Did Turkey Just Save Emerging Market Stocks?

By Aaron Levitt | Updated September 02, 2014 AAA

Emerging market stocks have had a tough time going as of late. Selling in popular developing market funds like the iShares MSCI Emerging Markets (NYSE:EEM) has accelerated in recent weeks. While some of their recent declines can be attributed to investors generally shunning risk as the Fed begins to taper its quantitative easing programs and raise interest rates, other reasons may be a bit more sinister- the devaluation of their currencies.

The flashpoint in this new currency crisis is the emerging European nation of Turkey. Bridging the gap between Europe and the Middle East/Asia, the Turkish economy has boomed over the last few years. Unfortunately, much of that boom has been fueled by high public and private debt loads. And with the Fed about to raise rates here at home, investors have fled the Turkish lira in spades- causing widespread panic in its currency. That contagion has spread to other emerging markets such as Argentina and South Africa.

Yet, sensing the troubles, The Turkish Central bank has made a move to save the lira and potentially other emerging market stocks. While it’s still inning one of this ballgame, investors may want to consider adding some Turkish and other emerging market stocks to their portfolios.

A Huge Rate Increase

The problem for Turkey- and many developing markets- is that they have been forced to keep interest rates low in order to keep economic growth cooking. Meanwhile, inflationary pressures in many EM’s have been incredibly high. With slowing economic growth, political protests and corruption charges in Turkey, the lira has plunged over the last year.

Since December of 2012, the value of a lira has fallen from $0.47 to $0.43 versus the U.S. dollar and more recently plunged by in excess of 5% in the last month. And as Turkish citizens and investors have fled the Turkish lira towards dollars, euros and other currencies, the yields on the nation’s 10-year sovereign bonds popped to nearly 10.5%. Meanwhile, Turkish equities have fallen about 11% this year and 27.3% in 2013. 

However, the Turkish Central Bank may have at least pumped the brakes on the falling lira.

In a surprise move, policy makers announced that they will raise interest rates on overnight loans from 7.75% to 12% and overnight borrowings from 3.5% to 8%. Overall, the move was generally applauded by analysts and will restore some confidence in Turkey and help reduce the capital flight. In the end, the higher interest rates imposed by the Turkish Central Bank should help to stabilize financial markets. 

How To Position Your Portfolio

While Turkey and several other emerging markets- such as South Africa, Russia and Indonesia- aren’t completely out of the woods yet, the recent rates hikes do signal that several of them are prepared to fight this issue. That could be a positive long term sign for Turkey and emerging market equities. However, investors should expect more rockiness in the developing world over the next few months. Prudent and careful bottom fishing maybe in order to strengthen their allocations to emerging markets.  

The obvious play would be the iShares MSCI Turkey (NYSE:TUR). The fund- which was up nearly 66% in 2012- has spent much of its time recently falling hard. The ETF tracks 98 different Turkish firms-including telecom Turkcell (NYSE:TKC). While the fund might seem like a value now, it could still be in for more pain in the upcoming weeks. While the rates will strengthen the long-term stability of the country, the near-term could still be very painful for the fund. Overall, long term investors should put TUR on their watch list.

Another area that has been hurt Turkey’s mess have been emerging market bond funds. Both the iShares Emerging Markets High Yield Bond ETF (NASDAQ:EMHY) and Market Vectors Emerging Markets Local Currency Bond ETF (NASDAQ:EMLC) feature very high weightings to Turkish debt- 14% and 7%, respectively. Both ETFs have plunged as investors fled the lira and its bonds. However, the strengthening of the lira could mean that the funds could finally be approaching a bottom. Investors could use the opportunity to pick some yield. EMHY currently yields 6.05%, while EMLC pays 5.18%.

On the whole, emerging market stocks are now trading at 30% discount to developed market equities when looking at price-to-earnings ratios. That’s certainly a bargain basement valuation. However with more rockiness ahead, investors may want to skip funds like SPDR S&P Emerging Markets (NYSE:GMM) and instead focus on a low volatility strategy in the sector. The iShares MSCI Emerging Markets Minimum Volatility ETF (NASDAQ:EEMV) tracks a strategy that helps reduce the overall “ups & downs” on investing in emerging market stocks. The ETF should investors capture some of the upside, while limiting some of the losses in the market segment. Likewise, the PowerShares S&P Emerging Markets Low Volatility (NASDAQ:EELV) can be used too. 

The Bottom Line

The rate hike in Turkey was certainly a welcome sign for emerging markets. It also highlights some of the major issues in the nations with regards to the Fed’s tapering plans. Ultimately, 2014 could be another year of sub-par gains for the asset class. But longer termed investors could use the opportunity to load up on some cheap emerging market stocks as the year progresses.

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