It has been a cold winter for the South African economy, but there are many green shoots appearing, says PSG Wealth CIO, Adriaan Pask. “I dare say, we are feeling excited about what may transpire in the months ahead.”
“Tito Mboweni’s appointment is the next chapter in an increasingly positive narrative, coming soon after the announcement of president Ramaphosa’s economic rescue plan,” says Pask.
“We believe this will unlock some economic drivers, particularly through the R400 billion infrastructure plan. And if implemented correctly on the new finance minister’s watch, this could be the catalyst we need for driving domestic demand and job creation.”
Despite the reality checks provided by recent GDP and unemployment data, leading business cycle indicators are on an upward trajectory.
“Although there are many structural hurdles impeding economic growth, the leading indicators have been overwhelmingly positive for some time now,” says Pask.
The Ernst & Young South African Growth Barometer shows that confidence in South African middle-market companies has increased, despite uncertainties. According to this barometer, almost one in three middle-market companies are predicting growth above 10%.
On the investment front, longer-dated government bonds are currently yielding near and above 9%.
“Yields at these levels will support investment portfolios, especially during tougher market conditions,” says Pask. “Even if domestic equities experience headwinds, bond yields should support portfolio returns, and it’s crucial for investors to remember the importance of asset class diversification.”
Stocks that have been hammered by harsh conditions and volatility can also offer great entry points to the market.
“Our research shows that the forward blended P/E of the FTSE/JSE All Share Index (ALSI) was trading around 13.5 times at the end of August,” says Pask. However, when the top five stocks by market capitalisation are excluded, the domestic market is trading below 11.5 times.
“This is much closer to its historic average, which means there are attractive investment opportunities,” says Pask. “Financial shares in particular look to be attractively priced, especially considering that their multiples are on weak earnings.”
These ‘unloved’ stocks offer investors an opportunity to enter some major banks at single-digit P/E ratios.
Impact of interest rates and inflation
“Although rate cuts are always the ideal outcome, at least over the short term, we think this is unlikely. However, we also think that hikes are even more unlikely,” says Pask.
This means that the cost of capital will not increase, and that interest rates could remain relatively low. “It also means that bonds are likely to stay in favour a little bit longer, and the hurdle for generating inflation-beating returns is relatively low,” says Pask.
When inflation was running at double-digit numbers, investors had to generate high double-digit returns to grow the real value of their capital. Now that inflation is lower, investors do not need an 18% return to cover a 13% inflation rate. Instead, they need high single-digit returns to cover inflation plus 4% or 5%.
Growth spill-over expected from developed markets
“Historically, when developed markets performed well, there has been a significant demand for resources to keep the growth trend going. A substantial portion of these resources usually come from emerging markets like South Africa,” says Pask.
“With fears around international trade tariffs increasing, the irony is that we may see an increase in trade activity as importing manufacturers build inventories to avoid any increase in taxes.”
Demand for EM commodities may eventually be compromised due to tariff talks. However, the overall structural demand could well be strong enough to accommodate some ‘demand leakage’ prompted by increased tariffs. And while domestic sentiment is currently poor, it reduces the odds of investing in a mature bull market or a bubble.
As such, South Africa’s risk is lower than that of most developed countries.