This ‘mantra’ has been very much at the centre of our investment thinking when constructing our SA investment portfolios, both from an asset allocation perspective as well as from an equity portfolio construction point of view. It has now become mainstream thinking or consensus opinion that the SA economy is underperforming and that poor governance and the lack of clear economic policies are the main culprits behind this. Even the governing ANC no longer denies this anymore. Indeed some within the ANC are openly advocating this. This poor GDP performance has never been more clearly evidenced than in 2017, as global growth hits 3.2% and is at its strongest and broadest levels since 2008. China is comfortably growing above 6.5% supporting strong commodity demand and thus benefiting the majority of South Africa’s exports by way of higher dollar commodity price and robust volume growth. Accordingly, South Africa should be growing well above 2% per annum (more or less in line with population growth) against this backdrop and yet forecast growth for 2017 and 2018 is 0.6% and 1.1% respectively.
This has had clear investment implications, with many SA-focused listed companies delivering weak earnings numbers and being steadily de-rated (i.e. becoming cheaper) over the past two years. Meanwhile, the global titans listed on the JSE such as Naspers, Richemont and British American Tobacco have delivered solid and even stellar earnings growth and been re-rated upwards. The equity market in general terms rewards higher growing companies with a higher P/E and punishes lower growth companies with a lower PE. Foreign investors have voted with their money, pulling ZAR237 billion out of SA listed equities in the past 18 months. Indeed, with the combination of Naspers, Richemont and British American Tobacco accounting for 14.1% of the JSE All Share’s year to date return of 15.2%, this implies that many of the smaller (domestically-focused) companies have detracted from the market’s performance. Fortunately, the global search for yield has resulted in substantial foreign capital flows into the SA domestic rand bond market, with year-to-date net inflows at R69bn. This together with a trade surplus has supported the rand.
One of the main consequences of weak economic growth and poor governance within state-owned enterprises (SOEs) has been a worsening fiscal position and this is one outcome that the ANC, within its own caucus, can no longer ignore, with the revenue shortfall for 2017/2018 projected to be between R40bn to R70bn – the largest since the great financial crisis of 2008. In combination with a cash crisis within several SOEs, this is forcing the budget deficit higher and making the possibility of meeting debt stabilisation targets all but impossible. Almost inevitably, local debt ratings downgrades will follow (more than likely in 2018), resulting in capital outflows and a higher cost of capital at a point when the fiscus can least afford it! Without resources or money, the ANC (or any party for that matter) can no longer advocate to be bettering the lives of its voters through social security increases, inflation-plus public sector salary increases (without concomitant productivity increases) and inflated SOE contracts to the politically-connected. The Zuma years have clearly eroded the fiscal buffer that the previous years under Mandela/Mbeki built up, and the fiscal piggy bank is now almost empty. Nevertheless, the current voting branch members, ANC Youth League, ANC Women’s league plus the NEC have a chance to stop this economic tailspin and save the country from its low growth/debt trap path. These voting factions need to give a business-friendly leader the opportunity to regain the confidence of international and domestic investors, companies, and even consumers.
There is a famous dialogue from Ernest Hemingway’s 1926 novel The Sun Also Rises. “How did you go bankrupt?”, Bill asked. “Two ways,” Mike said, “Gradually and then suddenly!”. Should the ANC elective conference usher in a new leader who promises more of the same of the past eight years, then the “suddenly” will become a reality for South Africa. The financial markets have, to some degree, moved towards discounting a poor economic scenario over the next few years, via a weaker currency, higher bond rates and poor domestic listed company ratings, but have not completely ruled out a positive outcome in December and thus a programme of economic reform that promotes growth. In this regard, the latest investment surveys have found that most investment managers, both domestically and abroad, are not positioned for a positive outcome and should this eventuate there could be a significant move in most domestic assets as participants scramble to reposition portfolios for that outcome. It is worth remembering that politics is not necessarily rational, but dependent on factional power plays and who has the most to lose and the most to gain. Investors are waiting for the 16th to the 20th December elective conference with baited breath.