ReThink the elections

It has become something of a cliché to say that this is the most important election since 1994. However, following years of lackluster economic growth and rising debt, the South African economy has finally reached a precipice. And the May 8th election will prove to be a decisive moment for the country.

The future

We struggle with the unknown, anxious to know what the future holds. And yet, even knowing the results of this election, we are unlikely to know to what extent – or within what timeframe – South Africa may see the necessary reforms to stem the tide and turn our collective futures around.

While much ink was spilt going into this election on what kind of a majority the ANC may win, even knowing this we cannot be sure to what extent President Cyril Ramaphosa will have a mandate from the ANC’s National Executive Committee (which remains divided and unchanged) to see through the necessary reforms to transform and grow the economy. As likely as not, South Africa could continue on its current listless path.

Investors and credit ratings agencies will be watching closely to see what steps government takes to strengthen the fiscus and reignite investor confidence. First to feel the effects of the market’s response to the elections will be government bonds and the rand.

The risks

While the rate on 10-year South African bonds is typically higher than that of two-year bonds, the bond yield curve has steepened of late. This suggests that the market is concerned about the economy’s long-term prospects.

10 year 2 year bond yield spread
Source: Bloomberg

The most pressing and important issue is Eskom. Government’s willingness to make the hard choices necessary to stabilise the state utility could well serve as a measure of its ability to tackle other urgent issues.

While Moody’s next credit rating action is only scheduled for 1 November 2019, any deterioration in the position of state-owned enterprises could see the ratings agency move the date forward. Should that happen, and should South Africa be downgraded, we could see a mass sell-off of South African bonds. By some estimates, this figure could be as big as R200 billion.

Most immediately, a downgrade would weaken the rand and cause a corresponding rise in consumer price inflation. Key to note in the longer term here is how government chooses to fund its debt as a result. With the increased cost of borrowing, government may look to prescribed assets – something that was in force under the Apartheid government, and which has been mooted in recent months – as a means of balancing the budget.

The market

Despite the fragile state of the economy, South African equities have extended a run that started late 2018 to be up 12% this year. However, a strong performance from a handful of large-cap multinationals and the resources sector has disguised the fact that other equity sectors have continued to struggle over the past few months.

The foreign investment inflows the country has seen of late are largely currency driven. These are short-term, opportunistic bets or “hot money”, quick in and quick out. Foreign investment is not a handout. The kind of sustained, long-term investment the country needs will only come with policy reform and stability. We need a consensus between government, business and labour that sees SA Inc become more competitive.

Local investors

Many local companies are attractively priced at present, thanks, in part, to negative sentiment surrounding the economy. But, while this risk aversion is rooted in very real challenges, there is a prospect that we could see the necessary reforms implemented to promote economic growth and attract investment, which will support fiscal stability, employment creation, company growth and earnings growth.

As discussed in a recent article, trying to time the market is a futile exercise that may see you fall prey to investment paralysis, missing out on critical time spent in the market.

Unless your circumstances have changed materially, or the underlying investment case in key stocks you own has changed, your best course of action would be to stay the course. Time is the most powerful investment ingredient, and in the world of investing, a sound philosophy, patience and resilience are rewarded in the long term.

In the short term, South African society and investors are anxious for direction from the soon-to-be elected parties. The degree of confidence and courage with which the President and his cabinet tackle the challenges facing the economy could do much to allay concerns.

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