On My Mind –
2017: a year of ineptitude

Hapless incompetence is what seems to have defined much of our world’s ethos during 2017. In the US, the first year of the Donald Trump presidency has been aptly labelled as that country’s ‘annus horribilis’. I need not elaborate. In the UK, Prime Minister Theresa May is struggling to keep head above water as Brexit gets messy and in Germany, Chancellor Angela Merkel is against the ropes after failing to build a coalition. This, as some have surmised, may well result in French President Emmanuel Macron – who replaced the inept François Hollande in May – stepping into the vacuum as unofficial leader of the European Union.

On our own continent, a seemingly ineffectual African Union-led agreement has failed to see Democratic Republic of the Congo President Joseph Kabila loosen his 17-year grip on power and ensure a peaceful political transition. At least further down south the people of Zimbabwe have finally rid themselves of the corrupt and autocratic rule of Robert Mugabe – after 37 years during which that country’s economy was for all practical purposes destroyed.

In South Africa, the most significant development over the past year has been the revelation and realisation of the true extent of state capture and corruption, which has had a profound impact on our economy, morale and investor confidence. The #GuptaLeaks emails and fearless reporting by investigative journalists – including Jacques Pauw in his recently released The President’s Keepers – have revealed that the tentacles of state capture go far wider and deeper than ordinary South Africans could have imagined.

And let’s not forget the ineptitude that has surfaced on the corporate front during 2017, with names like KPMG, SAP, McKinsey, Bell Pottinger and most recently, MultiChoice, ignoring the principles of sound corporate governance in order to gain favour and/or contracts with those in power.

ECONOMIC CONSEQUENCES

As a direct result of incompetent leadership, bureaucratic bungling and corruption, and a lack of meaningful economic policy on the part of our politicians, our economy remains under severe pressure. Years of meticulous supervision by central banks to counter the negative effects of the global financial crisis have led to synchronised global recovery in most regions, but South Africa has failed to reap much benefit from the economic uptick.

This year, 2017, will be remembered as the one in which South Africa’s credit rating was finally given the dubious distinction of being cut to ‘junk’. Rating agency S&P Global started the process by edging our foreign currency rating into junk territory in April, taking it down a further notch last week. To top it all, the agency at the same time downgraded our local currency debt rating to sub-investment grade. Moody’s has kept us at investment grade for now but put our government debt on review to be downgraded. Also last week, Fitch affirmed South Africa’s debt rating at sub-investment status.

Finance Minister Malusi Gigaba has done little to placate concerns – his extremely disappointing Medium Term Budget Policy Statement last month did little more than paint a grim picture of the challenges facing our economy – including national debt approaching 60% of gross domestic product.

IMPACT ON MARKETS

Globally, the broad-based upswing resulted in equity markets continuing to rally since the start of the year. The MSCI World Index has returned 19.45% in US dollar terms year to date (YTD), while the S&P500 has returned 18.36% (US$) and the FTSE100 7.75% (GBP). Other emerging markets have performed relatively well, with the MSCI Emerging Markets Index returning 36.14% (US$).

Following the largely sideways trajectory of the past three years – and in contrast to an underwhelming return of 3.4% in first-half 2017, the JSE’s All Share Index (ALSI) has so far rewarded investors with 18.41% in the second half. The ALSI has delivered 22.4% YTD, with the All Share, Top 40 and Industrial indices all powering to all-time highs earlier this month.

One can’t look at these figures without taking into account the extraordinary performance of some of the dual-listed rand hedge stocks on the JSE, particularly market heavyweight Naspers, which reached an all-time high of R4 142 per share on 21 November. If you strip out Naspers returns YTD (88.3%), the ALSI has delivered a more modest 12.3% YTD.

So who were the big winners and losers of 2017? Besides the stellar performance of Naspers, other outstanding returns include Kumba Iron Ore (107.54% YTD), Niveus Investments (80%), Exxaro Resources (77.65%) and Trencor (75.23%). The worst-performing stocks were Consolidated Infrastructure (-87.16%), Arcelor Mittal SA (-58.61%), Brait SE (-49.65%), Lonmin (-47.14%) and EOH Holdings (-48.3%).

CORPORATE HIGHLIGHTS

Despite the negative environment, corporate South Africa somehow got on with the job of building companies and shareholder value. Some highlights of 2017 were:

• British American Tobacco successfully acquired Reynolds America
• Old Mutual continued its process of ‘managed separation’ of the group’s four assets
• Steinhoff Africa Retail (Star), the African unit of Steinhoff International, listed on the JSE
• Vodacom bought Vodafone’s stake in Kenya’s Safaricom
• Barclays PLC continued the process of reducing its ownership of Barclays Africa
• Rand Merchant Investment (RMI) bought a stake in UK-based insurer Hastings
• Stadio, a subisidiary of private education group Curro, was listed on the JSE
• African Rainbow Capital (ARC) Investments made its debut on the JSE.

HOW HAS SPW HELPED INVESTORS?

As could be expected, it was again a challenging year for our investment team. We can, however, look back at another year in which we added value to the wealth of our clients over the long term. The main reason is that we were patient – our investment philosophy is grounded in valuation rather than hope.

But adding value isn’t just about investing in the right shares – it’s also about navigating the potholes in the road. Although we did so with skill, we didn’t succeed in avoiding all of them. Those we were able to dodge include the healthcare sector, which delivered a disappointing performance overall. In fact, Mediclinic, which lost around 23% of its value in 2017, and Netcare, which lost 27%, were the two worst performing shares in the Top 40 Index this year. Our clients were exposed to Mediclinic only in an indirect way via our shareholding in Remgro.

In terms of companies that disappointed operationally, one pothole we unfortunately couldn’t avoid was Steinhoff, which has declined by 23.75% YTD. The investment case for the share remains sound, but we would certainly agree that Steinhoff’s management needs to urgently address market concerns around corporate governance.

In jittery markets such as we’ve experienced over the past year, even marginal disappointment in operational results can lead to extreme share price response. There was thus a distinct possibility during 2017 of an ‘ankle tap’ from one of the companies we hold in our portfolios. Fortunately, we experienced another year of excellent performance and added to the long-term value creation for our clients.

THE YEAR AHEAD

Looking ahead to 2018, amid a bombardment of new evidence of ineptitude and corruption on an almost daily basis, one can’t blame investors for believing there’s not much to inspire optimism. Given our dismal economic outlook, and the expected uptick in inflation resulting from a weaker rand, the prospects for most South Africans look decidedly bleak – with our official current unemployment rate of more than 27% unlikely to be reduced any time soon.

In addition, considerable tax increases in the February National Budget presentation seem unavoidable if Treasury is to make any kind of inroad into South Africa’s alarming national debt. This will no doubt hit wealthier individuals the hardest, with expected increases in personal income tax, capital gains tax and estate duties.

Tax increases on their own can never be the solution, however. To get our economy moving again, there needs to be a drastic reduction in state expenditure – without cutting infrastructure spending – and an ambitious commitment to growth. It’s precisely the absence of a clear strategy on the part of our country’s leadership to address the significant structural issues facing our economy that’s preventing it from being steered out of the doldrums.

Many South Africans are pinning their hopes on the ANC’s elective conference to be held in two weeks’ time. At our September client events, Frans Cronje of the South African Institute of Race Relations (SAIRR) warned that our country’s long-term prospects aren’t contingent on the leadership conference, however, or even who wins.

It was initially believed that Deputy President Cyril Ramaphosa didn’t have much chance of taking over the reins, but according to the latest statistics this is looking increasingly possible – even the SAIRR is now cautiously optimistic that he may yet beat fellow presidential hopeful Nkosazana Dlamini-Zuma to the top job. It appears as though the market has already factored in a Ramaphosa win – it’s the only way to explain the rand’s resilience over the past week in the aftermath of the latest round of credit downgrades.

The potential election of Ramaphosa as ANC leader will no doubt bring renewed hope to South Africans who are by now ‘gatvol’ of corrupt and inept politicians. But even with fresh leadership in the ruling party, and potentially a new president by the end of January 2018, we shouldn’t be naive enough to expect meaningful change overnight. It’s going to be a long and arduous journey to claw our country out of junk status, to kick-start our economy again and to root out corruption.

New leadership will, however, give South Africans a renewed sense of purpose. And this is something to look forward to in 2018. Perhaps the last word should go to former US President Lyndon B Johnson: ‘Yesterday is not ours to recover, but tomorrow is ours to win or lose.’ Wise words indeed for South Africans as we come to the end of a challenging 2017 and go into the new year.

I’d like to thank all our clients for your continued support during 2017. On behalf of all of us at Sanlam Private Wealth, I wish you a blessed festive season. May 2018 be a year that brings hope to all South Africans.