The financial media cannot find anything better to explain equity market volatility than trade. As such, equity weakness this past week was due to signs that a trade deal with China was looking bleak. But equities rallied on Friday and, by coincidence, Trump tweeted Friday that he is optimistic about the resolving the trade dispute with China. So, Friday’s rally was based on trade hope. Tenuous causality. Like when people put up their umbrellas, it therefore starts to rain.
Not much happened this week, outside of continued volatility on the markets. Whatever your view of the next direction, you could have bought (shorted) the indexes, taken 0.50% to 1.0% in profits and reinitiated the same trade after a pull-back (rally) at least 5 times this past week. Traders are loving these meaningless swings. Investors just need to sit tight.
Price data topped the macroeconomic calendar this week. The CPI for October was in-line with expectations, +0.3% (+2.5% y/y). Import prices, however, accelerated much more than expected for October. +0.5% vs. +0.1% forecast. The venerable Alan Greenspan (yep he’s still functioning at 92) predicting that inflation is set to rise now (for whatever his opinion is worth). Otherwise not much on economic activity this week. Empire Manufacturing came in above expectations for November (and higher than October’s reading) while the Philly Fed disappointed economists, slipping from October. Finally, retail sales improved in October, +0.8% after slipping -0.1% in the prior month. Retail stocks, however, did not take comfort in the pick-up in sales, with the S&P Retail Index falling -4.5% on the week. No change in our economic outlook after this week. Macro data has not weakened enough to foresee a recession within the next quarter.
No, U.S. Out-Performance Was Not To Last Forever
The October swoon in equities has taken on a new dimension. U.S. equities continue to struggle in November while Emerging Market equities are recovering. We had forecasted that EM equities would do better than U.S. equities in 2018 (see our 2018 Market Outlook from last December). So far, year-to-date the MSCI Emerging Market Index is lagging the S&P 500 by about 15%. This is clearly due to the debacle on the Chinese stock market (A-shares now down -19% YTD). However ex-China, we see lots of hopeful signs in the EM space. Despite the heavy weight of China in the MSCI EM Index, Q4 has so far been a victory for EM stocks (which normally fall two-times the drop in U.S. equities in a correction).
We list below the EM markets that we like today.
1.) Brazil
The Brazilian elections resulted a victory for Jair Bolsonaro who is seen as a pro-markets president. The enthusiasm surrounding a business-friendly president has really lifted financial assets in Brazil. The Bovespa had suffered a rough patch in May/June, but has since exploded higher, +25% in the second half of 2018 and is +15.5% YTD (ahead of the S&P 500, +1.7% YTD). The choppy uptrend on the Bovespa is intact.
2.) Asian Tigers
We also have liked the Asian Tigers. We are long both the Philippines and Indonesia. Both stock markets are rallying on optimism interest-rate hikes by both nations’ central banks would help steady currencies, curb inflation and lure back overseas investors. And as U.S. dollar-based investors, we particularly like using our inflated Greenbacks to buy cheap EM currencies. The rupiah is now down -7.8% YTD (even after a rally of +4% over the past weeks) while the peso is down still -5.7% (despite a +3% rally over the past weeks). Since 2012, the rupiah is down -60% vs. the dollar while the peso is down -30% vs. the dollar. Needless to say, as the U.S. pays the price for quantitative easing, (relatively) unmanipulated currencies like the peso and rupiah will recover back to historical levels of parity with the dollar.
3.) Turkey
Financial Crises present generational buying opportunities. Just look at the U.S. post-2009. Turkey was hit by high inflation, rising borrowing costs, and correspondingly rising loan defaults in the past year. However, as we know from the U.S. experience, this situation can be remedied rather quickly by aggressive policy decisions. Turkey is not an economic basket case and Turkish assets at current levels represent an opportunity for a long-term investment.
The Turkish lira paid the price for all of Turkey’s woes: -120% from 2016 to August of 2018. If you don’t buy an asset (that isn’t going bankrupt) down -120%, then when do you buy? More on the lira in the Trade Recommendation section below.
Turkish stocks were also hit hard. Broad market pull-backs like this, whatever the stock exchange, are buying opportunities. What is nice about Turkey is the decorrelation with the U.S.: as the S&P 500 was hitting record highs over the summer, Turkey was plummeting. Then in October, the roles were reversed.
We picked up the MSCI Turkey index tracker (TUR) for our DGR Strategy in the depths of the panic in August (around a price of $19). We have been (and will continue) to play TUR to the upside, exiting on +8% to +10% rallies and buying back on dips. Recall that the TUR reflects both Turkish stocks and the lira. The 2018 high of $45 on TUR means that there is still a long way to go on the upside to reverse the correction in both Turkish stocks and the lira.
Conclusion
The S&P 500 and Nasdaq-100 may or may not have hit their bull market high in October. In either case, we see no reason to allocate to an expensive, fully-valued asset class with much greater downside risk than upside potential. Country outperformance goes through cycles. The U.S. just enjoyed an extremely long and powerful period of outperformance. Now is the time to begin looking for the next outperforming class of equities. We believe that the attractive relative valuations and growth rates make EM markets the next candidate for outperformance. For dollar-based investors, using your dollars to buy cheap EM currencies will offer an additional source of returns over the next quarters and years and provided currency diversification in the event that rising rates and high U.S. debt levels make the dollar unattractive.
Trade Recommendation
In line with our interest in EM stocks, we have been accumulating a Turkish telecom stock since August. Turkcell Iletism Hizmetleri, is far from a household name in the U.S. Turkcell is a digital operator headquartered in Turkey, serving its customers with a unique portfolio of digital services along with voice, messaging, data and IPTV services on its mobile and fixed networks. Turkcell Group companies operate in 8 countries – Turkey, Ukraine, Belarus, Northern Cyprus, Germany, Azerbaijan, Kazakhstan, Moldova. The company has been listed on the NYSE and the BIST since July 2000, and is the only NYSE-listed company in headquartered in Turkey.
Recent financial reports for Turkcell are very solid. The group recorded an all-time high quarterly revenue and EBITDA at the Group level in the third quarter. Group revenues were up +13.6% year-over-year to TRY 5.8 billion. Higher data consumption on the back of 4.5G services, increased usage of digital services, a larger subscriber base with a higher postpaid ratio in Turkey, as well as an increased share of multi-play subscribers on both the mobile and fixed fronts were the main drivers of this growth. Total assets were reported at TRY45.4 billion as of September 30, 2018.
We like Turkcell for three reasons going forward (1) the crisis in Turkey has run its course, leaving an extremely undervalued and attractive lira; (2) the company’s innovative foray into 5G will start getting international attention from investors; (3) in the WMA Fundamental Rankings, Turkcell rises above most other telecom companies, with top-tiered scores in Growth, Value and Yield.
Fat Pitch Buy Post-Crisis
Turkish assets were wiped out indiscriminately during the August financial crisis in Turkey. The lira plunged -90% from January to the August low. Despite the risk-off trade in global financial markets in October, the lira continued to recover from its August low. We believe that Turkey will continue to decorrelate from U.S. risk assets going forward. In a bubblish U.S. market, we are keen on seeking non-bubble foreign companies for the diversification protection in our portfolios.
As shown in the chart below, the lira needs to appreciate another +25% just to get back to its multi-year down-trend line! Note that the chart shows lira per dollar, so a falling curve means lira strength.
In other words, dollar-based investors in Turkcell have an enormous potential tailwind from the currency. Looking at the gap between Turkcell’s shares on the NYSE (in orange, quoted in USD) vs Istanbul (in white, quoted in TRY), we see clearly the currency impact. Yes, the gap between total returns for the two listings is over 50% since 2016!
Technically, the price chart of the Turkey-listed shares is looking bullish. Price has been in a gently upwardly sloping multi-year trend channel since 2006. The recent price fall essentially returned to the lower boundary of the multi-year trend support. The basing action over the past 2-month is likely setting the launchpad for a move back towards the upper end of the multi-year trend channel. The would represent a +50% gain from today’s closing price. If the lira continues to normalize back to its multi-year trend line, the U.S. listed shares could have over +75% upside.
Innovations Will Gain Attention
Turkcell is striving for Turkey to be one of the first countries to use 5G and has recently performed the first live 5G trial in Turkey. According to Turkcell CEO Kaan Terzioglu, the company “reached record speeds in one of the world’s first 5G tests, which took place under the roof of Turkcell. To lay the groundwork for Turkey to be a major player in the field, we are engaged in scientific cooperation with universities and collaborating with the world’s technology giants, all aimed at making Turkey one of the first countries to implement 5G”.
While we don’t think of Turkey as a cutting-edge technology country, Turkcell has in fact established the fastest mobile network of the world, today in Istanbul. This should eventually translate into sales and bottom-line revenue.
Leader Among Telcos
Turkcell’s fundamental scores place the company at the top of the WMA Fundamental Rankings in most categories. We calculate each week 12 key fundamental scores; each score being comprised of several company ratios and consensus estimates from analysts following the company. According to our methodology, Turkcell is one of the few companies that qualifies today as Growth, Value and Yield. In the WMA Stock Screener, we compare side-by-side Turkcell to leading telecom service providers in Europe and the U.S. Below is a screen shot from the Stock Screener page.
Bottom line: investors looking to add a telecom to their portfolios are well-advised to consider Turkcell.
