Investors are worried about Turkey. While the country is on the verge of normalizing inflation thanks to a highly restrictive interest rate policy, conflicts along its borders are increasing, and markets fear it is being drawn into the spiral of war in the Middle East.
However, we must face the facts: the authorities in Ankara are being pragmatic, playing their cards right, and taking advantage of these conflicts to gain privileged access to markets that others avoid.
Less risk-averse investors can continue to invest in it. Here's why.
The conflicts will have a limited impact
In a climate marked by uncertainty surrounding global trade, the conflict in the Middle East between Israel and Iran adds an unwelcome layer. Investors are particularly concerned about the impact this could have on energy markets. But the risks are limited.
Weakened by decades of sanctions, Iran is now only the ninth-largest oil producer in the world. It is, therefore, not irreplaceable in this market because other producers are limiting their exports to avoid sinking the price of black gold.
The threat of the closure of the Strait of Hormuz, once the bane of global hydrocarbon markets and the United States in particular, remains.
But the world has changed: the United States is practically self-sufficient in energy, and the bulk of the hydrocarbons that transit through the strait are destined for the East, particularly China and India. Iran has no reason to attack them.
A country surrounded by conflicts
For Turkey, a regional power, this conflict marks opening a new front close to its borders.
To the north, across the Black Sea, Russia and Ukraine continue to fight. In the Caucasus, its ally Azerbaijan defeated Armenia after decades of conflict. To the south, Syria is undergoing a profound transformation following the end of the Assad regime and a war that drove millions of Syrians to seek refuge in Turkey. A prolonged conflict in Iran (home to an estimated 15 to 20 million Turkic speakers) would have similar consequences for Turkey.
So far, it is clear that President Erdogan, one of the strong men in the region, and Turkish companies have managed to hold their own.
By keeping its borders open to nationals (and capital) from both belligerents, it has seen a massive influx of Ukrainian, Russian, and Middle Eastern capital into its banks, stock market, and real estate market.
As a neutral state, it has also enjoyed privileged access to these markets and supplied weapons to several of these conflicts and beyond.
Armament, a sector experiencing strong growth
Over the last decade, the country has developed a very significant arms industry. Today, the 2thTurkey's largest market capitalization comes from the defence sector. Another holding company in many sectors, particularly submarine defence, is among the Top 10. And other major players are present (and innovating) in areas such as drones. Turkey, therefore, has significant expertise in this field.
This is important in today's world. At a time when Europe is preparing a defense that would be less dependent on the United States, Turkey has a role to play. Its arms industry is competitive and present in sectors where European supply is limited, such as drones. It also offers significant production capacity for more traditional weaponry.
Moreover, while European armies are struggling to recruit and have few troops ready for deployment, Turkey has some 355,000 active military personnel, more than France and the United Kingdom combined. This is an abundance of experienced military personnel, which it can mobilize anytime.
Deeper military cooperation would not come without something in return. Erdogan knows full well that his country's entry into the EU will not be easy and will take decades, so this could be financial.
Orthodox policies brought stability
All these developments come as the country is determined to seek some stability. For a time, President Erdogan's stranglehold on the central bank and the latter's unorthodox monetary policies undermined Turkey's credibility among investors.
This resulted in a plummeting currency, skyrocketing inflation, and investors demanding ever-higher interest rates to finance the country, causing significant turbulence in the Turkish market.
Today, the country has returned to more orthodox policies and seeks to rebuild its credibility. Key rates of 46% have helped annual price growth to 35.4% in May, compared to 75% a year earlier. Of course, this is not easy, and household demand has slowed compared to the recent past.
Nevertheless, it remains attractive and is expected to pick up again as inflation is controlled and key rates are revised downward.
Turkey is also diversifying its foreign trade. While its leading trading partner remains Germany, others such as Iraq and the United Arab Emirates are growing rapidly, and markets other than the European Union no longer represent 40% of Turkish exports.
A particular stock market profile
Automotive, arms, electrical, and electronic products—the country has a wide range of products with advanced technological content, which are fueling new sectors of activity. More traditional sectors, such as refined hydrocarbons, textiles, and agriculture, also find buyers in the greater region.
This is reflected in the Turkish stock market. 2015 the financial sector accounted for approximately 40% of its market capitalization. Its share has since fallen to 26%, while industry represents one-third of the MSCI Turkey index.
Diversification at country and investment levels
The unique profile of the Turkish stock market and its exposure to markets and regions that others ignore make it an interesting asset for investors seeking diversification and wishing to avoid the vagaries of global trade or markets heavily dependent on the United States.
However, we stay away from this region in a more balanced strategy and with less volatility despite its merits. See here our current investment portfolio recommendation.