At the African National Congress (ANC) election in December 2017, Cyril Ramaphosa was elected as the new leader of the party, replacing the ineffective and corrupt incumbent Jacob Zuma. Pure relief at a change of leader led to such exuberance in financial markets that the phrase ‘Ramaphoria’ was coined. A relief rally followed. Over the 3 months from December 1st 2017 to the end of February 2018, MSCI South Africa appreciated 14%. Domestic facing stocks were strong, but the rand even stronger hitting a two year high of almost 11.50 to the dollar in late February 2018.
At that time, with the currency showing as slightly overvalued according to our in-house purchasing power parity analysis, and stocks looking less and less attractive, we undertook a process to sell all of our domestic South African exposure. This totaled approximately 5% of the Fund. South Africa’s problems are deep rooted, and we were skeptical that a new leader, however determined, would be able to push through reforms at anything like the pace implied by the moves in domestic oriented equities. With dollar valuations unattractive after the rally, especially in light of our macro, political and social concerns, we sold all domestic exposure and have zero today. One year on, and the currency has fallen approximately 20% from that 11.50 peak to 14.50, while domestic stocks have mostly fallen too, in particular, the names that we sold in a timely fashion such as Absa Bank, Growthpoint Properties and Woolworths.
Cyril Ramaphosa pledged not to disappoint South Africans when he was sworn in as president in February 2018, yet he faced the daunting task of reviving Africa’s most industrialized economy following nine years of Jacob Zuma’s rule characterized by stagnant growth, graft allegations and sliding support for the ruling party. Under Mr. Zuma’s watch, corruption became endemic, vital state institutions were mismanaged and had their independence compromised. Reviving a broken economy was never going to be easy, and key in achieving this will be restoring the confidence of the international investment community as well as the domestic corporate sector, in order to stimulate much needed investment. While Mr. Rhamaphosa has delivered improvements in some areas, such as providing greater certainty over mineral rights through a redrafted Mining Charter, in general he has been constrained by the prospect of the upcoming general elections scheduled for May this year. With the aforementioned secular decline in the ANC’s public support, the President has been required to execute a delicate balancing act between promotion of a pro-growth agenda amenable to investors, against the demands of certain domestic constituencies around controversial topics such as land reform, where headlines concerning “appropriation without compensation” would appear to confirm the worst fears of international investors concerned about the sanctity of property rights in developing markets.
This has had a tangible and damaging impact on productivity for business across all sectors in the country from the mining community, to mall operators struggling to even keep the lights on. The bailout also serves to highlight the country’s somewhat precarious fiscal position. The Treasury is battling to retain the country’s last investment-grade credit rating bestowed by Moody’s, and has forecast only a modest improvement in growth this year, to 1.5%. The continual power outages severely threaten this however, and it seems almost certain that another year will pass with less than 2% GDP growth.
Against this backdrop, we believe the outcome of the upcoming general election in May this year will be critical to the prospects for South Africa. While the ANC is widely expected to continue in power, the level of majority achieved is important. The ANC national majority has slipped steadily over the past several election cycles. Should it continue to erode significantly, it is likely that Mr. Ramaphosa will face significant obstacles from both within his own party, as well as potentially from coalition partners, in enacting meaningful policy reform. Should the ANC achieve a stronger majority however, then it is likely the President will receive a stronger mandate, and face less opposition in enacting the policies required to address the countries’ weak economic position.
Alongside weaker than needed GDP growth, most economic indicators are unfavorable for South Africa. The country has been perennially blighted by a substantial current account deficit which currently sits at -3% of GDP. The budget deficit is -4.1% of GDP. The unemployment rate is staggeringly high at 27%. At least inflation has been falling but is still stubbornly high at over 4%. The recent news coming out of South Africa, the unattractive data points above, and a research trip to the country in Q1 by Mondrian’s analysts confirmed our views that there is more to worry about, than to get excited about in domestic South African equities right now.
Our entire allocation to South African related equities in the Fund today are in global businesses earning US Dollar revenues. We own commodity companies – Sasol (global USD energy price linked), Anglo American (global USD metal price linked), and Mondi (global USD pulp, paper and packaging price linked). All three benefit from a depreciating rand, which we view as the likely outcome over the medium to long term given the country’s challenging position. For us to consider owning domestic South African businesses, we would likely need both for valuations to be at a very significant discount to compensate for the current economic, political and social risks, as well as greater confidence that the economy is on a firmer path to structural improvement in these areas. Until such conditions eventuate we remain very comfortable with our zero allocation to domestic facing stocks, which has served the Fund well over the last 12 months or so.
The above was written as of March 31, 2019. All returns are total returns in USD unless stated otherwise.
As of 03/31/2019, the following holdings were held in the Fund at the noted weights:
Absa Bank – Sold Out
Anglo American – 1.0%
Growthpoint Properties – Sold Out
Mondi – 1.8%
Sasol – 1.8%
Woolworths – Sold Out