JOHANNESBURG - The local market and South African citizens are elated by the ousting of Jacob Zuma and the swearing in of President Cyril Ramaphosa while global market players gave the thumbs-up for the turnaround of the country’s prospects.
Since the last downgrade of South African debt and currency by Standard and Poor’s on 25 November last year the South African equity market was one of the best-performing equity markets globally.
Although the JSE is approximately 3% down from the pre-downgrade level the sharp appreciation of the rand against other currencies had a major effect on South Africans investing in equity markets offshore as developed markets and emerging markets as measured by the MSCI World$ and MSCI Emerging Market$ indices are down by approximately 13% in terms of rand.
The South African bond market was a star performer among global bond markets since the credit rating cut by S&P. The risk premium on South African debt fell as the yield spread between the South African All Bond Index and the JP Morgan Global bond index narrowed by 1.4% - at a time when inflationary pressures and strong global economic growth lead to yield curves shifting higher, especially longer-dated yields.
A return to investment grade by the S&P and Fitch and a favourable assessment by Moody’s are probably priced into the South African bond and currency markets. So are the expectations that consumer and business confidence will improve further. From an investor’s point of view the question is where to from here. A return from tepid to solid economic growth will not occur overnight as several headwinds lie ahead.
The South African economy cannot afford a further strengthening of the rand.
According to my estimates in the region of 20 tonnes of gold representing some 20 000 employees are produced by underground gold mines at a loss.
If the rand strengthens by another 5% while the price of gold in US dollars remains the same, another 10 to 20 tonnes of gold will be mined at a loss and another 10 000 jobs will be at stake.
In the case of platinum producers approximately 700 000 to 800 000 ounces of platinum is mined near break-even levels with the risk that up to 50 000 jobs may be lost should the rand appreciates by 5% while the underlying prices of the metals produced remain unchanged in terms of US dollars.
The multiplier effect – taking into account the dependents of those whose jobs are at risk as well as the impact on their local economies and the economy as a whole – is that in the region of 1 million people’s lives are at risk to poverty.
Furthermore, the global economy is fast approaching the late cycle of the upswing and the signs of overheating are already there.
Long-term interest rates are rising strongly, commodity prices are rising strongly, business and consumer confidence are high, short-term interest rates are rising and production is on a strong upward trend.
It should be remembered that foreign inflows are fickle and when the tide turns the offshore investors are quick to exit the country or hedge the cash by selling the rand and buying hard currencies.
According to World Bank and UNCTAD statistics South Africa had not experienced net foreign direct investment outflows since 1991 but inflows varied widely.
To ascertain the cash or near-cash deposits of foreign investors in South Africa the net foreign transactions as reported by the Bond Exchange of South Africa (BESA) and net foreign transactions in equities were subtracted from the net foreign direct investment inflows into South Africa.
From that it was clear that while equities and bonds were sold on the local bourses the proceeds remained in the country. It is also evident that the cash or near cash is used to purchase South African equities and bonds.
The net inflows of cash and other direct investment is positively correlated with interest rate differentials between South Africa and developed economies such as the United States and Eurozone. Foreign investors held vast amounts of cash since the 3-month interest rate gap between South Africa and the US opened up as the country had to maintain a relatively high interest rate in order to attract foreign capital order to fund the current account deficit. Unfortunately most of the cash and other direct investment inflows were in fact the proceeds of foreign investors’ net sales of South African equities and bonds as recorded by the JSE and BESA.
Although Cyrilnomics is likely to improve consumer and business confidence the very tight budget is likely to dampen sentiment and economic growth. The only tool left to help the economy along is a softer stance by the SA Reserve Bank’s monetary policy committee by cutting lending rates. However, in light of the prospect of rising interest rates in developing countries the gap between the country’s interest rates and that of the major economies is likely to decrease further with the result that the net cash and other direct inflows are likely to turn negative as foreign investors find favour in South African equities and bonds.
From experience we know that when tighter monetary policies in developed markets begin to slow global economic growth emerging market assets such as government bonds, equities and currencies are the first to feel the bite as investors turn risk averse. The window of opportunity for the “new” government is therefore limited as, unfortunately, the gap between South Africa’s interest rates and those of developed economies are likely to widen again later this year.
So, yes, the South African investor should be aware that Cinderella Cyrilnomics is likely to peter out in coming months as we join other economies and markets at a relatively late stage in the global economy that precedes a “risk off” investment strategy. The rand and South African long-dated bond yields have therefore probably seen their best levels while the underperformance of global equity markets in terms of rand is probably over.