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Emerging Markets: Opportunities and Pitfalls

As I write this article, 670 million people are without electricity in India.

Stop and think about that for a minute.  That’s nearly double the population of the United States, and none of them have had electricity for the better part of two days.  Some homes and businesses have backup generators, but the vast majority of those affected were quite literally left in the dark.  Needless to say, business productivity has ground to a halt.

In a completely unrelated story, Turkish mobile telecom giant Turkcell ($TKC) released second quarter results last week that sent shares up sharply…even while the company hasn’t paid a dividend in over two years due to a boardroom dispute that could pass for an episode of the Jerry Springer Show.

Turkcell’s board is so bitterly divided that they can’t even properly schedule a shareholder meeting, and the Turkish state is threatening to intervene to break a legal deadlock that have involved courtrooms on three continents.  At one point, it was even being debated by Queen Elizabeth II’s Privy Council.

This is not a third-world, basket-case company.  Turkcell is one of the most respected mobile carriers in the world and routinely wins awards in Europe for its service quality.  And yet a boardroom circus like this can happen even at Turkcell.

Why do I bring up these two stories?  Because they illustrates both the risks and opportunities presented to investors by emerging markets.

Emerging markets are, by definition, not emerged.  They’re still a little rough around the edges and, frankly, investors should expect setbacks along the way.  The added risk is the price you pay for the expectation of higher returns.

Emerging market equities have not performed well in 2012, as slower growth in China, India, and Brazil have sapped investor enthusiasm.  The iShares MSCI Emerging Markets ETF ($EEM), which many use as a proxy for emerging markets in general, is down 16% over the past 12 months.

Emerging Market

P/E Ratio

Dividend Yield

Brazil

11.5

3.9%

China

7.1

4.4%

Colombia

15.0

2.8%

India

16.5

1.7%

Peru

37.0

5.1%

Turkey

10.9

2.3%

Source: Financial Times, July 31, 2012

Looking at a sample of emerging market indices, we see significant differences in prices.  Chinese shares, at 7 times earnings, are almost shockingly cheap, and Brazil and Turkey are priced attractively as well at 11.5 and 10.9 times earnings, respectively.

At the other end of the spectrum, Peru is trading at levels reminiscent of the 1990s tech bubble at 37 times earnings, and Colombia and India are comparatively expensive (at least relative to China, Brazil and Turkey) at 15.0 and 16.5 times earnings.

A summary comparison of emerging market stock prices does not constitute a comprehensive analysis, but one point is clear.  Outside of a few outliers, emerging market equities are cheap relative to their prices of recent years and relative to developed markets.  Investors, by and large, have fallen out of love with them as an asset class.

Barring a destabilizing meltdown in the Eurozone, I expect to see emerging market equities finish 2012 strongly.  The time to buy them is when they are cheap and unloved—as they certainly are today.

Disclosures: Sizemore Capital is long TKC.  This article first appeared on MarketWatch.

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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Turkcell: If I could be a Turkish general for a day…

Not to play on stereotypes, but if Turkcell ($TKC) were a government and not a private company, a cabal of stone-faced Turkish generals would have surrounded its headquarters with tanks months ago and forcibly taken over its board of directors.

And if they had, you could bet that the share price would have enjoyed a nice rally. The battle for control of Turkcell’s board—which has prevented the company from paying a dividend in over two years—has exhausted investor patience to the point that a coup d’état (or perhaps a coup de compagnie?) would seem appealing.

Investors may get their way, though alas, there will be no tanks. After a special shareholder meeting scheduled for June 29 failed to materialize, Turkish Transport Minister Binali Yildirim told Reuters that the government may soon intervene in the public interest.

The Turkish state certainly has the grounds to intervene. The Capital Markets Board, the Turkish markets regulator, warned Turkcell earlier in June that it had failed to comply with new rules requiring at least three independent board members. And why is Turkcell out of compliance? Because the two major shareholder factions can’t agree on who qualifies as an “independent” board member, and no one wants to give a vote to the “other guys.” Sigh….

For those new to this little bit of boardroom drama, two major shareholder groups are vying for control of the company, but neither currently has enough votes on the board of directors to prevail. The court cases that have ensued have spanned the globe, even ending up in locales as remote as the British Virgin Islands and Britain’s Privy Council.

The board drama has been a major distraction for the company and has impaired its long-term strategic planning, but it hasn’t slowed down the company’s operating results, which continue to be strong. Turkcell is widely praised for its Western-educated executive team and consistently ranks high among European peers for customer service quality. (Yes, you read that right. I said “European” and not “emerging market.” Turkcell punches above its weight.)

The proof is in the pudding. In the first quarter of 2012, Turkcell enjoyed year-over-year revenue growth of 12.3% and profit growth of 56.0% (see investor presentation).

Even better, the sales mix is shifting in Turkcell’s favor. The company enjoyed 35% year-over-year growth in smartphone sales, with the lucrative data plans that this implies, and the subscriber mix (which, like many emerging market providers, is weighted heavily towards pre-paid customers) continues its shift to post-paid contract customers.

Though the boardroom fiasco is no doubt keeping a lid on Turkcell’s share price, its moves have not been out of line with the broader Turkish market (see chart). Turkcell and the iShares MSCI Turkey ETF ($TUR) have moved in virtual lockstep since hitting a bottom in early June.

Turkcell remains one of my favorite plays on the rise of the emerging market consumer, and I consider the stock to be very attractively priced. Shares trade for just 10 times forward earnings, and the company has very little debt.

The board impasse will be broken—eventually. And when it is, investors can expect a modest dividend windfall.

Until then, they will have to be content with owning an emerging-market gem with great growth prospects trading at a modest earnings multiple. Come to think of it, that doesn’t sound so bad.

Disclosures: TKC is held in Sizemore Capital accounts.

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Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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The 10 Best Stocks for 2012

Charles Sizemore, the winner of InvestorPlace’s “10 Stocks for 2011” contest, offers his favorite stock for 2012.  Read about Charles’ pick and the other contestants below.

Wondering what the best stocks to buy for next year are? Well, look no further than the 10 Best Stocks for 2012.

This InvestorPlace feature lists 10 long-term investments from a group of money managers, market experts and financial journalists. The 10 Best Stocks for 2012 is meant to provide buy-and-hold picks you can purchase now and sit on for a year — ideally, winding up richer on the other side.

The buy list this year is a diverse group of stocks — from banks to technology, from emerging markets to Dow components, from old favorites to a stock that went public just a few months ago.

Throughout the year, the writers will regularly offer updates on the good, the bad and the unexpected as it relates to their best stock for 2012. We’ll find out in a year who had the best pick — but first, let’s examine each writer’s recommendation and what made them pick their stock as the best investment for the New Year:

Best Stock for 2012: Turkcell

Turkcell TKCMoney manager and stock picker Charles Sizemore, CFA, picked Visa (NYSE:V) as the single-best stock to buy and hold for all of 2011 — and thanks to market-trouncing returns of 40% year-to-date, his Visa pick was the winner among 10 picks in our similar contest last year.

This year, Charles gets a purer play on emerging markets with telecom stock Turkcell Iletisim Hizmetleri AS (NYSE:TKC), a mobile phone operator more commonly known just as “Turkcell.”

Yes, there is unrest in the Middle East and in the euro zone right now. But as Charles writes, this means you can buy a great company at a fire-sale price.

“If you believe, as I do, that Turkey has one of the brightest futures of any country on the planet, then the crises on Turkey’s borders should be viewed as a phenomenal opportunity to buy shares of some of Turkey’s finest companies,” Charles writes. “And my choice for 2012 is Turkcell.”

Read Charles’ complete recommendation on Turkcell.

Best Stock for 2012: Caterpillar

Caterpillar Inc. (NYSE:CAT)Investor and CBS MoneyWatch columnist Dan Burrows picked industrial giant Caterpillar (NYSE:CAT) as his best stock for 2012.

His reasons? Dan says CAT stock was oversold during the summer volatility, has good fundamentals (including retail sales that grew 31% in October) and a bargain valuation with a forward price-to-earnings ratio of about 10.

“Wall Street’s mean (and median) price target for Caterpillar currently stands at $114.50, according to Thomson Reuters data. Add in the 2% yield on the dividend, and the stock offers an implied return of 28% in the next 12 months or so,” writes Dan. “Not too shabby for a company with a market cap of more than $58 billion.”

Read Dan’s complete recommendation on Caterpillar.

Best Stock for 2012: FedEx

FedEx FDXCNNMoney’s Paul R. La Monica said, “When I was asked to pick one stock to write about for InvestorPlace that I was confident would do well next year, I immediately started thinking of companies that should benefit from a steadily improving U.S. economy.”

At the end of his deliberation, Paul settled on FedEx (NYSE:FDX).

Don’t think this is just a play on a broad-based recovery, though. A discounted P/E ratio vs. rival UPS (NYSE:UPS), a strong dividend history, recent rate increases and the lack of competition from a U.S. Postal Service in disarray are all reasons to be bullish on FedEx.

“FedEx may not be flashy. But that’s kind of the point,” Paul writes. “In a market where volatility seems to be the new black, you could do a lot worse than a stable blue chip with steady earnings growth.”

Read Paul’s complete recommendation on FedEx.

Best Stock for 2012: Hershey

Hershey HSYRenowned trader, journalist and money manager Jon Markman has a sweet play for you in 2012: confectioner Hershey (NYSE:HSY).

Why this consumer stock? Well, because in the short-term Jon is decidedly bearish on just about all corners of the market. The euro zone debt crisis will continue to rock Europe and subsequently affect nations that export goods there or rely on plush government subsidies from the content.

In fact, Jon thinks that in the short term, “the simplest trades next year will likely be short iShares Europe (NYSE:IEV), short iShares Emerging Markets (NYSE:EEM) and short solar energy equipment producers like First Solar (NASDAQ:FSLR).”

But what does this mean for buy-and-hold investors? Simply put, get defensive with consumer staples stocks.

For those who think that chocolate is discretionary, Jon adds, “Well, try explaining to my daughter that chocolate isn’t a household staple.”

Read Jon’s complete recommendation on Hershey.

Best Stock for 2012: Capital One

Capital OneBanks aren’t exactly super popular right now, so it might surprise you to see senior analyst Philip van Doorn of TheStreet picking Capital One Financial (NYSE:COF) as his best best for 2012.

But a closer look at the stock shows a lot to be bullish about, even as the rest of the financial sector melts down. Namely, strong fundamentals and a historically low valuation and book value.

Capital One also has two very important mergers in the works that will provide future growth beyond its generally well-run banking operations.

Philip is adamant that this is not just a dumpster dive, saying “the most important factor in Capital One’s strong performance this year is its outstanding earnings performance.” Compared with the big banks on Wall Street, COF is in a class of its own.

Read Philip’s complete recommendation on Capital One.

Best Stock for 2012: Mako Surgical

Mako SurgicalDavid Gardner knows a thing or two about picking stocks. As co-founder of The Motley Fool, he is the brains behind the innovative Motley Fool CAPS rating system. And from his own research and what other investors are saying, David thinks he has a quite a pick for 2012 in Mako Surgical (NASDAQ:MAKO).

What makes Mako special? It’s an innovative medical device company that has revolutionized joint replacement. It’s not profitable yet, but the potential is huge, and stories of treatments and recovery are quite dramatic.

“It’s a long way from here to there, but for the speculative portion of your portfolio, MAKO could richly reward a little patience,” David writes.

If you don’t mind taking a little risk with your investments in 2012, consider this up-and-coming medical company.

Read Dave’s complete recommendation on Mako.

Best Stock for 2012: Microsoft

Blogger, author and founder of Stockpickr James Altucher joined a similar InvestorPlace.com feature in the beginning of 2011, picking one stock to buy and hold all year. Back then, he picked Microsoft (NASDAQ:MSFT) — and his choice is the same a year later.

Similar to his previous write-up, the highlights of this year’s recommendation include:

  • 8x earnings
  • Huge stock buybacks
  • Secret weapon: Skype replaces all smartphones within next five years

The idea of Skype taking over the mobile market is intriguing, considering voice represents so little of what we can do with our smartphones these days.

Read James’ complete recommendation on Microsoft.

 

Best Stock for 2012: Arcos Dorados

Arcos Dorados ARCOJosh Brown, adviser at Fusion Analytics and the author of The Reformed Broker blog, picked freshly minted Arcos Dorados (NYSE:ARCO) as his top pick for 2012. ARCO is the largest McDonald’s (NYSE:MCD) franchisee in the world with more than 1,750 locations, largely in Latin America.

Arcos Dorados went public in April and has been up and down ever since — not a newsflash, considering the volatility of the market in general. But in the new year, Josh is expecting the stock to take off due to four factors:

  1. Expanding consumer spending in Latin America
  2. The ferocity of McDonald’s as a global brand
  3. Growth within a defensive sector
  4. The comeback potential for emerging-market equities in 2012

If you’re sick of trying to bargain hunt in struggling U.S. blue chips, and if you aren’t afraid of looking for growth abroad, ARCO could be your best bet in the new year.

Read Josh’s complete recommendation on ARCO.

Best Stock for 2012: Alcoa

Alcoa AAAs with previous picks Caterpillar and FedEx, InvestorPlace.com editor Jeff Reeves has leaned in favor of broad economic recovery with his recommendation of aluminum giant Alcoa (NYSE:AA).

Not only will growth in demand and higher prices result in bigger Alcoa profits, but overly negative sentiment has provided a great entry point, Jeff writes.

“Yes, big problems persist in the global economy, and aluminum demand and prices remain weak as a result,” he writes. “However, Alcoa hasn’t seen the $9 level since spring 2009. Are the macroeconomic fears really worse now than in 2009?”

In addition to valuation, Jeff likes Alcoa’s improving earnings, dividend potential, streamlined operations and hope for better margins in 2012.

Read Jeff’s complete recommendation on Alcoa.

Best Stock for 2012: Banco Santander

Banco Santander STDAccording to longtime stock picker, financial columnist and money manager Jim Jubak, your best bet for 2012 is a European bank. Really!

It’s an aggressive play, but Jim’s faith in Banco Santander (NYSE:STD) comes from a lot of number crunching — and the idea that as bad as things are over in the euro zone, they aren’t as bad as you think.

“The worry about European banks right now is that they can’t raise capital in the financial markets,” Jim writes. “During the past two quarters, Banco Santander has very clearly demonstrated that this bank doesn’t fit that profile of worries.”

It has attractive assets to sell if it has to, Jim says, and that’s on top of accessing credit markets just fine at the present — on top of $8 billion in free cash flow that shows a nice cushion for STD. The only catch is that Banco Santander holds almost $50 billion in Spanish government debt.

“If you think Spain will have to write off part of that debt, then Banco Santander sure isn’t the pick for you,” Jim writes. “If you think Spain is in better shape than Italy (or Greece), I think that in Banco Santander you’re looking at one of the best performers in 2012.”

Read Jim’s complete recommendation on Banco Santander.

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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Follow-up to Israel and Turkey: How Changing Demographics are Affecting International Relations in the Middle East

As a follow-up to my prior post on how demographics are affecting the calculus of international relations in the Middle East—and between Turkey and Israel in particular—I’d like to start with some comments from Mark Steyn.

Steyn is a bit of a controversial shock jock—the Howard Stern of conservative commentary, if you will—so I hesitate to quote him too regularly. Still, despite his rhetorical bluster, he is a man who has a firm understanding of demographic trends and what they mean for the future. (His 2006 book America Alone, though a bit of a political screed, is also an astute look at global demographic trends and what they imply for geopolitics.)

Writing for Investor’s Business Daily (link to article) on the Mavi Marmara incident, Steyn writes,

[W]hat was most striking was the behavior of the Turks… Ten years ago, Turkey’s behavior would have been unthinkable. Ankara was Israel’s best friend in a region where every other neighbor wishes, to one degree or another, the Jewish state’s destruction…

Making me reminisce about some of my own late-night bar conversations in Istanbul, Steyn continues,

I remember sitting in a plush bar late one night with a former Turkish foreign minister, who told me, in between passing round the cigars and chugging back the Scotch, that, yes, the new crowd [the AK Party led by Prime Minister Erdogan] weren’t quite so convivial in the wee small hours but, other than that, they knew where their interests lay. 

Like many Turkish movers and shakers of his generation, my drinking companion loved the Israelis. “They’re tough hombres,” he said admiringly. “You have to be in this part of the world.”

Six years later, the Turkish state is tacitly supporting a “charity” organization suspected of ties to terror groups and has gone so far as to threaten breaking the Israeli blockade by force—an overt act of war.

Turkey has essentially turned its back on more than twenty years of friendship with Israel and by proxy more than eighty years of friendship with the West in order to pursue an independent foreign policy nearly 100% at odds with its former allies.  Some have called Erdogan’s policy the “re-Ottomanization” of Turkey.  We’ll return to this theme shortly.  But first, we will return to Steyn.

Steyn asks rhetorically, “Who lost Turkey?”  His surprising answer is Kemal Ataturk, the founder of the staunchly secular post-Ottoman Turkish state.

Steyn writes,

The short version of Turkish demographics in the 20th century is that Rumelian Turkey — i.e., western, European, secular, Kemalist Turkey — has been out-bred by Anatolian Turkey — i.e., eastern, rural, traditionalist, Islamic Turkey.

Ataturk and most of his supporters were from Rumelia, and they imposed the modern Turkish republic on a reluctant Anatolia, where Ataturk’s distinction between the state and Islam was never accepted. Now they don’t have to accept it. The swelling population has spilled out of its rural hinterland and into the once solidly Kemalist cities.

Some readers might have heard the expression “Young Turks.”  For those unfamiliar with the term, the Young Turks were a reform movement in the late 1800s that sought to modernize the Ottoman Empire, making it more Western.

But as Steyn puts it, the Young Turks are now the Old Turks.  The new Young Turks are less modern than their forbears.  Call it the “demodernization” of Turkey.

The Re-Ottomanization of Turkey

How can we explain Turkey’s diplomatic break with its decades-long allies?  In short, Turkey is doing it because it can.  With EU membership now highly unlikely, Turkey has decided to change it focus to its other frontiers.  Rather than being an unwanted periphery member of the West, Turkey sees an opportunity to reassert the role it played prior to World War I the leader of the Islamic world and of the broader Middle East.

Writing for the Financial Times, Josef Joffe writes,

Next to Iran, Nato member Turkey is now the biggest headache for the west. With Egypt sinking into torpor and Riyadh firmly ensconced on the fence between Washington and Tehran, Turkey has seen the leadership of the region up for grabs – and is going for it. It has drawn Syria into its orbit and has reached a nuclear deal with Iran, its rival for hegemony.

What better way to pursue this end than to lead a crusade against the Jewish state? Going after the “Little Satan” is the card that trumps them all, and it embarrasses the “Great Satan” to boot. The real game is about dominance at the expense of America... The US must learn that the real contest is between itself, Turkey and Iran. It is now up against both. 

So, Turkey’s war of words with Israel has little to do with the Palestinian cause and everything to do with reestablishing Turkey as the preeminent power in the Middle East a role it has eschewed for nearly a century.

Given the regional alternatives, Turkish hegemony might not be the worst outcome.  Turkish hegemony would certainly be preferable to Iranian or Saudi.  Though drifting towards soft Islamism, Turkey is still a constitutionally secular republic.  And despite Steyn’s grim words, secular Turks are not exactly dying out.  Were Erdogan to lose the next election (which could happen if the Kemalist opposition found credible leadership),  Turkey’s anti-Western lurch could come to an abrupt end.

Outside of Israel, Turkey also has the most developed and diversified economy in the region and has its most important city in Istanbul.  Among emerging markets, Turkey remains one of Sizemore Capital’s favorite investment targets.

Still, shifting geopolitical relationships promise to make this region highly volatile in the decades ahead. And if we intend to invest in this part of the world, we must understand the changes taking place.

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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Israel and Turkey: How Changing Demographics Are Affecting International Relations in the Middle East

Years ago, when I was earning my master’s degree at the London School of Economics, I had a memorable conversation with a classmate of mine from Istanbul named Deniz. Over a couple beers at the Three Tuns, Deniz explained Turkey’s two most pressing problems—the rise of political Islam and the Kurdish separatist movement—and he tied both to one primary factor: demographics. (The Three Tuns is one of the few bars in the world where young men talk equally about normal bar topics, such as sports and the attractive young female at the next table, and topics as arcane as Turkish demographics.)

“When Atatürk founded Turkey, there was no Kurdish problem,” Deniz explained, “because there were practically no Kurds. But because the Kurds have had larger families for decades, they’ve become a larger percentage of the population. The next thing you know, they’re wanting independence and we have a problem. Ocalan, the leader of the PKK (Kurdish separatist group), is said to have suggested that every Kurd must either grab his gun every morning…or grab his wife every night.”

The rise of political Islam follows a similar storyline. Turkey is constitutionally secular. In fact, the separation of church (or mosque) and state in Turkey is in some ways significantly stricter than in the United States or in virtually any European country but France. (Atatürk used secular France as a model when he founded the Turkish Republic).

Turkey has become distinctly more Islamic in recent years, and this is largely a demographic phenomenon. Naturally, some formerly secular Turks have decided to grow out their beards and observe Ramadan. But much of the shift has been due to the simple fact that devoutly Islamic Turkish women have more babies and at younger ages than their secular sisters.

I recollected this conversation years later after reading Tobias Buck’s May 22, 2010 article in the Financial Times: “Secular Israel senses threat in rise of the ultra-orthodox.”

Ultra-orthodox Jews are easy to spot in a crowd. They wear wide-brimmed black hats, full beards, and distinctive side locks of hair that nearly stretch to their chins. To the casual gentile observer, they look a lot like the Amish or Mennonites. And they are becoming an increasingly large and restive percentage of the Israeli population.

Like the Amish in Pennsylvania, the ultra-orthodox are in the State of Israel but not of it.

As Buck describes the situation, “The ultra-orthodox have always had a troubled relationship with Israel. A minority reject the secular Jewish state as a religious abomination and refuse to vote or pay taxes…. Mostly, however, the two sides [secular/moderately religious and ultra-orthodox] have kept to an intricate set of live-and-let-live agreements. Crucially, the ultra-orthodox have their own stream of schools, and those in a yeshiva, of Jewish seminary, are exempt from military service.

“But that deal is starting to unravel because of the sharp increase in the ultra-orthodox population. Once a tiny minority, the community now accounts for at least 8 per cent of the Israeli adult population. It is forecast to double every 16 years.”

This is becoming an economic problem for Israel. Two thirds of ultra-orthodox men do not work, and for good reason. They learn no marketable skills in their religious schools. The only thing they are qualified to do is sit in a synagogue and read. So, ultra-orthodox families are becoming larger and larger burden to Israel’s welfare state.

By now, you might be legitimately wondering why any of this matters. I assure you that it does.

Turkey and Israel have had one of the strongest alliances in the greater Middle East for over two decades. The made sense for a number of reasons: Turkey and Israel were both secular, Western-oriented countries with world-class armies and dynamic economies. And perhaps more critically, both have a deeply-rooted fear and dislike of their Arab and Persian neighbors. (As another old LSE classmate, a Turkish Cypriot from Nicosia, explained it, “We Turks have never forgiven the Arabs for siding with the British in World War I. It’s their fault that we lost the Ottoman Empire.”)

In the days when nationality trumped religion, the Turkish-Israeli alliance was natural. But with religion increasingly filling the identity void once filled by the state, many Turks are starting to question why they are allied with Jews against their fellow Muslims.  The recent incident in which Israeli soldiers clashed with a group of Turkish pro-Palestinian activists at sea vividly illustrates how badly relations have deteriorated.  In protest over the clash, in which at least nine activists were killed, Turkish prime minister Tayyip Erdogan labeled Israel’s actions “inhuman state terror” against unarmed civilians while Israel defended the actions as being in legitimate self defense against armed agents provocateurs who were anything but innocent.  I suspect that once investigations are done, the Israeli explanation will prove to be closer to the truth (Israel has already released footage of its soldiers being severely beaten by the pro-Palestinian mob), but in the end it doesn’t matter.  The damage to the relationship between the two countries is done.

Of course, any war of words in the Middle East has to be viewed in a broader context. Some of Erdogan’s rhetoric is no doubt aimed at pleasing the core of his electoral support, Turkey’s devout Muslims. Some is likely aimed at buying other friends in the region.  But no small part of Erdogan’s motivation is his desire to assert a Turkish foreign policy in his own image.  By bashing Israel, Erdogan is asserting his independence both from Turkey’s traditional Western allies and from its own recent past.

Turkish-American relations in the wake of the Iraq War are at the lowest point since the Turkish invasion of Cyprus in 1974, and Turkish-European relations are likewise rather strained by the EU’s stonewalling of Turkey’s negotiations for membership in the bloc. It could be that the recent Turkish antagonism towards Israel is more of a blowback against the West in general than an attack on Israel in particular. But from the Israeli perspective it is disturbing nonetheless.

For Israel, losing Turkey as an ally would be a major strategic setback. It would leave Israel increasingly dependent on the United States and Europe for diplomatic, financial, and military support, and Europe has proven over the years to be an unreliable ally when allies are actually needed.

That leaves the United States. While both the Republicans and the Democrats are currently staunch supporters of Israel, the country is still taking an enormous risk by depending so heavily on one foreign ally. It reduces Israel to the status of a client state and reduces its room to maneuver. Should there come a time when the strategic goals of the United States and Israel diverge, Israel could find itself isolated. Given the country’s precarious existence in a hostile neighborhood, this could literally mean the difference between life and death.

All of this is speculation, of course. Demographics, however, are cold, hard facts. And the facts show that the Middle East is changing. The decline of the Lebanese Christians over the past three decades was one of the first major shifts (see “Changing Global Demographics: Christians and Muslims in the Mideast” ). Today, we see Turkey and Israel becoming distinctly more Muslim and more Jewish, respectively. This subtle shift away from their secular identities will make it increasingly harder for these two nations to cooperate in the future.

This is not to say that I am necessarily bearish on the economic prospects for either country. In fact, I’m actually quite bullish. Both have world-class companies and increasingly open and competitive economies, and I see both prospering in the years ahead. I’ve even recommended Turkish stocks in the recent past.

The changing demographic picture does, however, add an interesting wrinkle. And understanding this wrinkle will go a long way to helping understand the mystery and intrigue of Middle Eastern international relations.

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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