption, and now led by an Authoritative madman that’s driving a wedge between Turkey and their allies.

But that’s not what I’m writing to you about.

The problem my analysts and I see is that the overvalued stock market, collapsing currency, and huge debt burden are setting off our Macro-Fragility Indicator (MFI).

That’s why I think betting against Turkey offers an asymmetric opportunity and this is how i’m doing it. 

 

First let’s look at Turkey’s debt. . .

 

Turkey’s external debt burden has skyrocketed over the last few years to over $450 billion. This is one of the largest debt burdens of any Emerging Economy.

“So what, everyone is up to their neck in debt.”

True – the world is overleveraged and it’s only getting worse.

But most of Turkey’s external debt burden is denominated in US Dollars and Euros.

As interest rates across the globe have been rising in fears of stagflation – this makes the cost of Turkey’s debt harder to service.

Remember Greece? 

 

Adding salt to the wounds, the Turkish Currency – the Lira – has already lost 50% of its foreign exchange value since 2013 against the USD.

The 2014-2017 US Dollar bull market killed the Lira’s relative value.

February 2018 data shows that Turkey’s annual inflation rate is still above double digits – 10.4%.

That’s 10 cents out of every Lira a Turkish citizen makes.

High inflation has been a big problem there.

Turkish debtors – especially their companies – must now use more Lira’s to pay back the external debt.

And they can’t simply print it because foreign creditors – the external debt lenders – won’t accept Liras. They will tell them to convert it into their currency on the foreign exchange markets.

If Turkey tried printing that balance and converting it to USD or Euros, they would kill their already weakening currency – so this isn’t an option for them.

Turkey is stuck between a rock and a hard place. The way to fight inflation is to raise rates – but if they raise them too much or for too long, they will make their debt burden cost more and send their economy into a recession.

This is where the opportunity comes from. . .

Turkey’s hot housing market is fizzling out.

“The central bank published a report this week showing that residential property prices fell at the fastest rate in five years in September, when taking into account inflation. . .”

The stress of inflation and rising rates is impacting mortgage lending. The number of homes purchased with mortgages in Turkey dropped 20% year over year.

Political turmoil, unsustainable debts and accelerating inflation are pushing away buyers.

But regardless of these problems, the Turkish Stock Market – Istanbul Borsa 100 Index – has soared 55% since the end of 2016.

It’s not a stretch to say there is a bubble in the Turkish stock market.

And I believe there is a steep disconnect between their economy’s fundamentals and how the financial markets are pricing them.

The BIST 100 Index is far too ahead of itself. . .

At the very least there needs to be a steep correction – sooner than later.

There are too many negative catalysts that could be potential “Black Swans” to the very Fragile Turkish economy.

  • Further Lira Devaluation against the USD and Euro
  • A Grossly overheated Turkish Stock Market correction
  • Growing unsustainable debt and rising interest rates
  • Decelerating housing market
  • Conflict in Syria
  • Deteriorating US/Turkish relations

 

That’s why I’m buying long dated, Put Options on the iShares MSCI Turkey ETF (NASDAQ:TUR).

 

Why this ETF?

 

Because 30% of TUR’s index is Turkey’s five largest banks.

Bank earnings are very cyclical. During the ‘boom’ phase (expansionary with low interest rates) of the credit cycle they register inflated earnings. But during the ‘bust’ phase (tightening and rising interest rates) the losses on defaulted loans rise and bank profits get wiped out.

This has happened time and time again. Some big examples are. . .

The 1929 Great Depression. . .

Early 1990’s Savings and Loan crisis. . .

2008 Housing Market Meltdown. . .

 

How I see it, these Puts have two ways to win:

  • Turkey’s housing bubble continues deflating and further weakness in the banking sector and overall economy.
  • The devaluing Lira pushes down the value of the ETF and the high inflation eats away at investors real returns.

 

That’s why I view this trade as positively asymmetric.

The Minimum downside/risk – the Turkish stock market keeps rising and my Puts expire worthless. All that I lose is the upfront premium I paid to own the 1-year Put options.

The Upside potential – very significant if any one of the mounting catalysts hits Turkey – or if the market simply has a correction.

What we’ve learned throughout history is that markets are complex systems – all that it takes is one day to send years worth of gains and growth in a portfolio crumbling. 

Our readers know how important asymmetry and optionality is to my philosophy. Not only for portfolio hedging but too make out-sized returns. 

Don’t have your portfolio in such a fragile position that you will ‘blow up’ overnight if sentiment changes or volatility strikes.

Use optionality to make sure any volatility will benefit you.

 

My team and I have had our Macro-Fragility Indicator alerting us lately of fragile economies, currencies, and markets that are highly susceptible to minor tremors that can send them crashing down.

I’ll have more asymmetric opportunities emailed out to our subscriber list ASAP. . .

 

 

 

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