The World economy is shifting to policy normalization after the ultra-loose policy setting of the pandemic era
In 2022, similar to consensus expectations, we expect the World economy to generate growth exceeding the long-term average (which is roughly 3.5%), the disruptions in supply-chains to ease, demand-supply mismatches to diminish, and Global inflation to decelerate somewhat (particularly in 2H22). In reaching these views, we also assume that Omicron and/or other potential variants would not cause harsh restrictions that would lead to a severe slowdown in Global economic activity.
Despite these mild expectations, we do think that inflation in the US may remain well above the long-term targets, which may induce FED to stick to a tighter than expected monetary policy approach, i.e., initiating at least 4 rate hikes starting from March/May accompanied by a reduction process in its balance sheet. This may sure lead to significant market volatility. Yet, we also expect that FED would execute its communication with markets in a professional manner, as was the case in previous years, which would limit volatility. As such, we foresee (assume) that potential market corrections will not revert into a long-term trend.
There are significant risks to this constructive macro scenario
First, new virus variants and/or China’s “zero-Covid” policy may cause long-lasting disruptions in supply chains, which would in the end severely tarnish global trade and growth dynamics, as well as keeping inflation at elevated levels.
Secondly regarding China, the zero-Covid policy, the ongoing glitches in the real estate market and policy actions to transform the Chinese economy from an investment and export dependent structure into a domestic demand and service sector driven one, as well as reduce leverage, may led to a sharp growth slowdown (e.g.: below 5.0%).
Furthermore, most geopolitical risks which had been put into freezer during the pandemic, particularly the hegemony struggle between the U.S. and China, may resurface in 2022 (also considering the election atmosphere in both countries). Apart from that, there is also a significant potential for the relations between Russia and the West to get tense, particularly regarding the Ukrainian conflict, which may have dramatic impact on the World economy, particularly through energy prices.
While the government has reverted to «heterodox» policies, the unpredictable nature of the currency makes it extremely difficult to accurately forecast macro indicators
The government seems committed to heterodox policies, and the CBRT is likely to refrain from rate hikes despite rising inflation. As such, in order to maintain the TL’s stability, the government will stick to the FX protected deposit scheme (its scope may be expanded) and/or new instruments (such as inflation/ gold indexed bills, etc.) may also be initiated.
That being said, parallel to our expectation that CPI inflation may rise further towards 50% by March/April, deposit and loan rates may continue to increase, leading to further divergence from the policy rate. This means that financial conditions may tighten further despite flat or declining policy rate. Yet, as the real rate remains in deep negative territory, the volatility and depreciation pressure on the TL may resurface (though not to the extent in late 2021).
In addition to the strong export performance, we think that deteriorating inflation expectations have caused households to pull forward demand for major consumption goods, which has also been backing the economic activity. Negative real interest rates may reduce savings tendency and lead to further consumption for some time more. Yet, we believe that depreciating TL at some point may lead to a halt in domestic demand (especially for durable goods) as ballooning prices have tarnished the purchasing power of large communities, along with our expectation of a tightening in financial conditions. We also think that this may be accompanied by a stagnation in production activity due to the excessive currency volatility and unpredictability. As such, we sense that 2022 GDP growth may remain well below its potential.
We believe that in case the heterodox policies fail to curb the depreciation pressure on the TL, which may lead to a severe growth slowdown, the option to revert to orthodox policies is still on the table, although the government is likely to refrain from that until the very last minute.
Exchange rate and inflation forecast
In our base case scenario, we project (assume) that USD/TL will hover between 12.50-15.00 levels throughout 2022, ending the year at about 13.50 levels. We would expect YoY CPI inflation rise further to about 50% levels by March/April, and decelerate somewhat in 2H22, with the deceleration to be more pronounced from November onwards, if the stabilization in the TL could be maintained. Based on the mentioned currency forecasts, we would expect year-end CPI inflation at 21.0%. That said, we expect CPI inflation average at above 40% in 2022.
Despite the strong local currency based rally since the beginning of October 2021, Turkish stocks were unable to achieve a meaningful outperformance against the GEMS
Following a 26% absolute return in 2020, the BIST 100 index had returned -5% until the end of September 2021, yet through a strong performance thereafter closed the year up 26%. So far this month, this year, the index is up by 8%.
On the other hand, based on (currency adjusted) relative terms against the GEMS, Turkish stocks have underperformed their peers by 25% in 2021, and by 3.5% since the end of September 2021.
Despite the strong rally, Turkey’s EV/EBITDA multiple discount has widened from 28% three months ago to 38% following the mostly stronger earnings created from the weak currency, thanks to commodities and exporters, as well has higher pricing. Yet, this higher earnings base, along with the higher cost bases of companies, should place Turkey amongst the weakest countries in terms of inflation adjusted EBTDA growth for this year. For 2022, we expect a 7.5% decline in Turkey’s inflation adjusted EBITDA. The outlook for the banking sector also appears to be complicated in terms of margins (due to recently rising funding costs) and asset quality for the year. However, strong core margin and CPI linker based Q421 earnings, along with the BBVA led expected corporate action in Garanti create short term catalysts for the sector, in our view. All in all, we believe the lack of visibility in risk premium should continue and a sustainable performance to help Turkish stocks to close the valuation discount is unlikely for now.
Our target value for the BIST-100 index is 2,625, creating an upside potential of 30%
This upside is based on risk free rates starting with 25% and gradually declining each year based on our macro outlook. We stress a prolonged higher rate environment could create a downside for our valuations.
Model portfolio and stock recommendations
Our model portfolio provided a relative return of 13.1% and an absolute return of 42% in 2021. Since its construction in May 2019, the portfolio has an absolute return of 170% and a relative return of 16.5%.
Excluding Akbank, Erdemir, Petkim, Tofaş, and Turkcell from the model portfolio.
The relative performances and inclusion dates of the excluded stocks are as follows: Akbank: 3%, October 19th , 2021, Erdemir: 118%, March 9th , 2021, Petkim 51%, January 22nd , 2021, Tofaş: 123%, August 2nd, 2021, and Turkcell 3%, April 20th, 2020.
The reason of the exclusion of Erdemir, Petkim, and Tofaş is (1) profit taking and (2) to create room for potential names with better risk/reward. The reason for the exclusion of Turkcell is our view of risk that it may take sometime for the company to pass on higher inflation adjustments to invoices, while continue to believe the stock is cheap and like its longer term value generation capability. Lastly, Akbank is excluded for the inclusion of a banking mix which we find more optimal to own during this period.
Adding, Garanti Bankası, Galata Wind, Indeks Bilgisayar, Is Bank, Kardemir (D), and Sise Cam to our model portfolio.
Following the changes, our model portfolio is comprised of Arçelik, Galata Wind, Garanti, Indeks Bilgisayar, Is Bank, Kardemir, Koç Holding, Mavi, Migros, Sise Cam, Sok, and T. Telekom.
Their reasons for inclusion are discussed in greater detail at the 25th page of this report.
Additionally, further fundamental details of the portfolio constituents are discussed after page 27.
Gedik Invest, Economist Serkan Gonencler
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