The SA euphoria trade is not over yet — the figures indicate that foreigners are nibbling in SA’s financial markets. While the equity market is still experiencing net negative flows this year, the dial shows signs of a shift in the bond market.
Foreign investment in SA equities has declined steadily since 2005, when active global emerging-market investors held 9.3% of their emerging-market portfolio in SA assets, according to SBG Securities research and EPFR data. Since then, exposure has declined to less than 2.7% — more than two-thirds lower than the peak almost two decades ago.
In considering this positioning within active strategies, one has to account for the decline in SA equity representation within the MSCI emerging-markets index. Changes in active investors’ appetite for SA assets would signal a fundamental shift in sentiment. Passive investors invest based on the country’s weighting in the underlying index as their performance is intended to mimic that of the index.
Many factors are driving the size of SA within the index, but if stronger share price performance begets inclusions into the index and SA grows in significance, it would prompt passive flows into SA equities. The upcoming MSCI index reviews in mid-August and mid-November this year should provide early indications.
According to Prescient Securities research based on JSE settlements data, the government bond market experienced the strongest net inflows in recent years in July, after treading water in May and June and net selling by foreigners earlier this year. The graph highlights the pickup in foreign investor flows after the elections. However, National Treasury data reflects that the holdings of outstanding domestic government bonds are still significantly lower (25%) than when these holdings averaged about 40.2% in 2018.
Fiscal prudence
National government has been long on promises and short on delivery over the past decade. This gave rise to anaemic growth weighed down by load-shedding and logistical constraints, which errant implementation of structural reforms has been slow to ameliorate. We believe a sustained shift in the vector of big-ticket economic data, such as at least two or three quarters of strong economic growth numbers, may start to dent this scepticism.
Ongoing fiscal prudence will also be crucial, and there has been good progress in this regard. For the fiscal year ending March the National Treasury recorded the country’s first primary surplus since 2009. Additionally, national revenue and expenditure continue to meet expectations set by the Treasury during the budget in the first three months of the fiscal year.
An improved growth trajectory, combined with continued fiscal prudence, should improve national credit metrics, which opens up the possibility of a rating upgrade. S&P still has SA’s local currency debt rated at two notches below investment-grade status at BB. Credit ratings upgrades would significantly enhance the country’s status as an emerging-market destination and unlock billions of rand potentially available for investment in SA.
Political risk will remain a factor to contend with, but initial developments after the national elections leave us optimistic. The cabinet may be more bloated than before, but it is better than it was. There’s a diverse group of decisionmakers hungry to prove themselves, with the broad representation enhancing input, oversight and accountability.
Operation Vulindlela is the glue for the government of national unity (GNU). If all parties agree with the path ahead and allow it to continue unfettered, investor sentiment would be substantially bolstered.
Attractive prospects
The achievements during the first phase of Operation Vulindlela make us optimistic that there will be continued progress towards achieving its policy objectives over the next five years, during the second phase.
We consider the prospects for SA equities attractive, particularly those counters in the “lost and found” bucket. Our analysis shows that from a valuation perspective the aggregate SA market remains about one standard deviation cheaper than its long-term average. This backdrop is similar for SA industrials, but within the sector there is material dispersion — with, for example, retailers, construction and industrial transport all trading at a discount of more than 20%.
We believe this is the first phase in a multiphase recovery. Should a capex and credit cycle commence in earnest, the knock-on effects will be significant, leading to a major reversal in trend growth after the lost decade.
This outlook led us to tilt 2%-3% of the equity exposure in our multiasset growth fund to lean into the SA mid-cap space, specifically the currently unloved sectors of the market in which we think there are great opportunities. With our primary focus being on risk diversification, we think this positioning reflects our optimism prudently.
SA remains an emerging-market economy, historically subject to volatility and significantly affected by global events. While there seems to be consensus on the direction of travel for global interest rates (lower), views on the potential paths followed remain fluid and continue to drive much volatility. Uncertainty over global growth remains, and geopolitical risks continue to hold investors’ attention, especially in the Middle East. However, investing is never smooth sailing.
We believe “perfect is the enemy of good”, and when conditions are perceived to be perfect, asset prices usually reflect this already.
• Van Wyk is Stonehage Fleming Investment Management associate director.
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