THE current political environment has dampened expectations in South Africa, as macro-economic data, such as the business confidence index, which is at a generational low, shows. However, when you look at the performance of the local equity market over the past century, it could be that our expectations are too low.
From 1900 to the end of last year, the South African market was the best-performing in the world, delivering an average annual return of inflation plus 7.2%. This is according to the 2017 edition of the Credit Suisse Global Investment Returns Yearbook, which compared the returns of various asset class over 117 years in 21 countries with a continuous investment history. This might seem hard to believe. Given the country’s political history and economic difficulties, how could South Africa have been the best-performing stock market in the world since the turn of the 20th century?
Free markets dictate that companies with high returns on capital attract competition. Rising competition causes the balance of supply and demand to shift, driving down the prices of goods and services. As industry margins begin to narrow, returns on capital start to fall. In contrast, a lack of competition allows companies to continue earning excess returns on capital for extended periods. For this reason, it is often more important to understand and analyse supply than demand.
A possible reason for the outperformance of the South African equity market over the past 116 years is that local companies have faced less competition compared with their peers in many other countries. This is because of prolonged periods of political uncertainty, sanctions during much of the apartheid era, and a persistent fear that South Africa will suffer a similar fate to Zimbabwe.
The benefit of restricted competition is illustrated by short-term insurer Santam, which has compounded its share price at 18% a year (excluding dividends) from the beginning of 1985 to now. Headline inflation averaged 8% a year over this period. This return is particularly impressive when you consider that Santam is a domestically focused company.
Between 1985 and today, South Africa witnessed the Rubicon speech, narrowly avoided a civil war, weathered four recessions, and suffered through 86 months in which the year-on-year decline in the rand was more than 20%. Despite all this, Santam’s moat, its ability to withstand competition and retain its market share, has gone from strength to strength. Because South Africa has not been viewed as an attractive place to do business, there has been little competition from international heavyweights, which allowed Santam to build scale and make itself increasingly tough to compete with.
Heightened perceived risk and the way in which corporate decision-making takes place makes it more likely that foreign businesses will exit South Africa than enter it. Two recent examples that demonstrate this are the decision by Barclays Plc to exit its investment in Barclays Africa and the disclosure by Pioneer Foods that a large multinational had pulled out of a potential merger with the company. Similarly, on the back of the release of the new mining charter, we can expect very little new investment in mining, or in companies that supply mining equipment.
We believe that, over time, good management teams find ways to win regardless of the macro-economic environment. In fact, they often shine in times of distress precisely because of the lack of competition. Tough environments result in the strong becoming stronger, because weak players leave the market and allow the winners to grab greater market share.
Mikhail Motala is an equity analyst at PSG Asset Management.