JSE catches up with emerging markets after rand rises
The South African economy has rejoined the world of emerging markets. The JSE, measured in dollars, has almost caught up with the surging MSCI emerging market index.
Emerging market equities gained 47% between January 2017 and January 29 2018.
The JSE, in dollars, was up 37% over the same period, while the S&P 500 index, making new highs every other day, was 26% stronger.
These emerging market and JSE gains have come after an extended period of underperformance compared to the S&P 500, which has more than doubled since early 2011, while the MSCI index has only now come to exceed its dollar value of seven years ago.
This JSE catch-up has come with the burst of rand strength that accompanied the defeat of President Jacob Zuma and his faction at the ANC electoral congress in December. The rand compared to January 2017 had weakened by about 11% compared to a basket of nine other equally weighted emerging market currencies by November 2017. It is now worth about 14.5% more in dollars since early 2017, while the emerging market basket has gained about 9.6% over the same period. The dollar is now also about 13% weaker compared to a basket of developed economy currencies (DXY index).
A weak dollar is good news for emerging market economies, and especially their consumers. It brings currency strength and lower inflation — particularly of imported goods — and lower interest rates. It is very hard to see how the Reserve Bank can fail to respond to these trends with lower interest rates.
The renewed hopes for the economy have extended to the bond market, to the risk premiums attached to government debt, and by implication all other SA-domiciled financial securities — and the now lower returns expected from them.
Inflationary expectations — measured as the spread between a vanilla five-year RSA bond and its inflation-linked equivalent — have declined sharply, from more than 6.7% in November to about 5.3% now.
The spread between the RSA five-year bond yield and its US Treasury bond of similar duration, which represents the expected depreciation of the rand against the dollar (the interest carry) over the next five years, has declined by a similar degree.
The sovereign risk spread (the extra yield offered by a fiveyear RSA dollar-denominated bond) has declined 76 basis points since November, from 2.2% per annum to 1.45%, indicating that the credit markets now regard South African debt as almost investment grade. Yet all these spreads remain quite elevated by the pre-Zuma standards of the past. The belief in permanently lower inflation or a stronger rand is still lacking. Much room remains to reduce the cost of capital for investors in the South African economy.
Further support for the rand and emerging market currencies has come from higher commodity and metal prices. A stronger global economy combined with a weaker US dollar is helpful to emerging market economies, including SA, with their dependence on exporting minerals and metals.
SA’s politics and economics are now in a much healthier state, as judged by the marketplace. Inflation and interest rates can recede further and the exchange rate and sovereign risk spreads have much room to narrow.
The opportunity presented to SA is to do more than stop the rot; it is to follow through with wealth-creation and poverty-reduction initiatives.
Not only better government is called for, but less of it to play to the business strengths of the economy — strengths that global capital markets would recognise very quickly.