Making investment sense of the unrest in SA
25 Jul, 2022


Nazmeera Moola, Head of SA Investments, Ninety One
Clyde Rossouw, Co-Head of Quality, Ninety One
Peter Kent, Co-Head of SA & Africa Fixed Income, Ninety One

Nazmeera Moola: Hello everyone. Thank you very much for joining us today as we talk through the events of last week and what the implications are for financial markets. Joining us, we have Peter Kent, who is Co-Head of our South Africa & Africa Fixed Income team and a Co-Portfolio Manager of the Diversified Income Fund; and Clyde Rossouw, who is Co-Head of Quality globally at Ninety One and Portfolio Manager of the Opportunity & Franchise Funds.

Let’s start by examining what has happened over the course of the last week and how that has played out in financial markets. We know that the unrest in KwaZulu-Natal was initially triggered by the arrest of former President Jacob Zuma but that it soon started to get beyond that and move somewhat out of control as rioting rocked the province. We have seen estimates of R20-50 billion damage all-told. But, Pete, maybe if we can start with you – how has this played out in markets over the course of the last 10 days and what are we seeing priced in at this point?

Peter Kent: Thanks, Naz. Yeah, I would say that the market reaction has actually been fairly limited at this stage. You know the rand this morning is at R14.70. In the peak of the chaos last week, it got to R14.75. It is about R1.00 off the lows, which were reached around a month/a month-and-a-half ago. You know we were, not long ago, at R13.50 but that R1.00 depreciation that has happened since then has not been local factors. So the rand went from R13.50 to R14.50 over the last month. That has not been because of what has been happening locally. That was more what was happening in the US and the dollar. So I would say the sort of local element of what has happened in the currency has been the last 25 cents or so.

In the bond market, bonds have been exceptionally well-behaved. There hasn’t been much of a sell-off but, when you look under the surface, when you look at slightly more nuanced measures, you know curves, so the sort of fiscal part of the curve, the 30-year part of the curve versus the front-end, the SARB part of the curve, we have seen the fiscal part of the curve underperforming, which has resulted in a steepening, and you have seen our credit metrics overseas widen and deteriorate slightly. But the market reaction, all things considered, has been quite limited.

Nazmeera Moola: And I think one of the places we see that – you talk about the currency – is I always look at the rand/Aussie dollar cross as an indication of whether EM or local factors are driving something or if it is the global cycle and that has barely budged. So how are you thinking about the global cycle at this point in time because I think that is an important component of how people should view the recent events?

Peter Kent: Yeah, it is a great question, Naz. You know markets are very alive to a repricing at the moment on the global side of things. You know you have seen in the treasury market, for example, rates rally quite precipitously over the last month-and-a-half. Some of that has been a reappraisal of the post-lockdown world. It is not going to necessarily be as boomy as we had thought. So it is sort of more secular stagnation struggling to reach [indistinct] velocity, the same sort of stuff we have seen in the last 10 years post GFC.

That has been some of the repricing but then, more recently, over the last week or so, there has been a bit more of a sinister element into markets. You know, with what is happening with the Delta variant, I think there is some concern that perhaps a global recession is coming around the corner. I wouldn’t necessarily say that that is our core case. We are quite convinced that there aren’t recessionary dynamics there. So, from a global perspective, we think recessionary type pricing will probably reverse but, dealing with this post-pandemic world that is a bit of a damp squib, I think that kind of pricing will remain.

Nazmeera Moola: Okay. So what we have seen so far is limited movements in the currency due to local factors, driven by these global factors you are talking about, but we are seeing some impact off the developments in terms of the credit spreads and the relative pricing on the curve.

Peter Kent: Yes.

Nazmeera Moola: Clyde, if we can turn to you now and talk about the equity markets in both of these fears, both in terms of what has been playing out globally but also the impact of the local events in terms of the equity market and what you have seen in the last 10 days.

Clyde Rossouw: Yes, certainly. I think it is important what Peter has mentioned on the global side. We have seen some significant signs that we have seen the peak of cycle and we are in the process of de-acceleration but that doesn’t necessarily mean that it is a bad environment for investments. All it means in our minds, from an equity perspective, is that you have got leadership that is occurring and, if you sort of think back to February this year, where we saw peak cyclicals, we saw a very strong rally from the sort of depressed parts of the market, the re-opening plays, that leadership has changed and, with lower bond yields, some question marks around the longevity of the cyclical growth component has pushed the market back into the structural growth businesses and it is very important to also bear in mind that we are currently in the middle of earnings season, reporting season and the numbers are going to be quite spectacular in terms of growth numbers. So that is important just for investors to bear in mind.

I think, with regards to South Africa, again, it is important to note that we had quite a strong recovery in domestic equity markets and, again, South Africa has this luxury of being a double cyclical, both being an EM and also being a commodity player, and, as a result of that, we have seen significant upward movement in those stocks. But, again, with some of these speculative elements cooling – we see Bitcoin coming off; we have seen rhodium, which has been a bit of a poster child for speculation, cooling as well – I think it does warrant somewhat more caution on those cyclical parts of the market and that is probably where I would say some of the more challenging areas are to invest in.

This environment has, actually, been quite positive for our funds in general. We are, obviously, very mindful of the challenging events that are taking place in the country. We know there is quite a big rebuild that is going to be needed in KZN and Gauteng but, to Pete’s point, the markets are forward-looking and it is important that we continue to be mindful of the opportunities that may present themselves there.

Nazmeera Moola: So at this point, as we think of the causes of what played out the last week, you and I have had several conversations about the impact of this low growth environment in South Africa on this. Do you want to flesh that out a little bit because I think that will be very useful for our viewers?

Clyde Rossouw: Yes, certainly. I think, our portfolios, we have been positioned for quite some time being mindful of the fact that South Africa is somewhat stuck in terms of a low growth environment and we have had this bifurcation that we have received something of a boost from the commodity-producing counters and that has driven a cyclical recovery of the market and, of course, the South Africa incorporated players, the local-focused businesses, yes, there has been a recovery in retailers and banks to a certain extent but, in general terms, those businesses are somewhat growth-constrained if you look further out along the earnings curve, sort of looking 2-3 years out.

Clearly, the events that have sort of erupted last week are part and parcel of a lot of people that are probably slightly on the wrong end of the employment curve and also very marginal in terms of you know on the breadline and I think that it doesn’t require a lot in order to set off or to spark off challenges and this is an example of what we are dealing with my mind. To my mind, what really is needed now is an unequivocal ideological focus on economic growth because, without economic growth, the ability for people to build their livelihoods, I do think that the investment environment with regards to local only businesses is going to remain quite constrained.

Nazmeera Moola: I want to come back a little bit later on to talking about what sort of measures we need to see but, before that, Pete, we have been talking about the indirect and the direct consequences. So we know what has happened. Clyde and I have talked about the causes of that but now let’s go forward. What are some of the indirect and direct consequences of the events of last week in terms of South African policy in the next few weeks and the next few years?

Peter Kent: Thanks, Naz. I think Clyde hit it on the head when he spoke about growth. You know we have known in South Africa, and policymakers in South Africa have known for some time, that growth is way too tepid and there have been some movements on reforms. You know there has been some great movement on energy reforms, transport reforms, some real momentum you know and you saw it in South African asset prices.

So I think one of the indirect consequences potentially is you know the President has been very focused on these reforms and has started to deliver but you do wonder if the security situation, [indistinct] security, is perhaps going to distract from the energy that thusfar had been put into those reforms. I think that is potentially one indirect consequence. We will watch that one quite closely to see if that reform zeal that we have come to expect over the last few months continues. I think that would be one indirect consequence.

The other indirect consequence would be the investment environment, as Clyde mentioned. The investment environment, you know investment, as a percentage of GDP, has been a laggard for some time. We were discussing it this morning with the team. You know we were looking at it with [SISA]. It has been a laggard for some time and you do wonder around whether this does influence the investment environment going forward.

I think those are the two hard elements of GDP and outlook and the investment environment to quantify. The slightly easier elements to quantify are the more direct ones and the direct consequence, as a bond investor, is fiscal. So there are some real sort of direct implications of what is happening. There is a sort of monetary implication of what has happened.

So, for example, the President mentioned this weekend that they are considering a basic income grant. That is going to need to be paid for you know. We have run some numbers on it. It is a huge sort of estimate [indistinct] at the moment but there is potentially 30 million people between sort of 18 and 65 that would qualify, of which 15 would be employed. So you are looking at around potentially 15 million people. A whole bunch of other people are receiving grants as well. So maybe you are looking at sort of 7-10 million people who receive a basic income grant anywhere between R350.00 and R500.00 per month. You are looking at a bill of anywhere between sort of R50 billion and R100 billion a year as an annuity. You know that is going to have a direct consequence on the fiscus.

But, fiscally, I will say this (you know Clyde has alluded to the double cyclical) South Africa, fiscally, is in a far better position than it was 6 months ago. There has been an evolution in our fiscus. In October and for much of last year, we were staring down the barrel of a R300 billion hole in our tax revenues. That was as of October but then in the sort of February budget, given the commodity windfall, the tax windfall, that had close to halved and then, even subsequent to February, the numbers are looking very good. So there is some fiscal room in relation to the budget that was presented in February.

So these kinds of monetary implications that I mention like won’t necessarily be a problem this year but, because they are an annuity, they get included in expenses, they compound and they become a little bit more of a problem further out and fiscally then it does become a little bit of an issue when we are trying to stabilise our debt and that is why you have seen the sort of more fiscal metrics of our market starting to reprice.

Nazmeera Moola: And I think one of the key issues is how we think about this investment environment and the reforms because that, ultimately, becomes the answer to both of the discussions we have had in the last few minutes, is Clyde talking about how do we get growth going and, Pete, you talking about does the events distract and I think the hopeful scenario is one where there is a realisation by the politicians that, actually, they need to use the events to catalyse growth rather than to get distracted by other measures at this point in time.

So maybe what would be helpful at this point is to talk about some of the things that we think are really important for them to do. I think first up is the electricity sector because the changes that we saw in the market there are really important in terms of bringing new capacity on-stream. Actually, the mining sector is a case in point, where we already had Roger Baxter from the Chamber of Mines tell us that his members, at the announcement of the shifting of the cap from 1 megawatt to 100 megawatts, had 1.6 gigawatts of projects ready, R27 billion worth of investment over the course of the next 18 months. That, I think, will come anyway despite last week. Actually, last week probably increased the impetus for those investments to come, not decreased because it reduced confidence in the state. So I think you are going to see those investments coming through. I mean are there any particular areas that, Clyde, you think the government should spend the next 2 years focusing on?

Clyde Rossouw: Well, look, I mean, Naz, you have highlighted one of the key constraints to growth and that is the ability for an economy to grow without adequate power and, in particular, the energy transition required in South Africa is a substantial one. So these are all definitely steps that need to be taken in the right direction.

I think, added to that, look, we know there are perennial bugbears, the one being education and the quality of education coming out, where we still think we could do a bit better in terms of the aggregate outcomes as a population, and then probably the primary orientation for me on the government’s side would be specifically to get the grassroots competency levels up. What I mean by that is we need municipalities to function properly. I mean we have heard a lot of anecdotal stories around South Africa where business has been forced to retreat because the basic services are not being supplied and that, obviously, has profound implications for communities where people live but it also has implications for businesses wanting to operate there. So if we can get that right (my one wish would be a focus on that), I think that will put us in – you know go some way to create the environment where the entrepreneurship that is inherent in South Africa can, actually, flourish.

Nazmeera Moola: Okay. So, Pete, anything you would add to the list of energy, education and municipalities?

Peter Kent: Naz, it is a topic that gets a lot of head-time in South Africa. You know we have used a phrase on the desk, you know Malcolm and I talk about “incrementation”, right, incremental implementation, and that is what we have become accustomed to from the President. To some extent, it is slower than what you would like but it is, actually, more sustainable if you do it in a deliberate and considered way and I think last week’s events sort of highlight how sustainability of reforms are probably as important as what you do. So that incrementation must continue.

I think one thing we learned through the pandemic was you can come up with fantastic policies but, if you don’t have the capacity to implement them, you have got a real problem. So, for us, state recapacitation is a priority and I think last week’s events highlighted that to some extent, you know making sure that good policies, actually, had the ability to be implemented.

Then I think a little bit more closer to home out of the sort of realm of politics and reform is the bond market. You know what we have seen over the last 6 months or so is a National Treasury that has been very, very well-disciplined with the windfalls that we have been receiving. South Africa, from a fiscal perspective, is in a completely different position than it was last October and for much of last year and it would have been quite easy to just spend that windfall, and what we have seen National Treasury do is being very well-behaved in terms of reducing issuance, reducing borrowing as much as possible.

You know we completely understand the social needs of South Africa and I would not want to sort of underplay those but the discipline that National Treasury have shown in the debate we would like to see continue as bond investors and it has been part of the reason why South Africa up to now, over the last 6 months, has stood out quite highly versus our emerging market peers. We have outperformed materially because of that discipline that we have shown with the windfall. So as much as possible, try and keep that sort of fiscal discipline. It benefits in terms of borrowing rates, in terms of currency, importing, food inflation. It does have those benefits.

Nazmeera Moola: So it does feel like, if we look at the movements in markets over the last 10 days, SA Inc. shares have been remarkably well-behaved. We talked about the equities, the bonds and the currency as well. It seems to me that markets are effectively pricing this as a once-off event and, therefore, the risk scenario in this is that, actually, there are repetitions, maybe not of the same magnitude but that there are further disturbances that come up. So in that backdrop, Clyde, how are you and Sumesh and Duane thinking about your equity portfolio construction for your South African portions of your portfolios?

Clyde Rossouw: Yeah, again, it is important for investors to bear in mind that we have been quite defensively positioned in terms of our exposure to South African stocks. You know Pete has highlighted quite eloquently the investment case for bonds and, obviously, there is an attractive real yield on offer, which is quite scarce in the global context. As sort of cross-asset investors, it has always been difficult for us to sort of understand why you would want to pay a relatively high multiple for relatively low growth in the local markets and that has been a conundrum we have been wrestling with for the last 5 years. As a result of that, we have, obviously, had quite a lot of exposure to SA bonds, which we continue to maintain, not that we are expecting yields to rally materially but we just think that it is important to just bank those high nominal and reasonable real yields and then accessing the growth we are looking for in terms of the offshore exposure. Where businesses are offering that, we can access that. So that has been our approach.

I mean, clearly, in terms of the domestic landscape, it is important that we – we still have to quantify the costs of last week and your point is quite well-made in that we don’t know if there will be other events in the future and the probability of that must remain on zero for as long as we don’t deal with the growth dynamics. So that is imperative that we deal with those.

We would be a lot more optimistic and constructive on allocating more money to the local equities if the relative valuations were vastly more attractive and/or the rand were to price down and/or bond yields were to be lower. So we are waiting – we are still waiting, we are playing this patience game and we think that that positioning still seems to be correct.

The one thing I would just add is that the currency, the rand, you know Peter has alluded to it earlier, that it has lost about a rand against the dollar in the last month or so but it still appears to us to be somewhat on the extended side. Yes, there are good reasons why it has a relatively high valuation but we would still see that being a tailwind. In other words, accessing foreign returns would still be enhanced by the currency rather than taking away, which we have seen over the last 12 months. That will, obviously, be helpful for our portfolios prospectively.

Nazmeera Moola: Okay, so low growth environment still keeping you out of South African equities and recent events just compound that view.

Clyde Rossouw: It has continued to make us slightly – you know we are just more cautious on that rather than perhaps some of our competitors who have relatively chunky positions in some of these local stocks.

Nazmeera Moola: And, on a relative value, South African bonds offer better value at this point in time. Pete, on that, so if we think about the two anchors to the bond curve, one is the Treasury and we have talked about the fact that the Treasury so far has been quite disciplined about not spending the higher than expected revenues, but now these events do raise some risks that you are going to see increased spending, particularly for a basic income grant, but, despite that, we think they are going to try and implement it as conservatively as possible if they go down this route. But the other anchor for the bond curve is Reserve Bank. So how do you think the Reserve Bank’s thinking is affected by the events of the last 10 days?

Peter Kent: Thanks, Naz. It is always nice to be on a call with Clyde, who makes the bond investment case so well. I don’t really need to add that but I think you are right, Naz, and the other thing I would add, as bond investors, sort of everyone thinks we are a one-trick pony and we can only go into one bond but you know we do have a yield curve where we can move up and down and, as you mentioned, there are plenty of places to hide in this world where yields are high in South Africa.

So inflation is low. You know we have just had a print this morning that was marginally above the midpoint of the SARB’s band but [SISA] has got inflation realising close to the SARB’s band for the next couple of years. So, from an inflation perspective, the SARB is not under pressure. Inflation has sort of come off the lows of what we had in the midst of the pandemic but that has largely been base effects and fuel. Core inflation has still got a [three] handle on it.

So there isn’t nearly as much pressure on the SARB as there is on other emerging market central banks. So you have seen a whole bunch of other EM central banks hiking. You have seen Mexico, Chile, Brazil, Hungary, Russia all hiking but their inflation picture looks way different to South Africa. You know they are anywhere between 1% to 4% above their inflation targets in those countries and that is what solicited those hikes. South Africa hasn’t had that experience, largely because the rand has outperformed. You know the terms of trade effect has helped the rand outperform other EMs, so we just don’t have an inflationary problem like other EMs do.

So that means, for us, that we don’t think there is any urgency for the SARB to hike. We definitely think the next move is higher but we don’t think it is imminent. You know there is the potential for some votes for hikes starting to emerge within the MPC. We would think that the earliest is sort of November to the beginning of next year if things evolve as is. However, if the rand does depreciate, you know if the external environment does deteriorate or if some of these risk events that you mention move the rand above 15 (say) to the dollar, I think you would then start thinking about September hikes, November hikes. But the front-end of our curve, the SARB part of our curve that you mentioned, already has that priced to a large extent.

You know the market has been looking at other EMs, has been looking at the currency move R1.00 over the last month or so and has built in quite a lot of premium there. So we think it is a reasonable place to get some yield and the hint is in the name, Diversified Income. It is an income fund and, as Clyde mentioned, there is plenty of income on the table in our bond market.

Nazmeera Moola: Okay. So maybe to finish off the Diversified Income conversation, have there been any changes you have made in your portfolios over the course of the last 10 days, given the events in Kwazulu-Natal?

Peter Kent: Naz, no, we haven’t changed anything materially. As I mentioned, the rand started moving a month/a month-and-a-half ago because of external factors. We are positioned pretty well for that. We were worried about the Fed getting a little bit more hawkish. South African assets had had an unbelievable run as well. So we took a little bit of profit on all of our positions and we came into these events quite defensive. We had reduced our duration. We had increased our offshore allocation. Property, as you know, we have kept low for some time. So we came into this quite defensively, not that we anticipated this unrest at all. It was more from a global macro environment.

So we were set up pretty well for it. We haven’t changed anything materially from that. All we have done is we have shifted our interest rate risk, our duration risk. From that longer-dated part of the curve, the fiscal part of the curve, we have shifted a little bit closer to home.

Nazmeera Moola: Clyde, from our earlier discussion, it sounds like you haven’t made any material shifts after last week’s events because your portfolios were largely positioned in a way that took those risks into account but how are you thinking about your portfolios going forward now, both in light of the local events and the developments on the global side?

Clyde Rossouw: Yeah, I think again, at the margin, what we have done is we have continued to reduce what has been a [indistinct] exposure to cyclical stocks. One example would be Richemont, where we have taken a third of the weighting off. It has done particularly well. It has more than doubled from the lows. You know if you look at the results that came out last week, the sales growth is now 22% higher than it was in a pre-Covid base in 2019, so that is extraordinarily how strong the sales performance has been. So that is an opportunity for us to take some money off.

We have also, even in our offshore portfolios, reduced some of the more aggressive cyclical exposure that we have, which is not – well, it is not aggressive by South African terms or by our peers’ terms but, certainly, compared to where we are at. So we have moderated that stance even further and I think our equity weighting is still relatively low. We have added a little bit more to things like Naspers, where the discount continues to grow and the market is incorrectly focused on deal hysteria rather than focusing on the fundamentals of Tencent in the business. So there are opportunities there but, at the margin, no big asset allocation calls and just some tweaks here and there in terms of stocks, where we are either capitalising or banking profits.

Nazmeera Moola: Okay. So I think, to sum up, we are seeing some moderation in the global economic environment, which has been very supportive for South African commodities, in particular, over the course of the last year. We are still not at a point where we think that commodities are likely to fall in a heap anytime soon but there certainly is the moderation and, therefore, the key question for South Africa, as we look forward, is will this positive momentum that we have been seeing in the economic reform environment from the government, which we saw with the energy changes, the changes at Transnet, with corporatisation of the Ports Authority and other measures on the SOE side, will this continue and will the momentum preferably accelerate? Because that is what we need to see in order to sustain the growth in the country, to support even higher growth and to reduce the political risk going forward. Thank you all for your time.

Clyde Rossouw: Thank you.

Peter Kent: Thanks, Naz.


To view the video recording of the discussion, click on the link below….


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