Investing in SA:
are we nearing a tipping point?

WORLD ON A KNIFE EDGE

We heard from our CEO, Carl Roothman, that the major forces currently impacting global financial markets will of necessity filter through to emerging market asset prices – including our own – and some of these unpredictable upheavals may well result in game-changing shifts in the investment landscape. In the UK, the extremely messy divorce of that country from the European Union continues to have a ripple effect on economic activity in Europe. Across the Atlantic, US president Donald Trump’s ongoing trade spat with China is having a significant impact on the earnings prospects of companies in the firing line – and there’s no indication that the dispute will be resolved any time soon. His potential impeachment of course also won’t be doing the US markets any favours.

Another major theme currently impacting investment decisions globally is the dismal returns of government bonds, which have traditionally been viewed as a shock absorber providing protection against equity market volatility. Around 25% of bonds currently being issued are all but guaranteed to lose money for investors. And then there’s the so-called inverted yield curve in the US, which occurs when short-term bonds yield more than long-term ones – an inversion in the curve has traditionally indicated an impending recession in the US.

RAMAPHORIA, OR RAMAREALITY?

Against this turbulent global backdrop, what are investors to make of the political and economic realities we’re grappling with back home? Leading political economy analyst Daniel Silke told us the ‘Ramaphoria’ that had gripped our nation after the election of President Cyril Ramaphosa has given way to ‘Ramareality’ as the enormity of the challenges he faces has slowly sunk in.

The legacy our president has inherited is decidedly gloomy: mismanagement, graft and corruption, an economy that hasn’t grown by more than 2% since 2013, business confidence which is at its lowest ebb since 1999, and 10 years of market-unfriendly policy-making. Most concerning is the level of unemployment, translating into social dislocation, which plays out in crime, gender-based violence and attacks on foreigners.

The tough decisions President Ramaphosa needs to make to implement the reforms necessary to turn our ailing economy around are well-known. The big question is: given the political constraints and internal rivalry within the ANC, will he be able to consolidate the power he needs within his own party to make the necessary policy adjustments?

Another of our speakers, political analyst Ralph Mathekga, had a similar view. According to him, with multiple agendas in the ANC leadership and no single, coherent source of power, national priorities are becoming residues of the battle of the political elite. We’re seeing ‘politicking without focus on policy’, and reforms are taking place too slowly because there’s little consensus among our country’s leaders – our policies are increasingly a compromise between warring groups.

South Africa is facing a ‘crisis of democracy’ – our democracy is not legitimate, since it isn’t seen to be reaching out to all our country’s citizens and meeting their needs. When people feel they’re being left behind, they become disenchanted, start to pull back from the democratic process, and focus on alternative means of engagement. The result is the emergence of populism away from the political centre and a fractured society in which various groups attempt to bargain with the system – in essence, a rent-seeking society.

TIPPING POINT FOR SA?

So what does all this mean? Is South Africa edging towards a tipping point, as some observers have suggested? Our speakers all agreed that we’re not there yet – we’re not yet at a threshold or a point of no return in our country.

In Ralph’s view, much-needed reforms are likely to continue, albeit at a slow pace, and most will be induced by some sense of urgency, such as the Eskom debt crisis. One positive trend is that certain economic and political fundamentals are now being strongly challenged. For instance, there’s an increased awareness within the ANC that the party’s ‘moral authority’ can no longer be rooted in its liberation history. In an effort to increase its own legitimacy to govern, the ANC is now far more willing to consult and seek consensus beyond its own leadership in broader society than was traditionally the case.

Daniel was of the opinion that the political dynamics to keep our president on his toes, the support of the business community, as well as his own efforts to change thinking within his party, are slowly starting to have an impact. In his view, we’re at a ‘bottoming out’ rather than a tipping point – he was hopeful that despite the challenges, we may well start to see a moderate return to growth over the next 18 months. In his words: ‘South Africa is, in its own strange and bumbling way, moving forward’.

IMPLICATIONS FOR INVESTMENTS

A number of local financial commentators have, however, suggested South Africa may even be beyond a tipping point. So it’s within an extremely uncertain and volatile environment that local investors have to make financial decisions. Our Director of Investments, Alwyn van der Merwe, told our clients that what we may believe to be rational decisions under the circumstances, are not necessarily always the correct ones. American economist Herbert Simon referred to ‘bounded rationality’ – as investors, we often take decisions that may be entirely rational on the face of it, but they’re based on false information or a particular news flow, and they’re taken at the wrong time. This results in ‘satisfying’, but certainly not optimal decision-making.

Alwyn cited an example of perceived rationality: during 2001, investors got spooked when the rand weakened significantly against the US dollar for various reasons, including a delay in the privatisation of Telkom, concerns around unemployment, and tightening of exchange controls. The popular view in the investment world at the time was that South Africa was at a tipping point and on its way to becoming another Zimbabwe. Many investors were determined to ship their money offshore at all costs, despite an irrationally low rand. As it turned out, 2001 wasn’t the tipping point they had anticipated, and over the next two years the rand recovered to around R6 to the US dollar.

This perceived rational decision had dire consequences for investors who migrated their investments offshore. In fact, had one invested R100 in the S&P500 Index in 2000, it would be worth R500 today. Investing R100 in the JSE All Share Index (ALSI), however, would have resulted in this amount growing to R700 over the same time period. Investors would therefore have done better over the past 19 years remaining invested in South Africa in rands than in the US in dollars. (This example doesn’t imply Sanlam Private Wealth is arguing against offshore investments, but rather that financial markets often overreact in extreme cases and that so-called rational decisions under these circumstances may be sub-optimal.)

Alwyn told our clients that although it’s challenging to remain unemotional when being bombarded with negative news flow on a daily basis, it would be decidedly unwise to make investment calls based on fear-mongering by sometimes unreliable news sources, however ‘rational’ these decisions may seem. He recommended three ‘rules’ for investors in uncertain times:

1. Ensure your portfolio is appropriately diversified. This includes investing across geographical boundaries, but also diversification in terms of asset classes: equities, property, fixed interest and even private equity. At Sanlam Private Wealth, we offer balanced solutions in our multi-asset portfolios. By applying our proven investment philosophy of price, perspective and pattern, we quantify the expected returns and volatility for each asset class over the medium to longer term, and apply these insights to decide on the most appropriate asset class composition for each client’s objectives and risk profile. As the investment environment is constantly changing and the prices of asset classes fluctuate, we also strongly recommend that the asset allocation mix is managed actively.
2. Pay attention to price and valuation. The important lesson here is not to buy an asset that is expensive just because it has a great ‘story’ behind it, or conversely, to sell an asset that is cheap because you think you’re nearing a tipping point. At Sanlam Private Wealth, we seek out investments we consider to be cheap, and use them to replace those in our portfolios that our research has indicated as being expensive (although it’s of course challenging to get the timing on cheap local shares just right). If we can buy decent-quality companies at a reasonable price, value will almost certainly be unlocked over the long term.
3. Understand the relationship between risk and return. There’s no such thing as a free lunch in the investment world. Any asset likely to provide a decent return will have some risk associated with it. Equities are a higher risk asset class, since companies can go bust – they’re exposed to economic and political realities. But they also have the potential of delivering high returns. What we’re now seeing is that disillusioned investors are questioning the traditional risk-reward relationship associated with equities, with some looking to lower risk asset classes in the hope of enhancing overall returns. The problem is that they tend to sell off at precisely the wrong time. And the simple reality is that investing only in low-risk assets won’t provide the type of long-term returns most of us require for building wealth.

In conclusion, we heard from Alwyn that while we may not be approaching a tipping point just yet in South Africa, there’s no getting away from the significant risks investors now have to contend with, both global and local. In the face of tremendous uncertainty, the laws of finance will prevail over the long term, however, and reward investors patient enough to stay the course over time. The principles of diversification, price and value, and risk and return will continue to apply. However, political and economic realities require patience, and the biggest mistake investors can make is to allow bounded rationalism to make the satisfying decision – and not the efficient decision.