After narrowly escaping Fitch and Moody’s downgrades last week, South Africa is still on tenterhooks over S&P’s rating decision. But investors should beware of excessive pessimism over South Africa’s economy in 2017. In fact, its prospects are actually looking up.
OMIG Chief Economist, Rian Le Roux said that the fading of a number of economic shocks over the past few years is supporting the case for the South African economy to improve next year. “Load shedding is long past, commodity prices have stabilised and have actually recovered a bit, rainfall is improving, the food inflation shock will reverse in the months to come and the labour environment has stabilised notably this year,” he explained.
“The recent political turmoil will hopefully also fade, and the rand, while volatile and still vulnerable and which played a key role in rising interest rates from 2014, appears to be stabilising. Should these conditions continue, it is not impossible that interest rates could start to fall next year, although this will only materialise once inflation is back in its target range and the SARB is more comfortable that upside inflation risks have faded,” he says. “A further, possibly under-appreciated, positive for the local interest rate outlook in 2017 is the planned fiscal tightening indicated by the Finance Minister in the 2017 Budget. This will further reduce pressure on monetary policy.”
But Le Roux cautions that there are still headwinds, so any improvement will be slow. “The SA consumer is still under pressure, business confidence is depressed, private investment is still contracting and taxes will rise next year. Interest rates are likely to stay at their current levels for some time to come and the external risk of the US dollar firming sharply is an ongoing concern,” he said.
However, some of these headwinds could change into moderate tailwinds by next year. ”We expect an agricultural recovery, strengthening export demand off the back of the ongoing global recovery, a decline in inflation, and a boost to exporters, import competing businesses and tourism from the stronger rand. An added bonus will be a solid a confidence recovery, driven by less turmoil and controversy in the political arena,” said Le Roux.
OMIG Director of Investments, Hywel George, highlighted that a partnership between business and right-minded government leaders will become more important as the extent of corruption in SA institutions is revealed. “Investors should consider that with domestic political risk likely to be elevated for some time, financial markets will remain volatile. However, the collaborative response by business underscores the significance they accord governance within SA and supports the resilience of the companies constituting our equity market,” he explains. “Ultimately, the united efforts to rid South Africa of corruption should boost investor sentiment.”
Peter Brooke, Head of OMIG’s MacroSolutions boutique, said that while the global environment is moving into a rising interest rate cycle, the South African environment of peaking interest rates and inflation, will mean a more positive environment for interest rate sensitive assets like SA bonds and property, both of which have become cheaper.
“Property, in particular is looking cheaper, with our expected real return increasing by 0.5% to 5.5%. This means that value is improving,” says Brooke. “We still don’t expect equity to offer the kind of returns that we’ve seen historically, but after going nowhere for the past two years, the JSE is now starting to look incrementally cheaper than the expensive levels we saw recently and this is providing a little more opportunity. Better expected returns and lower cash yields will force investors to start moving off the fence, having been very comfortable sitting with cash in the bank.”
Brooke points out that there are material risks with an excessively strong US dollar “the main concern”. This is why his team is building a balanced portfolio tilting towards interest rate sensitivity. “In this environment, you want to hold offshore growth assets and SA income assets such as property, bonds and interest-sensitive shares,” he says.
On the global front, Brooke believes some significant secular changes are coming next year. “One of our key themes for 2017 is ‘Keynes is King’, which focuses on a shift away from monetary stimulus towards fiscal stimulus,” he explains. “This is as a result of monetary stimulus reaching its limits, with negative interest rates being detrimental to the financial industry, as well as a populist groundswell seeking redistribution of wealth and more investment activity, with the obvious solution being investment spending projects in low level investment areas.
“Ultimately, we’re seeing a confluence of different events where you have cheap money and political pressure pushing for fiscal stimulus. This is good for global equities over bonds and also adds an impetus for global growth. Global growth is currently looking better, but with the US generally quite robust and China recovering, adding fiscal stimulus to this environment should lead to better earnings growth and a shift within equities to value over growth assets and cyclical over defensive assets.”
When it comes to the impact of President Trump’s agenda on the global economy, Le Roux says that neither an inward-looking US or a strong dollar will suit the US well. “Therefore, expect political pushback in Washington against Trump’s more extreme policies and a dollar-cognisant Fed,” he said. “Moderate fiscal stimulus and faster US growth should be good for the world, but greater clarity will only emerge in due course and therefore markets are pricing a logical compromise outcome of the Trump manifesto.”
Rian Le Roux, Chief Economist
Hywel George, Director of Investments