Beware of excessive South African pessimism
While the decision by all three credit rating agencies to leave SA’s sovereign rating unchanged at investment grade was widely welcomed, the fact that they all still assign a "negative” outlook to their ratings is a clear message that unless SA makes decisive progress in improving the economic growth outlook, downgrades are likely in 2017.
While this highlights the urgent need for growth-enhancing macroeconomic reforms and continued fiscal consolidation, investors should beware of being excessively pessimistic about South Africa’s economic prospects during the year ahead.
Old Mutual Investment Group’s Chief Economist Rian Le Roux and Peter Brooke, Head of MacroSolutions, share their views on why South Africa’s economic trajectory in 2017 is not likely to be as bad as it seems.
Market headwinds turn into tailwinds
Rian le Roux, Chief Economist
First up, it is worth noting that the ratings agencies all still regard SA as fundamentally investment grade - owing to a number of structural strengths - and that the required policy initiatives to cement the investment grade ratings may not be too demanding.
The case for an improvement in the South African economy next year is based on the fact that a number of economic shocks over the past few years are now fading. Load shedding is long a thing of the 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.
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. A further, possibly underappreciated, 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.
However, there are still headwinds, so any improvement will be slow. The SA consumer remains 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.
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 recovery in confidence, driven by less turmoil and controversy in the political arena.
When it comes to the impact of President-elect Trump’s agenda on the global economy, 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. 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 in a logical compromise outcome of the Trump manifesto.
South Africa stabilises
Peter Brooke, Head of MacroSolutions
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 more reasonable.
Property, in particular, is looking cheaper, with our expected real return increasing by 0.5% to 5.5%. This means that its value is improving. 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.
There are material risks, with an excessively strong US dollar the main concern. This is why we are building a balanced portfolio tilted 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.
On the global front, I believe some significant secular changes are coming next year. One of our key themes for 2017 is "Keynes is King”, which encapsulates a shift away from monetary stimulus towards fiscal stimulus. This is as a result of monetary stimulus reaching its limits, given that negative interest rates are recognised as being detrimental to the financial industry, as well as a populist groundswell seeking redistribution of wealth and more investment activity, with the obvious solution lying in infrastructure spending projects in low level investment areas.
Ultimately, we’re seeing a confluence of different events, with cheap money meeting with political pressure pushing for fiscal stimulus. This is good for global equities over bonds and also adds impetus to 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 from growth assets and cyclical from defensive assets.
Article by Rian le Roux, Chief Economist and Peter Brooke, Head of MacroSolutions
Old Mutual Investment Group