It’s not easy being an optimist in South Africa. As soon as you think things are improving, something comes along to shake your confidence. This happens almost daily.
No wonder many people take a position of permanent pessimism. That way they are less likely to be disappointed. However, even the pessimists are reminded from time to time that things are not all bad. Perhaps it is part of our national character to be forever seesawing between the emotions of hope and despair.
Keep calm and carry on
This seesawing can make it difficult to keep calm and carry on investing. Especially when the last few years have seen disappointing returns from local asset classes, while global equities (more precisely US shares) have flown. As investors we need to keep emotions as far away from our money as possible, which is difficult when it comes to something that is literally close to home: your country, your family and your people.
Above all, investors should avoid what psychologists call confirmation bias, the strong tendency of humans to seek out information that chimes with their world view and ignore information that doesn’t. To be a successful investor, you need to be able to change your mind when the facts change.
And here we are in the second quarter of 2021, finding ourselves having reason to be optimistic about South Africa’s near-term economic prospects. And given attractive valuations on local asset classes, return prospects also seem bright.
It starts abroad
It starts with a strong global recovery. While South Africa has not always benefited from rising global growth, the local economy has almost never experienced a growth surge without a supportive external environment.
The International Monetary Fund (IMF) has again upgraded its global economic forecasts ahead of its annual Spring Meeting. It expects the global economy to expand by 6% this year, the fastest pace since it started measuring global growth in 1980. Only three months ago it projected 5.5% growth. A big reason for the upgrade is the additional fiscal injection given to the US by the Biden administration.
Chart 1: Global real economic growth and forecast
Source: International Monetary Fund
The US economy is expected to expand 6.4% this year and 3.4% next year. As a result, it will recover 2020’s lost output sooner than other major economies, but is also expected by the IMF to be the only major economy to actually return to where it would have been in the absence of the pandemic (by 2024). The headline forecasts for the US (and all other countries) mask the fact that there have been losers as well as winners across households, firms and sectors, but it would still be a remarkably quick recovery, certainly compared with the tepid and drawn-out post-2008 upswing.
President Biden last week announced another ambitious multi-year $2 trillion proposal to improve US infrastructure. This has not been factored into the IMF’s recent forecasts. However, this time he faces an uphill political battle, compared to the earlier rounds of fiscal stimulus, as it is paired with a proposed increase in the US corporate tax rate. The final version is likely to differ from the initial proposal.
China is also experiencing rapid growth, with the IMF expecting 8% this year, though next year’s growth will be more subdued by Chinese standards at 5.6%.
Terms of trade improvement
Global growth supports exports, and, in particular, we’ve benefited from elevated prices of industrial commodities and precious metals while the price of oil, our main import, has not rallied that much. The relationship between export and import prices is known as the terms of trade, and historically our economy has only performed well when the terms of trade has improved in our favour, as has been the case recently, allowing for the country to run trade surpluses. The February surplus was larger than expected (again) at R29bn. Exports in the first two months of the year were 13% higher than the same period a year ago, while the value of imports was 1% lower.
Chart 2: South African imports and exports
Source: SARS
One would normally also associate a strong global economy with increased overseas travel for business and leisure, but we don’t know when tourists will return to our shores in large numbers. A small consolation is that affluent South Africans are also less likely to go on overseas holidays, spending their money locally instead.
Positive data
Looking at some of the other data releases of the past two weeks, the general trend is positive. The SA Reserve Bank’s composite leading indicator has reliably predicted turning points in the local economy over the past 50 years. It typically does a better job of calling the direction rather than the intensity of growth. The strong increase in recent months points to a robust recovery underway. The IMF’s forecast of 3% for South Africa this year and 2% next year are on the conservative side, but if realised would still represent significantly faster growth than we’ve become used to.
Chart: SA Reserve Bank composite leading indictor
Source: SARB
The Absa Manufacturing Purchasing Managers’ Index surged to 57 points in March. As is the case globally, manufacturers are struggling with the cost and reliability of inputs as supply chains are stretched amid strong demand. While the Ever Given was freed from the Suez Canal before it could become an April fool’s joke, the pressures on global supply chains remain intense.
New vehicle sales returned to pre-pandemic levels in March. Though the monthly data is volatile and not adjusted for seasonality, it points to continued recovery in a sector that is extremely exposed to consumer confidence. After all, you don’t have to buy a new car. You can buy a used car or just stick with what you have.
Overall credit growth is still muted at 2.9% year-on-year in February, basically in line with inflation. Home loan growth is positive at around 4% per year, but hardly qualifies as a property boom (home loan growth averaged 20% per year during the last residential property bull market of 2003 to 2008). Reserve Bank data showed that the household debt service ratio (the portion of after-tax income households spend on interest payments on average) fell to a 15-year low of 7.7% in the fourth quarter of last year. This hides huge discrepancies in the financial positions of households, but on aggregate household balance sheets are in reasonable shape and they can increase borrowing if confidence improves. Subdued inflation means the risk of higher interest rates is limited. Confidence remains lacking, however.
Not confident…yet
The Bureau for Economic Research’s long-running consumer and business confidence surveys show that sentiment remains subdued on the ground even as economists mark up their growth forecasts. The FNB/BER Consumer Confidence Index increased by three index points to -9 in the first quarter of 2021. This brings the index back to the last reading before the global pandemic hit and the economy locked down, but it remains in negative territory, and well below its long-term average level.
Similarly, the RMB /BER Business Confidence Index is in net negative territory and below long-term averages. It dipped from 40 points to 35 in the first quarter. This can partly be explained by the fact that the sectors that comprise the index – chosen for their correlation with the local economic cycle – are mostly reliant on domestic demand. Most of the good news for the local economy comes from outside South Africa with exporters and commodity producers benefiting the most.
Sustaining the recovery
To sustain the recovery beyond the immediate bounce from last year’s record contraction, we need supportive policy changes. South Africa’s own infrastructure plan is also at an early stage, but is seen by President Ramaphosa’s administration as a key driver of growth. A new report from Business Leadership SA is very insightful about the opportunities and challenges. Suffice to say it is a longer-term project.
In the short term, the announcement of preferred bidders for ‘emergency’ independent power production is positive, though not without question marks as to the inclusion of Turkish power ships. There will be substantial investment in energy projects over the next year, while the fifth round of renewable energy procurement is also set to commence soon. Expect to see many more wind turbines and solar parks as you drive around the country over the next few years.
This does not guarantee an end to load-shedding, since Eskom’s ageing fleet of coal-fired plants are prone to breakdowns and several will be decommissioned over the next decade. But there is progress in the fight against rolling black-outs. Remember in South Africa things never move in a straight line. It is two steps forward, one step back.
The same is true of other economic and governance reforms. Patchy progress is still progress. While there is a lot of political noise at the moment, mostly within the ANC, it does appear as if there will be policy continuity for the next few years, which will be important to allow these reforms to mature and bear fruit.
Still, the list of bad news remains long and familiar: corruption, crime, maladministration, the near-implosion of the Land Bank, Bafana Bafana not qualifying for Afcon. However, since these items are persistent, they have little bearing on whether or not the economy can enjoy a cyclical recovery. So what are the real risks?
Risks
Clearly the main risk lies with the virus, its variants and the vaccines. South Africa’s vaccine roll-out is still extremely slow and hobbled primarily by a lack of supply. This should improve in the coming weeks, especially with J&J vaccines being manufactured in Nelson Mandela Bay. It is too soon to tell if the Easter weekend caused a third wave, but remember that the deadly second wave started long before the Christmas holiday in November already, driven by a new variant.
The other big risk is fiscal, given that global bond yields have predictably increased in response to the stronger outlook for the world economy (and the US economy in particular, which drives US yields, the benchmark risk free rate for global financial markets). Put simply, given how much the South African government has to borrow, it cannot afford for bond yields to rise much further. A disorderly rise in global yields could also put pressure on the Reserve Bank to prematurely hike short-term rates.
Fortunately, tax revenues are growing faster than expected, reducing the pressure on borrowing somewhat. Tax revenue for the 2020/21 fiscal year is R38 billion ahead of February’s revised estimate. This means the government can possibly provide some concessions to public sector workers without changing the overall necessary direction of fiscal consolidation. With a muted medium-term inflation outlook and the government remaining committed to fiscal consolidation, government bond yields remain attractively high, but the past two months have reminded us that they can be volatile.
Save like a pessimist, invest like an optimist
Investment is inherently an exercise in optimism. Rather than sticking money under the mattress, optimists believe that companies will grow earnings, bond issuers will repay, and that prices will rise even when things are uncertain. When deciding how much to put away for retirement, it is probably better to think like a pessimist and rather save too much than too little. Either way, even optimists should engage in risk management. They would be deluded not to. In our case it means appropriate diversification. It should not be a case of local versus offshore investing as often portrayed in the media, but rather of local and global investments, balanced in a sensible way to take account of valuations and risks.
The bottom line is that South African growth can surprise on the upside, supporting the profitability of domestically focused shares that are still cheaply priced despite the recent jump.
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