Looking back at what moved the dial in Q2 and discussing the themes in focus for the quarter ahead.
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Ramaphoria 2.0: Will local investors keep smiling this time?
Over the last decade South Africans have been relentless in moving money offshore. Local pension funds exemplify this shift, having increased their total offshore allocations from around 25% in 2004 to nearly 40% today.
There are two key reasons for this.
Firstly, offshore equity markets have outperformed South African shares by a long way. The 10-year return on the MSCI World Index has been 15.2% per year in rand terms, while the FTSE/JSE All Share is up just 8.2% per year over the same period.
There has also been growing awareness among investors of the importance of diversification. With South Africa representing only 0.3% of the global MSCI All Country World Index, concentrating investments solely in the local markets limits exposure to numerous opportunities worldwide.
A change in the air?
However, there are reasons to think that this flow of money won’t continue to be just one way. The performance of South African markets over the past three months is potentially an early sign of this.
In rand terms, the JSE was up 8.2% between the start of April and the end of June, and the bond market gained 7.5%. Over the same period, developed market equities were down 1.1% in rands, and global bonds lost 4.7%.
Some of this has to do with the currency. We have now had 12 months of the rand strengthening against the dollar. But a large part of this rally is also down to May’s election. Markets have unquestionably seen the outcome as positive.
This is significant, because South Africa’s biggest challenge over the past 15 years has been declining economic growth. That has been a significant drag on local assets because low growth leads to a worsening fiscal trajectory and growing government debt. That increases the risk investors see in the country.
Following the election, however, some of that risk has been priced out.
Positive signs
That is not to say that we are suddenly in a new environment where South Africa’s growth is going to take off and our markets will soar. But the implementation of the government of national unity (GNU) with Cyril Ramaphosa staying as head of state is being seen by markets as more than just continuity.
Ramaphosa has been the main sponsor of Operation Vulindlela, a project to unlock structural reforms in five key areas. The problem in South Africa, however, not been a lack of good policy. It has been implementation. And there is a growing appreciation that not only might the GNU drive real change, but that in fact some has already been happening.
We have now had more than 100 days with no load shedding. If that continues, just adding that lost production back into the economy could push growth above 2%.
Transnet is the next big issue, and we are already seeing some improvement in the congestion at ports. A big positive there has been bringing in private operators.
There is, therefore, a backdrop of an improving economic outlook. That creates the possibility for a change in how investors look at the country.
Since about 2016, foreign investors have sold R2 trillion of South African bonds and equities. Local investors have also been selling South African assets, with the average multi-asset fund now holding 30% in US equities, compared to around 7% in 2008.
The selling pressure has led to cheaper local markets. Based on the local stock market’s CAPE ratio, which shows how cheap or expensive it is in relation to history, the All Share Index is still at a 19% discount to its 20-year average.
Consider the alternatives
The structural forces driving the sell-off of South African assets may be waning. This should also be seen in context of where else South Africans could invest. The US market has given incredible returns over the past decade, but there are questions about how expensive it has become.
The ten biggest shares on the S&P 500 now make up 37% of the whole market. And while there is no question these are great companies – the likes of Apple, Amazon and Nvidia – their earnings only account for 27% of all S&P 500 earnings.
That’s a big number, but it’s a lot less than their size in the index. And that creates some doubt as to whether they can continue to grow their share prices at such incredible rates. We think it’s prudent to be wary of the risks of investing in shares that have already run so hard.
Positive outlook
Overall, we think large investors have a handful of reasons to look more optimistically on local markets.
We have seen positive momentum around structural reforms for the first time in 15 years, and some of those are probably still under-appreciated. More importantly, the GNU provides even more impetus to those reforms.
This should unlock some economic growth, and it doesn’t have to be huge to just bring down the risk associated with the country. That could lead to both foreigners and local investors being more comfortable with investing here again.
The combination of reforms, potential growth, and attractive valuations creates a strong case for increasing allocations to South African assets. The potential for inflation-beating returns is hard to ignore.