3rd Quarter 2024 Market Outlook – SA should be celebrating

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The Cabinet and a New Dawn for South Africa

The much-anticipated cabinet has been announced. While not perfect, it’s a relief that it appears reasonable. Negotiating and balancing these positions must have been tough, especially getting the ANC to relinquish power they’ve held for years.

The new cabinet is large, with 32 ministers and 43 deputy ministers. This initial bloated cabinet is a compromise to include most parties in the Government of National Unity (GNU). While it leans towards the ANC, a more representative and less powerful ANC is preferable to the previous dysfunctional cabinet. Of the 32 cabinet positions, the ANC has 21, the DA 6, and smaller parties take up the remaining 5. This is not in proportion to the GNU members and election outcome.

Accountability and a Successful GNU

The key to a successful GNU is increased accountability, leading to greater productivity and fewer instances of incompetence that were previously shielded by a majority party. The next step is to see if the GNU, or coalition, can succeed. All parties, especially the ANC and DA, will need to work together effectively. This requires compromise, trust, and respect, which some may find challenging given the history and diversity within the GNU.

We believe it is possible, but we place a large reliance on Ramaphosa remaining president through his second term and the DA managing cautiously during some major transformations.

Election Outcome and a New Political Landscape

The election results were a positive development. The ANC’s share of the vote dropped to 40%, and the EFF weakened to 9%, likely due in part to the formation of the MK party and the influence of Jacob Zuma. The DA maintained a respectable 22% and its majority in the Western Cape.

Ramaphosa’s Leadership and the GNU

Initially, Ramaphosa’s decision to form a GNU might have seemed like an easy way out. However, it proved to be a shrewd diplomatic move. It was likely the only path for the ANC’s potential survival until the next election. Remarkably, Ramaphosa retained the ANC leadership despite the party’s decline under his watch. This suggests a potentially more rational majority within the ANC, with the MK party and EFF catering to radical leftists.

A New Dawn for the Economy and Investment

After a decade of economic decline, it’s understandable to be cautious about the possibility of real improvement. Over the past ten years, GDP growth averaged less than 1%, government debt to GDP ballooned to 71% from 40%, and unemployment rose to 33% from 25%.

Restoring Confidence and Growth

The pathway to economic recovery lies in an improvement in business and consumer confidence. This will lead to increased spending and investment. For example, local banks currently have R500 billion in lending capacity that could be directed towards businesses and consumers if the economic outlook improves.

Interest Rates and Inflation

Interest rates are expected to decline this year. Consumer inflation is projected to fall from 5.2% to around 4.5% by year-end, driven by a stronger Rand and lower fuel prices. This could lead to two interest rate cuts of 25 basis points each this year and a further 50 basis points in 2025.

The End of Load Shedding?

There have been 96 days without load shedding, thanks mainly to operational improvements, lower demand, and 3,000MW of new off-grid generation. Additionally, 2,500MW of capacity will be returning to service in the second half of the year. South Africa has also received a reprieve to continue operating five of its old coal power stations until 2030, providing an additional 10,000MW of capacity.

A Potential Surge in Foreign Investment

The most significant potential boost could come from a wave of foreign investment returning to the country. This influx could drive GDP growth back above 5%, a level last achieved between 2005 and 2007, when the Rand strengthened significantly from 12 to 6 against the US dollar.

Years of Foreign Investment Outflows

The graph below shows that net foreign outflows from South African bonds began in 2018, and from equities in 2016. These outflows have been substantial, with foreign ownership of SA bonds dropping from a high of 42% in 2018 to just 25% currently. Foreign ownership of SA Inc (banks, retailers, property etc.) is now negligible.

Cumulative weekly foreign equity and bond flows (USD Bn)

Foreign selling of SA equities in May was R32bn, the largest on record, as election uncertainty prevailed. This is despite R100bn flowing into Emerging Markets in May. The previous largest outflow was R28bn in 2008 during the financial crisis.

Year-to-date, foreigners have been net sellers of SA financials and industrials to the tune of R26bn and R18bn respectively.

Just over a decade ago, SA comprised 10% of the MSCI Emerging Market Index. Now, SA makes up just 3%.

SA fund managers have also dramatically reduced their holdings in SA equities.

SA fund manager % SA held shares of fund

This continued outflow or selling of SA equities has resulted in SA shares becoming extremely cheap relative to Global and Emerging Markets.

MSCI forward P/Es

To fully understand how far SA Inc. equities have fallen behind Global equities, the graph below shows the performance of the Global MSCI Equity Index versus the SA Mid and Small Cap Index (the best proxy for SA Inc.). In ten years, global equities (company values) have grown 6 times more than SA Inc. equities.

MSCI World Index and SA Mid and Small cap. Index

Global interest rates are declining, but how fast?

US markets have tempered their interest rate outlook to only one or two 25 basis point cuts this year, from 6 cuts at the beginning of the year. This is largely due to a slower than expected decline in inflation to 3.3% and a relatively firm jobs market. Despite a stubbornly slow decline in inflation, markets have held firm, anticipating the eventual economic benefits of a significant interest rate cut, now delayed until 2025. US economic growth is slowing, and the job market is weakening, which bodes well for lower inflation.

US Inflation and Interest Rates

US Election not a major market disruption

Predicting the outcome of the US election is difficult. Polls currently show a tight race, with a 50/50 split, despite President Biden’s recent poorly received debate performance against Donald Trump. However, the question remains: how will a Trump victory impact the global economy?

Trump’s policies, if re-elected, would likely involve fiscal expansion, global tariffs, tax cuts, stricter immigration controls, and reduced regulations. While this approach could stimulate growth, it may also lead to higher inflation.

Given the closeness of the projected election results, it’s unlikely either party will gain complete control of both the Senate and Congress. This divided government could act as a check on any radical policy changes, regardless of who wins the presidency.

The graph below highlights the historically strong market performance during presidential re-election years. This trend is often attributed to increased economic incentives offered by incumbents seeking to secure voter support.

Geopolitical risks remain elevated

The tragedies in the Middle East and Ukraine continue and sadly highlight the large divide between East and West as these terrible wars are protracted without global cooperation to resolve them.

Major political shifts are brewing in Europe. The UK may elect a Labour Party seen as less favourable to markets, while a potential swing to the right in France could be disruptive for the already fragile European Union.

Global growth driven by Emerging markets

The World Bank forecasts 2024 global economic growth at 2.6% and an average 2.7% for 2025 and 2026, which is far off the whispers of a global recession. Emerging markets and China continue to be the major growth engines.

Global growth per area

Global market valuations are very skewed

The performance and valuation gap between the US and other markets continue to widen and highlights the need to diversify more globally.

US and Global ex-US forward P/E ratios

US S&P 500 and Chinese Hang Seng Index

Global, China (Hang Seng) and Emerging Market P/E ratios

A Stronger Rand on the Horizon

The Rand’s fundamental value against the US Dollar (R/$) is determined by purchasing power parity (PPP), which reflects what R1 can buy compared to US Dollars. Our model currently estimates PPP to be around 14.5.

However, due to economic risks like high debt, low growth, and a dysfunctional government, a risk premium was added to the PPP valuation, ranging from 20% to 30% as these risks fluctuated.

As these risks are mitigated, particularly the removal of the debt trap with improved growth prospects, the premium should decrease, leading to a stronger Rand. Historically, this premium has even fallen to zero, but that only occurs in exceptionally favourable conditions, and evidence of such a scenario might take time to emerge.

Potential for Rand Appreciation

We believe that a stable governing coalition (GNU) adhering to the ANC/DA agreement could propel the Rand below 17 against the Dollar within the next year.

Investonline’s Prosperity Fund: Consistent Performance

Investonline’s in-house Prosperity Fund continues to deliver strong and stable returns. Despite the challenging market of the past 12 months, the fund has achieved a growth of 13.7%. Since its inception (almost ten years), the fund has averaged a net return of 9.3% per annum.

The Prosperity Fund prioritises capital preservation through conservative management. It caters to investors seeking a balanced portfolio with local and international exposure, offering consistent investment returns.

Prosperity Fund’s returns since inception

Investment strategy and outlook

Potential Boom for South African Markets

The outlook for South African (SA) equity and bond markets is very positive, with a potential strengthening of the Rand adding to the optimism. We expect the tide of investment flows to turn positive in the coming months, leading to possible sharp gains in SA markets.

This optimism echoes the “Ramaphoria” era when Ramaphosa became ANC leader. Back then, R50 billion of net foreign buying flooded SA equities in just two months.

While predicting the duration of a new market euphoria is challenging, a stable governing coalition (GNU) is crucial. Nonetheless, SA markets are undervalued, with only negative news currently priced in. Even modest improvements, like reduced load shedding and lower-than-expected inflation, could significantly accelerate the South African economy, leading to a positive market response.

Despite the exciting prospects, it’s important to acknowledge the remaining risks. Therefore, a well-diversified and balanced portfolio tailored to your personal risk tolerance is essential.

Global Opportunities

Attractive pockets of value exist globally, as the potential benefits of future interest rate cuts haven’t been fully priced in by many markets. We particularly favour markets like the UK, Europe, Emerging Markets, and especially South Africa.

Review your Investment Strategy

With widening global investment valuations, ensure that your investment portfolio is properly balanced and adjusted to suit your personal risk profile to achieve your goals. Check that your financial plan is up to date. It is critical to ensure that the risk you take in your investment portfolio matches your financial plan, especially when nearing or during retirement.

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