Should investors back the SA investment thesis?

We have been here before, but is it different this time? South African equities and bonds have responded positively to the formation of the Government of National Unity (GNU), but investors who were buoyed by Ramaphosa’s first term might be wondering if the current market optimism around South Africa is once again misplaced.

Just like in late 2017, South Africa in 2024 narrowly avoided a market unfriendly outcome. In 2017 the reformist ticket of Cyril Ramaphosa scraped through the NEC election by less than two hundred votes for ANC President, while this year despite losing its majority to populist splinter groups the ruling party successfully hobbled together a seemingly pro-market government of national unity.

In both cases bond markets rallied – SA 10-year yields have fallen close to 1.5% since the May election, just as they did in the short-lived Ramaphosa market rally of 2018.

In hindsight, however, the 2018 market optimism was short-lived as the reformist agenda was only tepidly implemented by a divided NEC, with (arguably) ruling party unity prioritized over national interest, and stalled consumer and business confidence further exacerbated by the COVID-19 pandemic and endemic ESKOM loadshedding.    
 

Within six months, SA bond yields had retraced back to their prior levels, while SA economic growth underperformed market expectations over the past ten years, even controlling for COVID. And SA government debt levels continued to deteriorate.

Are things different this time around?
The SA government is still borrowing at interest rates well above its expected nominal growth rate, even under optimistic growth scenarios. Bond yields would perhaps need to fall a further 1.5% at least to place debt on a more sustainable path, even if economic growth were to improve and spending appropriately re-prioritized.  

This optimistic scenario has clearly not yet been priced into the market, and it is too soon to know for sure whether the GNU will be effective in driving through the required reforms. In our view, while politically it may have been necessary to bloat an already large cabinet and insist on a GNU with multiple parties; a simple coalition between the ANC and the minimum necessary to implement a market-friendly agenda might have been more effective.  
Having said that, the bet against the SA turnaround story is no longer titled firmly in favour of the naysayers.

With SA equity and bond valuations remaining attractive, there are cautious grounds for optimism given the structural reforms that have been implemented already, and the expected urgency the GNU rather than the NEC will bring to future policy implementation.  

How are we positioned?
In our own portfolios, we moved to an overweight position in SA equities in the week post the May elections. Given our view, the negative tail-risk of a populist outcome was unlikely but we have remained cautious on the SA bond turnaround story (here we are neutral) given our concern that the GNU may be ineffective in improving SA’s economic growth rate and improving our debt trajectory.

Of course, more factors are at play than just the SA success story, and in the short-term SA markets will also respond to the geopolitical tensions, and the timing of the US Federal Reserve interest easing cycle, both of which may allow for more attractive entry points into SA assets if things turn out worse than expected.  

That said, getting one’s timing right can be hellishly difficult, and investors that remain significantly underweight SA assets should carefully assess whether the narrative is changing, as there are tentative and welcome signs that structural bottlenecks are being alleviated and business confidence improving.    

No one, however, should be surprised if the SA economy disappoints again, or even that the US Federal Reserve eventually cuts interest rates assertively to make up for lost time. After all, this has very much been the playbook over the past fifteen years. But what if this time is different? Investors should be prepared for more than one eventuality if they are to successfully negotiate an uncertain future.