* ISE seen reaching 65,000 points in near-term

* Stocks are up 14 percent compared with flat emerging
benchmark

* Turkey's robust banking sector drives gains

* September referendum could increase political noise

By Alexandra Hudson

ISTANBUL, July 30 (Reuters) - Further gains lie in store for
Turkish stocks which are trading at life highs and have
massively outperformed the BRICs and eastern Europe this year,
yet still offer valuations below average for emerging markets.

Underpinning the Istanbul Stock Exchange's (ISE) 14-percent
rise this year is a robust economic recovery in Turkey, due to
its large domestic market, well-capitalised banks, benign
inflation outlook and continued record low interest rates.

The central bank has said rates will stay low until 2011,
and Turkish lenders, which account for around half of the
weighting of the ISE, are expected to post another quarter of
solid profit growth as lending accelerates.

Banking sector profits rose 14 percent in the first five
months of 2010 according to the banking regulator (BDDK).

"Increasing interest in Turkish equities is a long-term
re-rating story, as Turkey moves towards investment grade. I
don't see any reason for a change to this," said Namik Aksel,
who runs funds of $1.2 bililon in Turkish stocks and debt at
HSBC in Istanbul.

Turkey was rewarded with a series of upgrades to its
sovereign debt last year for its handling of the financial
crisis and its improved debt management, but it has still not
reached investment grade, a move analysts see as long overdue.

While Turkey has easily outperformed the flat MSCI emerging
equities benchmark, Russian stocks are up only 2 percent since
the start of 2010, and Chinese stocks have slumped almost 20
percent.

Despite the gain Turkish stocks still trade at 11 times 2010
earnings, compared to around 13 times in Poland, 12 times in the
Czech Republic and some 15 times earnings for the MSCI.

The ISE index which breached the 60,000 points mark last
week is currently trading at 60,734.47 points, after setting
successive record highs.

"Technically I believe an upside of 5-10 percent is
possible, we could see 64,000-65,000 points," Aksel said.

Head of Research at Oyak Securities Yurdal Yalman thinks
while it could get somewhat harder for the index to rally it
still has room to grow up to 15 percent in the next 12 months.

The Turkish economy, which contracted 4.7 percent in 2009,
notched up growth of 11.7 percent in the first quarter. The
government has an official target of 3.5 percent growth this
year but most analysts see expansion at around 6 percent.

Turkey's once-chronic inflation fell to an almost 40-year
low in May 2009. Although it spiked with the onset of the
recovery it has since eased prompting the central bank to cut
its inflation forecast to 7.5 percent from 8.4 percent.

"Turkish valuation multiples might not look cheap versus
history, but one needs to look at this in the context of
interest rates at historic lows, which has brought down the cost
of capital, in addition to the medium-term attractions of the
economy and market. This provides justification for where we are
now," said Tom Wilson, manager of the Schroder ISF Emerging
Europe fund.

"From a macro perspective it (Turkey) is not only attractive
for dedicated money but it is also attractive for crossover
money as well. That has been driving the market and will likely
continue to do so."

RISKS AHEAD?

With almost two-thirds of the ISE in foreign hands the index
is highly sensitive to wider risk appetite, which could take a
knock if global recovery fails to continue apace elsewhere.

On the domestic front a referendum due on Sept. 12 on the
government's reforms to Turkey's constitution could increase
political noise in the country of 73 million, although many
analysts downplay the chance of any serious hit to confidence in
Turkey. For a factbox on reforms click on

"Foreign investors are not too worried, in all honesty.
There has been talk of the risk of an early election in case of
a "no", but I don't see a chance of an early poll," said Yalman.

Potential downsides could be a stock overhang from secondary
public offers which could come later this year, such as in
government-controlled Halkbank.

The fate of General Electric's planned sale of its
20.85-percent stake in Garanti Bank is still unknown and part of
it could become publicly traded, pressuring the stock price.

But risk factors notwithstanding, analysts say, there are
enough positives to keep the Turkey investment case intact.

"The long-term structural growth story for Turkey is very
interesting: it enjoys good demographics via a young and growing
population, a well-run and well-capitalised banking system and
an excellent geographic position as an export hub," said
Schroder's Wilson.

(Editing by Sitaraman Shankar)