SA’s potential as a top emerging market buy yet to ripen

Feroz Basa, Joint Fund Manager of the Old Mutual Global Emerging Markets Fund.

In the first quarter of 2017, the average GDP growth experienced by emerging markets was around 4%, while South African GDP growth came in at a dismal -0.7% as it entered into a technical recession. For a foreign investor looking into emerging markets, South Africa isn’t looking like a very attractive prospect at this point. However, as the growth outlook continues to suffer, pockets of market value are likely to emerge.

This is according to Feroz Basa, Old Mutual Investment Group’s Joint Fund Manager of the Old Mutual Global Emerging Markets Fund, who believes that when it comes to South Africa’s macro-economy the worst isn’t over yet, but, while the local equity market is still not looking very cheap compared to other emerging markets, the deteriorating economy is expected to yield more market opportunities.

Basa says that his Fund remains considerably underweight South African stocks. “In terms of pure South African companies, we only hold ABSA and Netcare, which make up roughly a 4% weighting in the Fund.

“Statistically speaking, we’ve been fundamentally vindicated by this underweighting in South Africa, considering that the MSCI Emerging Markets Index has delivered 12% in rand terms this year, while the JSE Shareholder Weighted Index (SWIX) is only up 1.7%.”

Despite this underperformance, Basa adds, the South African market is trading on a forward price earnings multiple of 14.5 times, versus the MSCI Emerging Markets Index on 12.8 times. “The emerging markets composite as a whole – bearing in mind South Africa is about 8% of that index – is still cheaper than the South African market.

“This implies that while the negative sentiment around South Africa is slowly starting to feed into the companies, none of these companies have de-rated to a level that would position South Africa as a screaming buy right now,” he explains. “However, despite the SA market having been fairly resilient recently compared to other emerging markets, a continued decline of SA market performance should create better buying opportunities.”

Tinyiko Ngwenya, Economist at ‎Old Mutual Investment Group, says that a major driver of the negative economic sentiment has been the ongoing political uncertainty in South Africa. “We’re currently at a stage where we’re looking towards December’s ANC leadership election and what this means in terms of policy implementation.

“In the meantime, business and consumer confidence is at 1994 lows, when a political regime change significantly shook confidence levels in South Africa. Government policy continues to scare both local and foreign investors away and the growth of South Africa’s middle class is stagnant compared to its emerging markets peers. Considering the country’s current GDP backdrop and a dismal medium-term outlook, company earnings are starting to feel the pressure,” she explains.

But irrespective of what this brings, Ngwenya warns that South Africa is going to need growth enhancing reforms in order to turn the current sentiment around.”

However, Basa says that South Africa, in the emerging market context, has excellent, world-class companies with good corporate governance standards and first-world financial systems, which allow money to flow into and out of the country. “While this has largely protected us from any major corporate decline, the market does appear to be turning and is beginning to underperform. This underperformance is what will trigger value in South Africa, from an emerging markets perspective.”

Basa concludes that unless something politically significant were to happen that drives up confidence and strengthens the rand, there is more pain to come. “Our fear is that the worst is not yet over, with heightened political instability and the potential for another downgrade. However, if the trend of underperformance continues, over time, the Old Mutual GEM Fund expects to see increasingly more pockets of opportunity unfold in South Africa.”