The Turkish Equity Markets

There is a common joke that Turkish equity analysts walk around with copies of the Turkish constitution and major (non-economic) laws, so high is the degree to which politics influences the economy and the equity markets. We disagree with the fawning adulation given to political news at the expense of the economic, but such is the Turkish operating environment. Politics will be a major concern for the markets in 2002-2003.

The second most important thing is the economic environment. While Turkey is rebounding sharply from recession, the public sector debt looms overhead like the Sword of Damocles. Its sustainability, coincident with the successful progression of the latest IMF standby, will be crucial.

Rather less important than either of these two other issues is the state of the companies listed on the Istanbul Stock Exchange (ISE).

Political background

We believe the Government will not last another six months.

The over-riding question is: when will the Government go? Since the Government continues despite recent mass resignations - to enjoy a highly comfortable majority this would appear to be a silly question. However, important figures within the coalition (including at least one head of a coalition partner) have called for early elections, and it appears that the Government is on the way out.

We believe there are two scenarios: either the present coalition will call elections itself (in October or November 2002) or there will be a new coalition which will call elections in January to February 2003. The main argument for the current coalition is that one assumes the IMF programme will remain on track. The main argument for an alternative (without the MHP) is that EU-related reforms might be made - and the IMF programme need not necessarily go off the rails.

However, there is uncertainty, and it is unlikely that politics will be conducive to a meaningful and sustained recovery in equity prices until around the election date.

The second question is: do the main parties differ in economic policy and practice? The leading parties in Turkey subscribe to the ideals that go with their political persuasion. The markets have however made them economic liberals. We believe there is practically no difference between them in office (except, of course, we have a high regard for the present Government for going further than many previous ones.) Therefore, no-one will argue for a unilateral dismemberment of the IMF stand-by.

The third question is: which Government would the ISE like? The ISE has generally performed well during the initial days of any government, and then has reacted to economic policy. In figure 1, we can see that no particular party can lay claim to being the favourite amongst investors, although the period of Mr Ecevit's previous administration takes the record for the best performance in the shortest possible time.

We assume history will repeat itself: the market will be in the doldrums until just before the elections, then stabilize. Traditionally, opinion polls have been quite unhelpful and the election result a surprise. After a knee-jerk reaction, the markets then rise.

Economic environment

An abysmal 2001 and recovery in 2002; debt situation intriguing.

This is one of the major headaches for strategists. We find it difficult to forecast developments in 2002-2003; we believe the other market players have the same problem. The result is confusion.

Since this subject is being discussed at greater length elsewhere, we would like merely to present our assumptions:

Essentially, we are looking for a smart recovery in 2002 - under normal conditions we would expect the Government's growth target of 3% to be overshot, though investments decisions in particular in Q3 and Q4 2002 are likely to be hampered by political uncertainty. In any event, we expect the recovery to gain strength going into 2003.

Concerns over the current account should be modest: we would not expect this to spiral out of control in either 2002 or 2003.

Further out, 2003-2004 seems to hold two possibilities: a worsening of the economic environment caused by an unwillingness to proceed with reforms, or a very sharp rebound, with measures introduced in 20012003 finally breaking the vicious cycles in the Turkish economy. We believe that the Turkish Lira will continue to devalue, but not in real terms.

In the economy, the most important factor is likely not to be the level of inflation or the TL rate but whether the public debt can be rolled over.

Worth a commentary all of its own, we believe that the debt will be manageable. Our opinions can be summarized as follows:

The stock market

Unlikely to provide bottom-up support in 2002; 2003 looks much more promising

The recent past

The Istanbul Stock Exchange is a volatile place, and has continued to (over)react to news in the past two-anda-half years.

Looking at the performance since the beginning of 1999, one can ascribe various reasons for the changes in market mood and direction. In the first period (January-April 1999), the caretaker Government led by that veteran of Turkish politics, Bulent Ecevit, first took good care, and then it appeared - after the capture of the PKK leader - that it would do very well at the elections at the end of April. The second period (May-- November 1999), the new Government started negotiations with the IMF, and passed a few reforms. However, the incipient party atmosphere was interrupted by two major earthquakes. In the third period (December 1999-January 2000), the stock market rejoiced in the most comprehensive, IMF-backed economic reform programme that it had seen since the early 1980s. This generally positive mood continued in February-May 2000, but afterwards the market began to drift lower as the pace of reforms slowed. In the fourth period (November-September 2001) the market was wracked by economic crisis and the attack on the WTC. Then began a cautious recovery which the recent upheaval in politics has fully reversed.

Listed companies

Since its inception in 1986, the ISE has grown tremendously, in terms of the companies listed, the total market capitalization, and the daily trading volume. Starting, officially, with 80 companies listed on the market, the ISE has seen a steady increase over the years, and, as of writing, the shares of 306 companies are listed. This number has decreased from 315 since the beginning of 2001, an exceptional occurrence, but not surprising, given the economic environment. The greatest number of companies (32) are in a broad range of textiles, followed by 25 food companies, and 17 cement. These sectors, however, do not account for a substantial proportion of market capitalization.

Market capitalization

The listed companies are diverse, but the largest sectors are banks ($8.7 billion); conglomerates ($5.5 billion); consumer durables (including autos) at $3.3 billion; oil, gas and petrochemicals ($2.6 billion); and telecommunications ($2.3 billion). The market capitalization of the ISE grew exponentially since its founding, rising from under $1 billion to $75 billion by the end of 2000. The devaluation and the generally poor index performance since that time drove the market capitali zation down to $28 billion by the end of Hi 2002.

The single largest company is Akbank, a leading and solid private commercial bank. Turkcell (which holds the distinction of being the sole Turkish company with a full dual listing in Istanbul and New York) ranks second. In addition to banks, conglomerates and oil companies are also well represented among the largest companies by market capitalization.

Fortunately, with the exception of Turkcell and THY, none of these companies is particularly leveraged. Therefore, worries about interest rates or debt levels are unlikely to have a severe impact on the most important companies in the market - and the sample below represents c60% of total market capitalization.

Trading volume

Trading volumes have risen even faster than the total market capitalization. Total trading volume in the whole of 1986 was $14 million. In 2000, this rose to $181 billion (or approximately $750 million per day). In 2001-2002, liquidity has shrivelled: down to US$100 million or less a day.

While this still makes the ISE one of the most liquid emerging markets in Europe, it is scant consolation to starving brokers. In any event, a log scale is necessary to show the development of trading volumes.

Companies' trading volumes in the ISE vary widely, and are not always in line with their market capitalization. As usual, the most heavily traded share in Turkey in 2002 was that of Yapi ve Kredi Bank, and indeed the four large banks made up c1 7% of total daily trading volume.

Earnings dynamics and valuations

2002 is likely to be a better year for profits than 2001 but still poor overall, as companies are only just beginning to recover from the financial losses seen in 2001. We do not expect a surge in operating income either. Therefore industrials are currently trading at a P/E of some 18x, around their historical average. However, we do expect profit growth in excess of 50% in 2003, so these valuations probably have room to rise. EV/EBIT and EV/EBITDA levels are cl 5-30% below their historical levels, which supports our view of the long term attractiveness of the market.

Banks too have been bullwhipped - and their recovery may take longer as the liquidity position has deteriorated after taking significant provisions. With NPLs sometimes in high double digits, banks have taken quite a hit to their equity, which the expected volatility in the markets should do nothing to ameliorate.

In short: equities in Turkey continue to be attractive, but a good performance is likely to be contingent on unexpected good political news.