South Africa’s financial markets, which for many years have traded at a discount when compared to their emerging market peer group, could finally be seeing some light at the end of the dark tunnel caused by the economic growth coupled with a deterioration in household and business confidence.
The impetus for a change in the country’s fortunes is political and economic.
The first change agent was the emergence of the government of national unity (GNU) and a new cabinet, which is bringing new levels of confidence to many emerging market investors. The second factor was the announcement of real GDP growth of 0.4% in the year's second quarter and an anticipated cut in the base interest rate on September 19.
The predicted GDP rebound came after three months of no growth, with a steady power supply from Eskom without load-shedding adding impetus to the growth experienced. We believe that nominal interest rates have peaked, and another rate cut of 25 basis points can be expected in the latter part of the year.
These changes are encouraging when it is considered that until a few months ago the domestic equity market was trading at valuation levels that were last seen during the global financial crisis and the 10-year benchmark government bond yield crossed the 12% mark.
Despite lower real economic growth, earnings growth from South African-listed stocks is expected to be higher than the average emerging market peer group over the next two years. In addition, a small change to South Africa’s top-line growth due to improved household and business confidence could result in positive earnings revisions over the medium term.
International investors will also consider that South Africa’s equity market is trading at an atypical discount to the emerging market peer group, while the dividend yield on offer for a wide range of shares is well above inflation.
Even if the economic growth trajectory does not improve to the degree expected, both the positive earnings trajectory and dividend yields are likely to support inflows from these investors.
This is important given that the MSCI index in South Africa, which is used to benchmark various investment products such as mutual funds and exchange traded funds (ETFs) across 26 emerging market countries, excludes large dual-listed shares such as Anglo American, Billiton, Richemont, Anheuser-Busch and British American Tobacco.
South Africa could benefit most from portfolio flows, which explains why financials, when viewed as a barometer of the economy, have been the top performers this year.
The fact is that South Africa has been mired in a low-growth environment for more than a decade. Though changes and a mood of optimism are to be welcomed, significant headwinds will have to be faced in the near term
While the positive sentiment directed at South Africa may help propel the country on the road to reform and growth, Melville Douglas cautions that expectations for an immediate economic recovery should be tempered.
The fact is that South Africa has been mired in a low-growth environment for more than a decade. Though changes and a mood of optimism are to be welcomed, significant headwinds will have to be faced in the near term. These include persistent high interest rates, escalating levels of national debt, and high levels of unemployment, inequality, and poverty.
Though the JSE, in line with the major macroeconomic indicators, has disappointed in recent years, the value of local equities is backed by two foundation ratios, dividend yield and the price/earnings (P/E) ratio. Presently, dividend yields meaningfully above inflation are being recorded.
Lower P/E ratios flag the potential for a future rise in share prices, and the JSE shows signs of being attractively priced, with a P/E ratio significantly below the MSCI average.
A further tailwind is that National Treasury changes introduced in 2022 are now nearing an end. These changes increased the limits on retirement and unit trust investments held offshore by South African portfolio investors to 45% and saw significant outflows from the JSE.
Prices of local equities were dampened, but the process now seems complete, and with it has come a change in outlook for local equities. Financial markets are forward-looking, and a positively evolving political landscape will bolster the investment community's confidence.
Key factors such as political stability, the implementation of growth-supportive policy reforms, sustained inflation deceleration, and efficiency improvements in critical infrastructure such as ports, rail, water, and electricity can bolster South Africa's economy and finances in the medium to long term.
• Drotschie is CIO at Melville Douglas, the boutique investment management company for the Standard Bank Group
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