Pessimism Starts Paying Off for Turkey Stock Bears

After nine frustrating months, Turkey bears are gaining the upper hand.

Istanbul stocks are heading for the first monthly decline since November 2016, after posting one of the five best gains globally in 2017. This month, the benchmark index has slipped to the world’s worst performance in dollar terms after Qatari stocks as technical signs deteriorate. The pain may just be getting started if a surge in short traders’ bets is any indication.

The reversal implies NN Investment Partners, which has been underweight on Turkey this year, and Hermes Investment Management, which shunned the market altogether, can at last see their bearish strategy beginning to work. The Hague-based NN is shorting Turkish equities in the funds it has the mandate to do so and may increase its underweight position in others.

“Turkey has started to underperform and once it starts, it goes pretty fast,” says Maarten-Jan Bakkum, a senior strategist at NN Investment, which oversees 8.5 billion euros ($10.2 billion) in emerging markets. “It is going well for me for a few weeks.”

The nation’s equities posted the best gains since 2009 for January-August amid a surge in state-backed lending, faster-than-expected economic growth and tempting valuations. The central bank’s tightening policy stabilized the lira, providing an additional boost to the stock market. Analysts’ earnings projections for companies on the Borsa Istanbul 100 Index extended to a record high.

Now, investors are struggling to find a new catalyst to keep the rally going. An 19 percent jump in crude prices this quarter is prompting some to reallocate funds from importing countries like Turkey to exporting nations such as Russia. Inflation is rising and the economy remains vulnerable to sudden shifts in global money flows.

Read More: Commodity Stocks Signal Comeback as Emerging-Market Drivers

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Not everybody is ready to give up on Turkey. The outlook for equities will be shaped by changing expectations for the Federal Reserve’s actions and by Turkish inflation, according to Marko Daljajev, who runs the SEB Eastern Europe Small Cap Fund from Talinn, Estonia.

“Quite a lot has been built into expectations, but if key factors continue to support, then momentum might take us further from here,” he said.

Yet the government’s policy of promoting credit growth may lead to over-lending and undermine the economy, according to Gary Greenberg, who helps oversee about $2.6 billion as the head of emerging-markets equities at London-based fund manager Hermes Investment Management.

“It’s terrible economic policy especially for a country that has a big current account deficit,” he says. “This is not a recipe for a healthy, sustainable economy.”

Greenberg says he owned shares of home-appliances maker Arcelik AS and liquefied-gas producer Aygaz AS, but has sold them.

Short interest in the iShares MSCI Turkey Exchange Traded Fund has jumped to 11.6 percent of shares outstanding as the number of those borrowed to sell short hovers above 1 million, a three-month high, according to IHS Markit data. The Borsa Istanbul 100 Index is below its 50-day mean, with its moving average convergence-divergence line, a measure of momentum, turning negative for the first time since December.

The government’s credit guarantee fund to support lending to smaller businesses and a hefty increase in minimum wage helped Turkey’s economy grow 5.1 percent in the second quarter. While it reinforced a rally that added $90 billion to stock values, it failed to convince bears who were concerned growth isn’t sustainable.

“The market will be prone to bouts of profit-taking,” said Rollo Roscow, a London-based analyst at Schroders Plc who manages the 749 million-euro ($895 million) International Selection Emerging Europe fund and has an underweight position on banking stocks.. “We are concerned that economic policies in Turkey are too focused on short-term consumption.”

— With assistance by Ksenia Galouchko

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