Turkey’s brokerages faced sharp trading falls in a tough climate last year of which 30% reported losses during the first half. That said, we had seen some downsizing-related layoffs as well as some international investment banks simply quitting the business. While this was partly due to some earnings recession felt in the industry, the underlying reason was that it was overcrowded so that more analysts rate Turkey’s bank than cover Wall-Street based banks.
After having a bad year, Turkey’s brokerage firms appear to showing early signs of a turnaround as ROE sector-wide hit double-digit figures again, also taking the 12-month trailing ROE above 10%. As of Q1 the industry returned 11.5% on total equity (excluding FX companies).
Below is the evolution of the profitability metric across the industry.
Despite the bottom-line improvement, there still seems to be issues related to the trading volume which would weigh on revenues. However, derivatives including FX, index futures and newly introduced warrants continue to help.
See the following report released by Turkey Capital Markets Association for the industry explained in broad strokes.
Turkish Capital Markets: At A Glance
Turkish central bank has been failed to use its monetary policy tools to maintain low inflation. The headline inflation rate has been extremely volatile due to fluctuating food prices, while core inflation has remained stubbornly above the target rate of 5% over the past five years. Recently, Turkish economy has seen a glimmer of hope for inflation as annual CPI growth has lowered to 6.6% by 300 basis points in May from 9.6% in January, mostly driven by the impact of lower food prices which is likely to reverse starting June. Meanwhile, the core indicator known as I-index was up 8.77% on annual basis, down almost 1 percentage point since February. Turkish bond markets have enjoyed the indisputably favorable developments on the inflation front. However, we expect this to come to an end being of the opinion that the long-term trend still signals a high core inflation.
Long-Term Core Inflation Trends
The long-term core inflation trend estimated trend via Hodrick-Prescott filter where lambda value is assumed to be 14,400 as generally accepted while analyzing the monthly data, shows that prices still move upwards in Turkey. More importantly this malign cycle in core inflation is unlikely to finish soon unless the I-index posts large decreases in a short while. With that being said, the cycle, which is shown in dark color and digitized at the right axis, suggests that there still may be some downside potential in the core indicator before a new peak is in the making. We foresee the continuation of the easing in core inflation over the next three months but a high possibility that yearend core inflation rate will be around 9%.
Higher Real Wages to Blame?
One of the most important generalization of the science of economics is that wages are positively related to productivity. And, in a frictionless economy, if wages increase faster than increase in labor productivity, we will have inflation in the economy, equal to that differential. The following is the chart showing how real wages and output per worker has changed since 2010.
In a previous post we addressed the declining productivity as to what underlies the par below growth in Turkey (see it here: Is Productivity in Decline?). It was many years ago when Marx claimed that productivity growth would eventually reduce wages, apparently, if he was alive, he would be extremely astonished to see the relationship of these two phenomena in Turkey. You may guess the gap will wildly widen after the minimum wage hike. Interestingly, higher wages are expected to lead higher productivity for a number or reasons including motivation to work harder, more capable and productive workers being attracted, lower turnover. The theory simply does not work in Turkey. This is a triumph for workers but a defeat for the central bank as well as the economy after all.
The results of Turkish central bank’s survey of expectations released which showed that participants were expecting to see monthly reading of 0.65% in May inflation. Having said that, the year-end CPI growth is now projected at 7.80%, 11 basis points lower when compared to the linked month. 12-month and 24-month expectations almost remained unchanged at 7.81% and 7.14%, respectively.
Considering the fact that a monthly inflation of 0.55% was reported in May 2015, the survey signaled the end of the benign cycle in inflation. Despite a core inflation remaining stubbornly high, the surprising decline in headline inflation painted a rosy picture for the monetary policy outlook. However, the decline was primarily driven by the base effect which now seems be not supportive anymore. Note that inflation in Turkey hit a 3-year low in April at 6.57%. Since we expect monthly CPI growth to be at 0.7% which is 5 basis points higher than consensus, the annual inflation, in our view, should hit 6.75% and finish the easing process.
Meanwhile Turkey 10-years bond is currently trading around 10%, almost 100 basis points higher since the beginning of May. The core inflation around 9.5% keeping real rates extremely low results in a need for a higher risk premium for Turkish bonds. With oil prices set to be higher for the rest of the year and the strengthening US dollar would continue to support a switch between Turkish and Russia ’43 Eurobonds since Turkey’s current account deficit will weigh on the its assets in this scenario.