As the S&P 500 continues to scale record highs, investors worldwide are faced with a US business cycle situation that continues to defy logic and expectations. In the post-2008 business cycle, 6 years of near-zero interest rates have led to an average annual GDP growth of around 2%, and inflation far below expectations. Consequently, we remain stuck in an expansion – but an incredibly slow one, and the ‘are we ready to raise rates, and if yes, when’ question continues to haunt Wall Street’s finest minds. Alongside, while the US has done its fair share of contributing to global growth, international markets haven’t exactly taken the baton and run. Europe remains stunted due to internal functioning and prolonged austerity (now ending), China’s red-hot markets continue to overlook the underlying debt and real estate concerns (noted in our May 4th column), and several emerging nations are underperforming due to factors far beyond fundamentals, including Brazil and Russia. Given low bond yields and fairly valued stock markets, investors continue to search for any returns possible. On this note, this week we’re focusing on South Africa as a gateway to the sub-Saharan African economy – a region with untapped potential and vast resources, but not yet on the forefront of investors’ horizons. Being ahead of the curve on Wall Street is usually extremely difficult, but this is why we think South Africa may be around the corner before other investors join the safari:
South Africa: Recent worries about South Africa’s current account deficit, regional instability, labor disputes and the prolonged dependence on commodities have overshadowed the country’s underlying economic potential, based on our research on the ground last week. Following the zoning philosophy, South Africa remains the major gateway to the Southern African region, along with Nigeria to the west and Kenya in the East – but the economy is far more developed, with a well-trenched multinational presence, a solid logistics network connecting the metro regions, and a robust banking structure already in place. While Nigeria’s GDP growth rate surpassed South Africa’s last year, at around $60 billion in market capitalization, the Nigerian stock market represents less than 15% of GDP, according to the World Bank. Meanwhile, South Africa’s market capitalization, at over $600 billion, instead stands at over 150% of GDP – significantly higher than its emerging market peers and more in line with the US’s 100%+ ratio, suggesting a relatively developed capital market and higher access to liquidity for South African entrepreneurs and corporations. Now, this comes with a domestic economy under significant strain, with nearly 25% unemployment in 2014 (according to the CIA Factbook), a declining political approval sentiment (Jacob Zuma’s government had a 34% approval rating in September, according to research firm Metro OmniCheck, compared to over 60% 5 years ago), and a continued under-performance of state-owned firms, including Eksom, who’s erratic load shedding schedules continue to hurt manufacturing and mining operations.
Despite this, the Johannesburg Stock Exchange continues to hover near all-time highs, and South Africa’s primary ETF, EZA, is up nearly 9% this year, far outperforming its emerging and developed market peers (the S&P 500 is up only 3.9% YTD). This resonates with our opinion that a stabilization in commodity prices due to the world coming to terms with China’s slowing growth, gold’s price floor given the low inflation in the developed markets post-recession, and renewed privatization efforts will lead to earnings growth and are propping up the market. While Zimbabwe’s economic woes continue to get attention, lesser-followed neighbors, such as Namibia, Botswana, Mozambique and Zambia are actually showing quite robust economies and internal demographics, and we believe investors are undervaluing South Africa’s benefits derived from them. Goldman Sach’s MD, Colin Coleman, noted in December that ‘while foreign corporate acquisitions of South Africa counterparts have all but evaporated, the capital markets have maintained faith in the earnings power of South Africa corporates. Balance sheets are solid, earnings strong and recent deal making suggests corporates ability and potential to expand abroad’. Meanwhile, Renaissance Capital, at the same conference, displayed confidence in Sub-Saharan African growth in the long term due to the ‘excellent demographics and best-educated labor force the continent has ever seen’.
As of April 30th, the MSCI South Africa index indicated a forward P/E ratio of 17.0, well above the emerging market index’s 12.1 ratio. However, South Africa has provided an annualized 5-year return of 6.7%, outperforming the emerging market index’s 3% return. According to Wayne McCurrie, a portfolio manager at Momentum Wealth Management in Johannesburg and profiled by Finweek, ‘a market can be expensive as long as the future outlook supports the evaluation’, and that ‘the earnings outlook for the South African market is reasonable, especially in rand terms’. We’re on board, and our opinion is that South Africa’s role as a gateway into sub-Saharan Africa remains unparalleled. With the inevitable development of infrastructure, communication, banking and increasing consumption in this region, South Africa stands to be a tremendous beneficiary given its existing infrastructure and relatively robust capital markets system. US interest rate hikes coming soon are likely to hit the market in the short term (as with most other markets with notable current account deficits), and it’s worth taking the opportunity to invest then.
What it means for you: Staying diversified helps. At a time when global market returns are significantly impacted by policy decisions, it’s worth benefiting by being exposed to the world’s progress. South Africa provides this exposure to sub-Saharan Africa. ETFs such as EZA, (which represents the South African index), are worth considering for buying and holding. Keep in mind, though, that while emerging and frontier regions can be great long-term plays, they’re subject to significant short term volatility and political and currency risks, among other factors. It’s best to play it slow and steady by investing over time in South Africa for the long haul, rather than going all in and expecting a full house on the next hand.
