It looks like a contrarian’s dream…
A currency that’s down 28.6 percent against the U.S. dollar over the past 12 months. A stock market that’s down 42.6 percent in 2018. And just months ago, the country’s economic meltdown was all over the headlines for days on end just a few months ago.
And (maybe) best of all: The stock market trades at a price-to-earnings ratio of 6.6… that’s low enough to make it one of the cheapest in the world. That’s even well below the emerging markets average of 11.7 (and the S&P 500’s 17.6… and Singapore’s 12.6).
Terrible sentiment… economic collapse… cheap assets… what’s not to like?
I recently went to Turkey – a country of 82 million people that’s a geopolitical bridge between Asia and Europe, which has averaged annual GDP growth of 6.4 percent over the past five years – to find out.
A picture worth a thousand words
The building below tells the story of what I found.
I stayed in the incredible historical quarter of Istanbul, a stone’s throw (literally) away from the extraordinary Hagia Sophia. During the peak tourist season, the area is overrun with people who are wandering through the cobblestoned streets to visit carpet shops and kebab restaurants, and staying in boutique hotels, at what is one of the true crossroads of centuries of religions, cultures and languages.
And yet… smack in the middle of the neighbourhood, was this (I took this photo from the rooftop patio of the hotel where I was staying)… a decrepit abandoned building that, from the look of it, hadn’t been touched in years.
Perhaps it doesn’t make economic sense to clean up the lot and build something new. And maybe I’m completely mis-estimating the business potential of the area, and perhaps all those tourists passing through the area don’t buy anything. Maybe the owner of the lot can’t be bothered to develop it, or sell it. Or perhaps no local entrepreneurs have noticed the opportunity.
Or… maybe the bureaucracy involved in doing something with it, the number of payoffs and the regulatory challenges associated with creating something new have deterred anyone from trying to make anything of the plot. Too often, when things that should happen given reasonable financial incentives that capitalism allows, wind up not happening… it’s because self-interested bureaucrats and poorly conceived rules have made it almost impossible to make it happen.
And if it’s so difficult to cart away some old bricks and make something new there – well, how difficult would it be to open and run a business? Or, as a minority shareholder in a company, how easy would it be for me to get a return on my investment? Not a good sign.
Buy when things are bad, bad, bad – right?
Things are bad in Turkey. And, from the surface, it’s a contrarian’s dream. All that bad news… all that selling… it can’t be that bad. And… the law of mean reversion means that Turkey is going to bounce back soon. Anything that’s down that much is going to come back, right?
At its core, defying the conventional wisdom – the know-it-all on CNBC, the taxi driver who passes on his hot stock tip – is what contrarian investing is all about. It’s defying everyone else and conquering your gut instinct, which is telling you to run in the opposite direction.
And in particular, it’s the belief that when everything seems pitch-black, when there’s “blood in the streets,” and when everyone else is selling… that’s the time to buy, because things can’t get any worse. And then they get just a bit better, and the brave investor makes a killing.
But sometimes, bad is just… bad
But some investors take contrarian investing to an extreme. They interpret any bad news, or market correction, or stock decline, or literal blood in the streets, as good news in disguise.
That kind of attitude – knee-jerk contrarianism – is a great way to lose a lot of money, because sometimes – and maybe even most of the time – the boring, plain, they’re-all-saying-it conventional wisdom is, in fact, correct.
And I think that that’s the case with Turkey right now.
You see, I think Turkey will always be an emerging market. One of the key characteristics of emerging markets is that individuals, rather than institutions, are what’s most important to a government and an economy.
In developed markets, the rule of law makes sure that things keep working regardless of who is in power. The different organs of government balance each other out. A mostly independent judiciary makes sure that people stick to the rules. Politicians may fight each other and policies might change, but the underlying foundations are strong. Turkey’s foundations weren’t all that strong in the first place. And Turkey’s president, Recep Tayyip Erdogan, has been busy tearing them down.
Since coming to power in 2002, Erdogan has been focused on obtaining more and more power. In June, he was re-elected (in an election that was tightly controlled so he was sure to win) president for another five years and with expanded powers. Now Erdogan has the right to dissolve the parliament, rule by decree and have greater control over the judiciary.
And Turkey is undergoing a structural change – a bad one. The institutional framework that is an essential prerequisite for investment is crumbling. The president can do whatever he wants – and he’s going to continue to do whatever he wants. That kind of unpredictability and uncertainty is investor kryptonite.
Don’t get me wrong. All emerging markets have some problems with the rule of law – that’s why they’re “emerging”. But if an asset is very cheap, it might be worth buying even if the investment environment is lousy.
There are lots of very cheap stocks in Turkey right now. But most of them will stay cheap for a long time – and may well get cheaper. Chances are that Turkey is on the way to being a value trap like Russia… if it isn’t already.
Of course, sometimes an asset can be just too cheap… and that’s an opportunity. But when a market is in the process of re-setting, like Turkey’s is now, finding that opportunity is difficult.
Publisher, Stansberry Pacific Research