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With South Africa entering a new era of politics, we will soon find out whether coalition politics actually look more like collision politics. Either way, “the market” matters and will continue to matter, punishing poor policy decisions and any related uncertainty.
In this show, Mohammed Nalla and The Finance Ghost discuss concepts like GDP growth, bond yields, the rand and the situation on the ground for South African consumers.
This podcast is for informational purposes only and is not financial or investment advice. Please speak to your personal financial advisor.
Full transcript:
The Finance Ghost: Welcome to episode 178 of Magic Markets. It’s in the aftermath of the South African election and so Moe, we decided to switch things up a little bit this week. I think for quite a while now, our free show has been based on covering a couple of US equities in each show. And obviously there we’re trying to point our listeners to just how interesting that market is and how great some of the analysis is that we do in Magic Markets Premium. But I also think that there is a lot of relevance, especially for our South African listeners, in just understanding some of those macro concepts, some of our original DNA as Magic Markets. If you think back to when we started over 170 shows ago, we talked a lot about the rand. We talked a lot about macroeconomic indicators, what it really means for South Africa, and just helped our listeners navigate some of this stuff. So we’re going to try and go back to that a little bit, and I think what’s really important is if our listeners could let us know what you think. That would obviously be super helpful. Do you want us to do a mix of the US stocks and more macroeconomic stuff on the free show? At the end of the day, we want to do what our listeners are looking for and what we enjoy. So reach out and tell us. That’s my two cents before we get into the show.
Mohammed Nalla: Yeah, Ghost, I certainly remember, I think one of our earliest shows was called “Rolling with the rand”. In fact, it was probably one of our most popular shows. So I’m excited because macro is my playbook. You know, this is really what I live, eat and breathe every single day. So I feel as though I’m going to be speaking a heck of a lot on the show, Ghost, I’m certainly going to let you have a word in sideways there, you know, tongue in cheek.
The Finance Ghost: I’ll let you know as soon as I can tell the difference.
Mohammed Nalla: Let’s jump straight into it because there’s so much to digest from a macro perspective and obviously there’s elections and so forth. But I want to maybe start off on a different point because as we speak, in fact, just today at the time of recording, we’ve just had the release of South African GDP data for the first quarter. And why I want to touch on this is it’s probably telling us what we know already. So it’s maybe a good place to start. Then we’ll come into some of the noise around elections and you know how that’s actually played through into financial markets. But starting off with GDP, we actually saw a contraction in the first quarter of 0.1%. Now, the market’s expectations certainly weren’t very bullish, but they were more bullish, right? They were positive 0.1%. So definitely a disappointment based on the market’s already very muted outlook.
And what’s concerning is on a year-on-year basis, the economy expanding by only a half a percent. So a slight uptick from the year-on-year number in Q4. But we’re talking about growth well below 1% here, and remember, South Africa is an emerging market. Emerging markets are supposed to be growing at 3, 4 or 5%. In the more exciting ones out there at 7, 8%. And so when you contextualise it in that kind of framework, you realise just why South Africa has been an afterthought when talking to international investors. Certainly everyone I speak to, South Africa is not on the agenda. Now, quickly unpacking that GDP number, obviously the biggest impact coming through from load shedding over the quarter. This is interesting – even though load shedding was less bad than it was maybe in Q4, it certainly does impact production quite heavily, and you see that come through particularly in the mining and manufacturing sectors. Now, if we superimpose on that, certainly on both mining and manufacturing, the challenges with regards to freight, transport and logistics – I know you’ve written about this quite a bit, Ghost – it really does constrain the overall picture, and that’s certainly from a production side. From an expenditure side, now this might be something interesting for us to pick up on here, is we actually saw this broad-based weakness on consumption expenditure as well. You know, demand has been down, fixed investment and government spending has also declined, and this is a product of a number of factors. The economy is not growing, certainly salaries haven’t increased the same kind of click when you look at inflation-adjusted increases. And then you’ve got the government story, where we have these massive fiscal constraints. So overall, not surprising to see GDP disappoint. And what does this mean if we look at it for a full fiscal year? Well, the outlook is still for growth below 1%. That’s certainly not encouraging.
Now, if we bring all of that into the backdrop that we find ourselves with today: elections. That’s certainly been all the news flow, and interestingly enough, before the election results were released, so we’re now talking Friday last week, we actually had a fairly negative reaction on the market. You saw bond yields higher, you saw the rand weaker, and the market was really quite uncertain. Over the weekend, we now all know the news, we’ve got the ANC coming through, losing its majority, it’s down around 40%. And so coalition politics are really a reality in South Africa. So now the market’s gone into what I would call a holding pattern; it unraveled some of the risk premium that crept into the price on Friday, it’s now in a holding pattern, waiting to see what happens around negotiations. The timeframe to this is around two weeks before parliament actually convenes again and we need to see what happens, which parties are going to contest the results, which parties are going to jockey for position. And if you look at the market’s perceptions, and I’m just going to bucket these into two buckets, you’ve got the prospects for a coalition between the ANC and let’s call it the left-leaning parties, either MK or the EFF, and the market perceiving that as less friendly from a market outcome and from an economic standpoint. And then the alternative would be a coalition with the DA or maybe a government of national unity type of setup, which the market – I would say, if you ask me, looking at where we are standing right now on the rand, on bond yields – the market’s reasonably optimistic about that. They’re pricing in a reasonable probability of that as an outcome. So the risk here is that obviously you’re sitting around the middle of that spectrum, maybe slightly to the positive side. I’ve known South Africans to always be so positive, to always say it’s the benefit of the doubt, we’re going to get this right. I would argue that the risks are then skewed to the downside. If you get any disappointment, the move to the downside would probably be larger than the move to the upside, arguably, because if you get the move to the upside, the market is going to say, yes, this is great news, okay, it’s time to deliver, let’s see some proof around that. So that’s really the economic backdrop, Ghost. And again, we can unpack how this has been reflected in some of the asset prices out there.
The Finance Ghost: Yeah, I’ve spent probably way too much time on Twitter/X in the past week, obviously, I think everyone has, who cares about what’s going on in South Africa. And I mean, the analysis ranges from really good to really horrible, obviously, there’s a lot of debate around whether MK is actually left or right, interestingly enough, and there’s some good arguments made on both. What they’re not, I can tell you for free, is very business-friendly. So that is what it is. And I see a whole lot of people then, you know, there’s this upswing in commentary of like, well, who cares about the markets? As though it’s this incredible force run by one person, you know, we’ll just do whatever we want. And I must be honest – the only thought I’ll leave there, and obviously we don’t want the show to get political, there’s really no point – but the thought I will leave there is it’s very easy to shout about the markets when you earn a public sector salary or you are funded by an NGO or a research grant or something of the sort. When you are a business owner or you are earning a salary or you are, whatever, trying to enter the job market, you’re going to learn the hard way very quickly that – what’s that old saying, Moe? – the capital flows to the path of least resistance. And listening to what you said at the start of the show about how, from an emerging market perspective, we’re not necessarily that high up on the radar, why would we be? With 1% growth? It’s just not enough for the risk that’s baked into South Africa. And it goes back to policies for years and years now that have hampered growth. Infrastructure is horrible. Look, at least the load shedding hasn’t come back. I’ve got to tell you, it’s still not back. So when those next quarter GDP numbers come out, they will be a quarter that was pretty much devoid of load shedding. And that’s going to be pretty interesting to compare to what happened in the first quarter.
Mohammed Nalla: Yeah, you get the low base effect, right? So you had a really bad first quarter. If you have less load shedding in the second quarter, you’re going to actually see that bounce back up again. But again, that’s why it’s so important to look at the bigger picture. And, you know, to your comments, Ghost, you ignore the market at your peril because at the end of the day – and maybe we talk our books here as markets individuals, markets people, we’ve always spent our careers in markets – the markets tend to discipline bad actors. Now, ironically, in South Africa’s case, that really hasn’t come through to resonate. South Africa has remarkably always had the benefit of the doubt. So let’s unpack that, because I’m going to start off firstly with bond yields. How is risk perceived around South Africa? And again, just for emphasis, right, we had a SARB decision last week as well. And again, maybe it’s because they kept rates on hold, they updated their forecast and again, nothing that’s unexpected, they’re expecting growth to be weak, they’re expecting inflation to have upside risks to it and so forth. But how does the market price this?
Well, first and foremost, if you have a look at bond yields – and I’ll start there, because the rand is a lot more volatile – if you look at bond yields, that’s the price that the South African government, and by extension the South African public through its taxes, have to pay for the policy actions. And if you look at the yield on the South African ten-year, it’s been around that ten and a half, 11% range for quite some time now. Simply, if you want to deconstruct this, it’s quite easy to say, well, what’s fair value? And there are a number of models you can use. But first of all, you start off with the risk-free rate, which is the US ten-year. Then on top of that, you’ve got to actually add in a South African risk premium as well as what’s happening with US inflation at the end of the day. And you look at the inflation differentials and you look at the yield differentials. So in aggregate, if you look at those moving parts, you could argue that South African ten-year yields are trading at close to fair value. How does this correlate with another expression of risk in the bond markets predominantly, you’ve got to look at credit default swaps because this is the price of insurance on South African debt, on dollar-denominated debt. And if you have a look at that, remarkably, it’s actually been quite range bound. I’m going to give you some interesting numbers here Ghost. We know in the global financial crisis back in 2008, things got completely crazy and we were at really elevated levels. But subsequent to that, it actually traded down, around 2010 to 2011, down to around 100 basis points. And I would call that very compressed. Lots of good news priced into that. Then we had Nenegate around five years after that and it went from around 200 basis points pre-Nenegate to around 370 basis points. So almost an effective doubling in the cost of insuring against South African risk. And that’s because of political uncertainty. And usually you get a 60/40 split if you’re looking at the rand and bonds between global factors 60, local factors 40. But Nenegate showing you the political risk premium starting to come through. Then it again – remarkably, the market gives South Africa the benefit of the doubt – it actually pulled all the way back down to around 200 basis points. Covid got us back up to around 400 basis points. But where we are now, 288 basis points.
Now, how does that compare? Like I said, fairly range bound. If you look at well-performing emerging markets, Mexico, India, they’re at below 100 basis points. So it doesn’t matter what the credit rating is, it doesn’t matter what your debt’s rated, this is the market’s expression of risk around those economy sub-100 basis points. China as well, really seen as a premium credit out in the emerging market space, Turkey maybe doing less. Well, Turkey at around 320 basis points. So South Africa closer to the likes of Turkey when assessing global emerging markets on the fixed income space. And then let’s bring that lastly – my last point, then I promise I’m going to stop talking because I want to hear what’s happening on the ground, Ghost, I want to hear what’s happening there – let’s look at the rand. Because I see the rand as the ultimate expression of volatile near-term risk premia with regards to South Africa. They always call it the share price of the country. And if you look at the rand, remarkably, that’s been quite well-behaved. You know, we’re currently trading, if you look at a short-term trend, a short-term regression, we’re trading around the lower two standard deviations. So this suggests that you might get some upside momentum come through and that would be the, let’s call it political disappointment.
But if you actually rewind a lot further, you take a super, super long term chart and you map it on that, it’s actually closer to around one standard deviation above the trend. Now, the reason I want to raise this is that if the politicians in South Africa start making decisions for the long-term prosperity of South Africa, you can actually expect the rand to strengthen. It can actually go to around the mean of that trend – and wait for it – that gets you a 16 in front of the big number instead of an 18. However, if the decision-making is shorter term in nature, then you’ve got to look at the short-term trend and that’s where you’re probably going to see this blow up to above the twenties. So again there, what’s interesting is the asymmetry is you might get two to three rands to the downside. You might get three to four rands to the upside longer term, this is really the expression, and again, we’re watching with bated breath. We can certainly hope for the best. But I would argue South Africa has been given the benefit of doubt. Let’s not squander that, Ghost. Now, let’s bring this to what’s happening on the ground, because we know it’s a tough economy. A lot rides on confidence. People spend based on confidence, on their perception of the future. What’s been happening on the ground there, Ghost, in terms of the companies you look at – what’s the consumer been doing? Because consumers vote with their wallets. Money flows to the path of least resistance when you’re in the markets. But guess what? With consumers, it’s the same story.
The Finance Ghost: It absolutely is. And you know, if the rand blows out, what that does to what you pay at the fuel pumps and food, and I mean, you know, everyone listening to this podcast I think understands what that means. So there’s probably no point in belabouring that point. But what I will say is that the story on the ground at the moment, I mean, we’ve had a flurry of results recently on the JSE. So all of the February year-ends have been keeping me very busy. And a few March year-ends as well, who reported a bit earlier than they have to under JSE rules. Quite a few retailers as well. And I think the trend coming through there is quite clear, which is that credit sales are driving growth right now. If you are only a cash sales business, then at the moment you are going to find life pretty difficult. So two good examples of this would be Lewis, which to be fair, has been driven by credit for quite some time now. I mean, anyone who’s followed the sort of furniture retail industry will know that, that a big part of the income model there is to actually sell on credit. But I think the one that I find more interesting is Pepkor, which is the sale, let’s face it, of clothing. So it’s one thing to go and have to buy lounge furniture or a bed on credit because that’s a durable good. It kind of makes sense. You know, you should only really be buying something on credit that is durable. It’s an unusual purchase, hence you didn’t have the money you needed to go and borrow and pay it off over time. Fair enough. But clothing? What state are your finances in if you need to go and buy clothing from Ackerman’s or from Pep on credit? That tells you what is going on among lower income consumers.
And it’s particularly stark when I look at, for example, Nedbank’s numbers for their latest operational update. They actually show that they’ve been a little bit conservative on unsecured lending because they are worried about the economic conditions. Now, the same people who are going to banks for unsecured loans are exactly the people who are buying on credit at places like Pepkor, but the difference there is the retailer is obviously driving their core business by selling on credit. They are earning a nice big gross margin on the clothing. They are presumably then getting more full price clothing out of the door as opposed to promotional markdown style stuff. Whereas the banks don’t get quite that upside. You know, they lock in a funding margin at best. So they have to be very cautious. The retailers can afford to be more aggressive. But I think the overarching point is that, that is the situation on the ground. And that’s why we decided to call this show Collision Politics instead of coalition politics, because we really are at that point. It feels like South Africa has finally reached that fork in the road. We’re either going to get a lot more business-friendly or we’re going to get a lot less business-friendly. But I don’t think we’re going to be at a similar level of business-friendliness or unfriendliness as we have been in the past few years, because the outcome of this election is that things are going to change, one way or another they’re going to change, for better or for worse. And if I look at what’s happening in company results sort of ground up, consumers are just getting more and more and more hurt and we desperately need a stronger rand, more foreign direct investment. We need better unemployment numbers, etc. etc. to actually drive this economy. Because it’s not great to see things like cash sales under pressure at Pepkor because people are buying clothing on credit.
Mohammed Nalla: Yeah, Ghost, I think this is really an important time to try and tie the loop between the macro and the micro. You know, we’ve got to tie it from the macro stuff I discussed upfront to the companies and then down to the consumers. And the reason I want to do that is that it can be, we’ve had this spiral, this negative spiral, but it can be a virtuous cycle. And if we get confidence ticking up again, well, what happens? As we indicated, bond yields probably trend lower. The rand probably gets stronger. Now, what happens then, if the rand gets stronger, given the high import component in the South African economy, is that this actually mutes inflation. And if this mutes inflation, the Reserve Bank then has the scope to actually cut interest rates. And if they cut interest rates, well, guess what? That starts to help aspects like, for example, consumer balance sheets. Maybe you get some kind of spend that you don’t want. If you don’t want people spending on credit to buy clothes, absolutely. But it will give a shot in the arm to the underlying economy. And again, the composition or the mix of how consumers are spending their money, we know there’s been a lot of spend that’s been redirected towards mitigation for the energy crisis that you’ve got down there. People go and spend on inverters or solar or whatever it might be, that takes away from other discretionary spend, and it hurts overall consumption in the economy, which then hurts overall growth.
So in order to get this flywheel really spinning, we’ve got to get the confidence game to actually turn around and to move on to the positive. Then the virtuous spillover is if bond yields come down, guess what? Corporates actually get a lower cost of funding they can invest. And then the last point I want to raise here, and I actually want to ask you the question, is that if you get this confidence coming through, you get growth to start to come through, you get local companies starting to invest. It then starts to incentivise international investors to start looking at equity investments in South Africa again, because my big bugbear is that they’re very happy to invest in South African bonds because they get a good, let’s call it a real yield, if you look at it over South African inflation. South African bonds are nice and liquid, but the type of investment that South Africa requires is probably more equity-related. It’s probably more direct investment, whether that’s through the listed markets or actual investment in the ground in actual unlisted assets. What do you see as the outlook for foreign investment acting as a catalyst for local investment as well? Because we know government’s balance sheet is tapped out, we really have to start tapping the balance sheet of the private sector. We’re not seeing that yet. Do you think there’s enough of a flywheel? Should we get some positive outcome for that to unleash what I see as intrinsically undervalued South African stocks?
The Finance Ghost: Look, it certainly helps. I mean, I make no claims to be a macroeconomics expert by any stretch, but ground level South Africa still offers a lot to foreign investors, if we can just get the policies right. From a time zone perspective, we make a world of sense for business process outsourcing. So there’s a lot of that happening at the moment, specifically in the Western Cape. There’s obviously the whole renewable energy story. I mean, yes, load shedding to a large extent seems to have miraculously disappeared, but there’s still big opportunities for renewable energy, particularly focused on commercial and industrial applications. And those are literally just two examples. We’ve always had the automotive industry which has been very strong here, and yes, everyone talks about electric vehicles and this and that. The reality is that petrol-powered vehicles are not going away tomorrow, and they will take a very long time to go away, if ever, in emerging markets. So South Africa is a great place to manufacture vehicles for not just this market, but other emerging markets, and send them away on a port that hopefully works. But again, if none of that stuff is working, you’re not going to get the FDI. And if you don’t get the foreign direct investment, you’re not going to get the supplier who pops up down the road from the Volkswagen factory supplying the stuff that goes into the vehicles.
This is what people forget, you know, when the internationals pull out, if they do pull out of South Africa or not, even if they pull out bluntly, but they do this like, like quiet quitting, you know, that silly trend that came out in the pandemic. That’s what they actually do. They don’t say, oh, we’re shutting down our factory, they just don’t open one that they might have opened, or they don’t expand something that they were thinking of expanding. And then people like to say, oh, look, there’s no impact. Well, actually there is an impact because you don’t know what might have been, and you don’t know how many other companies would have sprung up around this investment to actually grow the economy. So we do know what might have been. That’s why GDP looks as bad as it does really, and why South Africa has fallen out of favour with so many international investors. Are South African stocks cheap? If we get the right coalition in place and everything else, maybe. We’ll see. I still don’t think it’s quite that straightforward. A lot of it is going to actually depend on what the story is with Eskom, I think. If this is real and load shedding is genuinely somehow gone, and we get the right sort of coalition in place that is business-friendly, then sure, maybe some of the stocks are cheap, but having the right government in place, I don’t know. There’s a lot of little miracles in a row that need to happen for that to be the case. Chances are there’s going to be lots of political infighting. I can’t see us getting through all of winter with no load shedding. And the trains are not exactly perfect yet either. So I think there’s still some way to go.
Mohammed Nalla: Yeah, Ghost, I mean, you’ve kind of summed up what my overall stance has always been on South Africa is that it’s got tremendous pent up potential, but they fail to capitalise on that potential. I mean, we haven’t even touched on the prospects for inbound tourism growth. I mean, tourism is a remarkable opportunity for a place like South Africa. But guess what? You’ve got to get governance under control and you’ve got to get a handle on the crime situation down there. Then you’ve got to look at agriculture. Agriculture I see as one of the highest potential sectors in South Africa from an employment perspective and from an export perspective as well. And then maybe the last one, the litmus test for me in terms of current sentiment of big business on South Africa, was the whole story around BHP and Anglos, because there was a deal on the table. But guess what? The deal wasn’t really about the South African assets. You know, that that’s not really where the emphasis was. And again, that’s telling you that yes, South Africa has some prime assets, whether that’s in the listed space or not, but whether that makes sense for international investors, well, if you look at BHP and Anglos, South Africa was not the impetus for the deal. It was some of the international assets in other emerging markets. And that is why it’s so vital, because it shows you an appetite from international investors to invest in emerging markets, but the right emerging markets and South Africa now really has to work quite hard at being the right emerging market.
I’m not naïve enough to go out there with rose-tinted glasses. The benefit of sitting out here in North America is I get to take some of the emotion out of it. I like to believe that I can provide a nice level-headed assessment of what’s going on down there. And I think your comment is absolutely spot on, is yes, we can hope for the best, but hope is not a strategy. We need to actually start to see some delivery. The fact that there is a prospect for some sort of turnaround in governance is one that I believe represents some optionality and it’s what’s been priced into the markets. But again, my parting comment here, Ghost, is ignore the markets at your peril. Certainly in an era of, as we’re calling it, collision politics, right?
I guess that’s where we’ve got to leave it this week, Ghost, again, we’re out of time, but what do you think as our listeners? Let us know, engage with us on social media. It’s @magicmarketspod, one word, @financeghost and @mohammednalla, all on X. Let us know if you like this kind of flavour, this kind of topic, what you’d like us to actually be covering. We hope you’ve enjoyed it. And until next week, same time, same place. Thanks and cheers.
The Finance Ghost: Cheers.
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