MARCO BARBIERI: SA Inc still has much to offer investors

SA equities have fared particularly poorly over the past decade, having underperformed the MSCI world index, in dollars, by 7% a year over this period.

While this performance is broadly explained by deteriorating SA macroeconomic factors, particularly in the post-Covid era, many SA investors appear to be turning positive despite no obvious improvement in medium-term expectations. At face value, the most common reasons for this are technical factors (such as delistings and corporate actions), cheap valuations and the concept of “how low can the market really go”.

On a three-year time horizon, empirical data shows that attractive valuations are generally a good entry point for JSE investors. At present there are significant opportunities because of this, but we believe that the equity investment case has more to it than just valuation support.

SA’s weak growth track record over the past decade highlights its deep structural constraints and the urgent need for significant reform. A good way of assessing the effect of this and the deteriorating SA fiscal position on asset prices is to regress monetary and fiscal variables. These include debt-to-GDP and budget balances, thus evaluating their impact on the cost of capital, or as a proxy the SA 10-year bond.

As expected, it is evident from the chart that both monetary and fiscal factors have pushed yields higher since the global financial crisis, and more recently after the Covid-19 pandemic. But while the effect of monetary factors tends to be more cyclical in nature and has arguably peaked in this cycle, the impact of weak growth and higher sovereign debt levels is more structural and persistent.

Based on the National Treasury’s latest debt and budget balance forecasts, however, with the debt-to-GDP ratio now expected to peak in 2026 at 75.3% and with debt service costs forecast to decline thereafter, we think the pressure on yields caused by fiscal dynamics could subside slightly from current levels and support asset prices.

In a relatively stable fiscal environment, as modelled by the Treasury, various cyclical tailwinds should provide significant impetus for SA-sensitive assets.   

Arguably, the fiscal and monetary support provided during the Covid-19 pandemic was not enough to help local consumers recover to the extent seen in other economies. The subsequent tighter monetary conditions (475 basis points of interest rate hikes), high inflation and load-shedding have further impinged on consumer health and expenditure.

The lethargic post-Covid rebound in corporate earnings has reflected this slow recovery in consumption and, unsurprisingly, sectors that benefit from global drivers have fared much better. In particular, precious and industrial metal miners have experienced a powerful profit rebound, while SA-sensitive sectors such as retail, healthcare, property and general industrials, have been weak, as evidenced in chart 2. 

Four main drivers of the bull case for local equities are likely to have a strong positive effect on consumer health, corporate earnings and, ultimately, stock price returns.

First, it is estimated that load-shedding alone shaved 1.5% from 2023’s GDP growth numbers, and the Reserve Bank forecasts a 0.6% effect in 2024. Improvements over the past six months, with the return online of Kusile units, together with better-than-expected private sector investment in solar generation, have resulted in various economists revising growth estimates higher.

Second, expected interest rate cuts later in 2024 will significantly buoy consumption, corporate health and the cost of capital. While this cycle is expected to be rather “shallow”, with only a cumulative cut forecast of between 1 and 1.5 percentage points, we believe its effect, as inflation further moderates, to be meaningful.

Third, the outcome of the elections will have a far-reaching impact on local assets. There is no doubt that in the year leading up to elections, local asset prices suffered from abnormally high risk premiums. While we note that there are binary risks to the election outcome, particularly in the event of an ANC-EFF-MK tie-up, we think the probability of this occurrence is low.

And, finally, while not necessarily an economic driver, it is hard to disregard extremely depressed equity valuations against improving corporate fundamental prospects. In particular, this asymmetric return profile for SA Inc equities presents an excellent medium-term entry point for investors.

• Barbieri is director, SA equities, at Northstar.