Mahfi Eğilmez, one of Turkey’s most important economists, warned stock and housing investors. Eğilmez wrote in his blog: “When the day comes when interest rates must be raised to inflationary levels, stock values and stock market real estate prices, unable to get enough of these records, will this time become insatiable for falls.‘ he warned.
Here is this article by Eğilmez:
In the last year and a half, inflation has increased rapidly in Turkey. On the other hand, demand remained stable. According to the law of demand, which is perhaps one of the most valid laws of economics, if goods that qualify as inferior goods are excluded, demand for those goods with a higher price should decrease. In Turkey, however, the opposite is happening: even if prices are rising rapidly, the demand for goods is also increasing as prices rise. To explain this seemingly contradictory situation, we need to take a closer look at two variables: inflation and interest rates. According to official figures, the current inflation rate is 85 percent, while bank interest rates on deposits are around 20 percent. In the CBRT survey of market participants, the expected inflation rate for the next 12 months (November 2023) is 37.5 percent. If we accept this as a general expectation, the real interest rate [(1 + Nominal Faiz) / (1 + Beklenen Enflasyon) -1 =] minus 12.7 percent. Since deposits at the bank result in a loss of purchasing power in this case, large savers tend to buy properties on the stock exchange to replace their cars with new ones, while small savers who cannot afford to buy them tend to do so , to buy and stockpile the commodities which they believe will increase in the future and, if only partially, to the stock exchange. In summary, due to this interest-inflation inconsistency, there is a kind of money flight process in Turkey and this process also fuels inflation. Those who cannot analyze the event and believe in the “exorbitant price” discourse, which has no value in the economics of the market, tend to blame the markets collectively.
Until recently, some savers also bought foreign currency to protect capital. When banks were penalized for holding foreign currency deposits, demand for foreign currency fell as banks shifted their customers to other areas.
When interest rates rise, demand for bonds increases while demand for the stock market decreases. With the interest rate lagging far behind the rate of inflation, demand from individuals and businesses for bonds and bills remains virtually non-existent. On the other hand, because of the legally enforced relationship between the loans they grant and their bond purchases, banks are forced to buy these bonds despite the low interest rate. In other words, the low-yield bonds that appear to have been sold are entirely due to “demand pressures”.
Since interest rates are well below the rate of inflation, individuals and companies prefer to invest their excess funds in the stock market. The unusual surges that have been occurring in the stock market of late are entirely due to this “directed demand.” If you build a wall in front of a creek to change its bed, the creek will start flowing in the other direction. That’s pretty much what happens in the stock market. Even those who have never thought about the stock market, since they cannot earn interest and cannot protect their capital, tend to invest their savings in stocks and hence the values of the stocks and with it the BIST 100 index shoot up .
Although this accelerated economic policy seems to support consumption-oriented growth and employment for the time being, it is causing bubbles in various areas, particularly in the real estate and stock markets.
In such an environment, it is unrealistic to say that “the stock market is not getting enough of the records, so the economy is doing well.” When the day comes when interest rates must be raised to inflationary levels, stock values and stock market real estate prices, unable to get enough of these records, will this time become insatiable for falls.
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