SA economy is on the up

TRADE WARS: SHOULD INCREASE ACTIVITY

Hammered stocks can also offer great market entry points.

It has been a cold winter for the SA economy, but there are many green shoots appearing. Tito Mboweni’s appointment is the next chapter in an increasingly positive narrative, coming soon after the announcement of President Cyril Ramaphosa’s economic rescue plan.

If implemented correctly, this could be the catalyst we need for driving domestic demand and job creation.

Despite the reality checks provided by recent GDP and unemployment data, leading business cycle indicators have been overwhelmingly positive for some time.

The Ernst & Young SA Growth Barometer shows confidence in middle-market companies has increased; almost one in three are predicting growth above 10%.

On the investment front, longer-dated government bonds are currently yielding near and above 9%.

Yields at these levels will support investment portfolios, especially during tougher market conditions.

Even if domestic equities experience headwinds, bond yields should support portfolio returns and it’s crucial for investors to remember the importance of asset class diversification. Stocks that have been hammered by harsh conditions can also offer great entry points to the market.

Our research shows that the forward blended price-earnings ratio of the FTSE/ JSE All Share Index was trading around 13.5 times at the end of August. However, when the top five stocks by market capitalisation are excluded, the domestic market is trading below 11.5 times. This is closer to its historic average, thus there are attractive investment opportunities. Financial shares look attractively priced.

Impact of interest rates and inflation

Although rate cuts are always the ideal outcome, at least over the short term, we think this is unlikely. However, we also think hikes are even more unlikely.

This means the cost of capital won’t increase and interest rates could remain relatively low. It also means bonds are likely to stay in favour a little longer and the hurdle for generating inflation-beating returns is relatively low.

When inflation was running at double-digits, investors had to generate high double-digit returns to grow the real value of their capital. Now that it’s lower, investors need high single-digit returns to cover inflation plus 4% or 5%.

Developed markets growth spillover

Historically, when developed markets performed well, there was a significant demand for resources to keep the growth trend going. A substantial portion of these resources usually come from emerging markets (EM), like SA.

With fears around international trade tariffs increasing, ironically, we may see an increase in trade activity as importing manufacturers build inventories to avoid any tax increase.

Demand for EM commodities may eventually be compromised due to tariff talks. However, the overall structural demand could well be strong enough to accommodate some “demand leakage”.

And while domestic sentiment is currently poor, it reduces the odds of investing in a mature bull market or a bubble.

As such, SA’s risk is lower than most developed countries.

Adriaan Pask is CIO at PSG Wealth