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Turkish Stocks Will Implode If Islamic Democracy Unravels in 2014

Stocks in this article: TURVWO

NEW YORK ( TheStreet) -- The Turkish stock market has had a difficult 2013 to say the least, but it could be downright rosy compared to 2014, as investors in Turkish stocks may be underestimating the potential for serious political shocks to the country.

"Although a meltdown on Egyptian lines is implausible, a transition to Islamic authoritarianism is not," writes Christopher de Bellaigue in the latest issue of The New York Review of Books.

Noting that "many Egyptian Islamists now associate democracy with pain, humiliation and death," and that "the prospect of a democratic Syria has in any case long since disappeared behind the blood and smoke," de Bellaigue argues Turkey -- the country where Democracy and Islam have done the best job of living side by side -- is under serious threat.

The writer points to widespread unrest earlier this year that began with protests over plans to turn Gezi Park -- a small public space in Istanbul -- into a shopping center. Three and a half million people, or more than 4% of the population, took part in 5,000 demonstrations. The culprit, according to de Bellaigue, a journalist who writes frequently about Turkey and spent several years living there, is prime minister Recep Tayyip Erdo─čan. The Turkish leader has shown less and less tolerance for dissent, jailing journalists with impunity and alienating the country's Alevi and Kurdish minorities.

De Bellaigue's article suggests Turkey will see increasing tumult ultimately leading to ever more severe crackdowns.

Most investors in Turkey presumably don't read The New York Review of Books, and it isn't clear they are giving enough thought to Turkey's politics.

But clearly they aren't in love with Turkish stocks. The iShares MSCI Turkey (TUR) exchange-traded fund, which tracks the broad Turkish stock market, is down about 21% this year compared to a 9% decline for Vanguard FTSE Emerging Markets (VWO), a broad-based emerging markets exchange traded fund.

Much of this reaction appears to relate to concerns over the flight of foreign capital as U.S. interest rates begin rising, a danger Deutsche Bank acknowledged in a report on Turkey published Friday.

"Large external financing needs leave the economy vulnerable to higher US interest rates and weaker capital inflows," Deutsche's analysts write.

Moody's Investors Service, on the other hand, believes Turkey can withstand a rising U.S. interest rate scenario.

Moody's report, however, doesn't address the political situation in Turkey. Deutsche Bank's analysts refer to an "election wild card" at the end of their report, with "several key elections over the next 18 months." Among several possible outcomes, the chance for "further polarization of politics of the kind that triggered the Gezi Park earlier this year," is buried toward the bottom.

Deutsche Bank's analysis suggests that if the right people win the right elections, everything will be fine. De Bellaigue suggests a far deeper fissure has been opened in Turkish society, one that isn't likely to close peacefully.

If Turkey were to become an authoritarian regime, that in itself wouldn't necessarily be bad for stocks. China's stock market has done well enough for most of the last 15 years. On the other hand, if that is indeed the direction in which Turkey is headed, it will likely mean considerable violence before it gets there.

Such an outcome would likely rattle Turkish stocks considerably, given that the markets don't appear to be prepared for it.

-- Written by Dan Freed in New York.

Disclosure: TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.

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