Turkey ETF Could Be Next To Be Stung By Credit Downgrade

In the wake of the iShares MSCI Brazil Capped ETF (NYSE:EWZ) being stung by Standard & Poor's stripping Brazil of its investment-grade credit rating, financial market participants, as they so often do, are wondering what country could be next to draw the ire of a major ratings agency.

As some recent media reports suggest, the emerging markets patch has plenty of candidates that could suffer ratings downgrades, including Turkey. If EWZ is an accurate guide, the iShares MSCI Turkey ETF (NYSE:TUR) probably will not react favorably to Turkey suffering a credit downgrade.

As it is, TUR, the lone dedicated Turkey ETF, is down 35.6 percent year-to-date and resides at its lowest levels since the second quarter of 2009 as traders long ago pinned Turkey as one of the emerging markets most vulnerable to the Federal Reserve raising interest rates due to the country's heavy dependence on external funding.

In May, S&P downgraded its rating on Turkey's lira, one of this year's worst-performing emerging markets currencies to "BBB-/A-3" from "BBB/A-2. At the time, the ratings agency said there is in a one-in-three chance it could downgrade Turkey's sovereign in six to 12 months. Well, it's now September, meaning six months is a month away. The lira is continuing to tumble and TUR is down more than22 percent over the past 90 days.

Just last week, S&P said Turkey is unlikely to see a stable government before the end of this year and that foreign investors are flocking out of Turkish stocks in droves, selling $462.1 million worth of Turkish shares last month. Year-to-date, TUR has added $40.6 million in assets, but the ETF has bled $18.4 million in the current quarter.

Some other factors are worth noting. First, Turkey has long had a contentious relationship with S&P several years, when S&P rivals Moody's Investors Service and Fitch Ratings upgraded Turkey's sovereign credit rating to investment-grade and S&P did not follow suit, Turkish leaders publicly complained, lobbing some feisty comments at S&P.

Second, in June, Moody's took the knife to its ratings on abatch of Turkish banks, which is bad for TUR because the ETF allocates 28.6 percent of its weight to the financial services sector. That is more than double the ETF's second-largest sector weight.

For Turkish equities and TUR, ratings agency risk comes in the form of S&P taking the country further into junk territory and Moody's and/or Fitch stripping Turkey of its investment-grade rating.