South Africa picking itself off the ground

South Africa’s economy and financial assets are exiting a period of malaise and seeing growth, but this still falls short of levels seen only a few years ago.

Izak Odendaal, Chief Investment Strategist at Old Mutual Wealth, said that inflation in South Africa has fallen faster than expected. At the same time, the medium-term outlook has also improved due to a stronger currency and stable global energy prices.

The South African Reserve Bank is also set to follow the US Federal Reserve and cut interest rates when it meets on 19 September.

Odendaal said that lower interest rates should help stressed consumers.

Reserve Bank data showed that the share of after-tax household income used to pay off debt increased to 9.2% in Q1 – the highest level since 2010.

Weak credit growth indicates a need to cut interest rates, with household credit growth at only 3.2% year-on-year in July. Corporate borrowing only advanced by 4.5% and barely kept up with inflation.

An improved growth outlook could also raise the fiscal outlook as tax revenues start to increase.

“The October Medium-Term Budget will update the fiscal projections, but declining debt risks mean investors should demand a smaller premium for lending to the South African government,” said Odendaal.

“This translates to somewhat lower bond yields, all else equal, which further reduces the debt burden and lowers borrowing costs in the private sector, potentially further stimulating the economy.”

Interest rate-sensitive sectors, such as banks, life insurers, retailers, and listed property, have been the major winners of domestic equities.

That said, not all local sectors have benefitted from resource shares, except gold, are under pressure.

“After the rally in domestic assets, it’s reasonable to ask whether more juice is left in the tank. Expectations of a global soft landing are probably largely priced in, while the national unity government’s positive surprise is similarly reflected in local markets, as are the looming SARB rate cuts.”

“Further rallies require more positive surprises, either globally or locally, while disappointment on the pace and extent of rate cuts could still unwind some positive sentiment.”

That said, valuation remains favourable for South African assets, while other economic improvements, such as lower interest rates, can snowball positively.

“We’ve already seen growth forecasts by major banks being upgraded in recent months. Future upgrades should provide fresh impetus to local market valuations,” said Odendaal.

Although most South African GDP outlooks for 2024 are roughly 1.0%, many analysts and economists have upped their GDP projections for 2025 and beyond to over 2%.

Fund managers in the Bank of America survey said that logistics and electricity transmission reforms should increase South Africa’s GDP by 2.0% to 2.5% in the next three years.

Off a low base

“It is always natural to anchor off the lows, making current levels seem very high. Take the rand, for instance,” said Odendaal.

“Compared to a level of almost R20 to the dollar in May last year, the end-August close of R17.76 seems very strong. But not that long ago, in August 2022, the rand traded between R14 and R15 to the dollar, around 20% stronger than today.”

“Similarly, despite the rally in South African bonds this year, the All Bond Index has not returned to pre-Covid levels yet. Of the 12% year-to-date return, 5% was due to higher bond prices, with the remainder being interest income.”

“Even if the improvement in bond prices stall, yields are still high enough to offer solid real returns to patient investors.

Thus, patience is crucial, as markets don’t go up or down in straight lines.

Read: The worst is probably over for loans in South Africa: Nedbank