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Monday, August 11, 2014 - 10:23
Fraught with uncertainty

The South African investment outlook remains fraught with uncertainty.

Ursula Maritz, Chief Investment Officer at Southern Charter, says that the biggest concern is the state of the South African economy, which contracted by 0.6% in the first quarter of this year, hurt by a 24.7% and 4.4% drop in mining and manufacturing respectively. She says that together, these declines subtracted 1.3% from GDP, which implies the rest of the economy only grew by 1.4%. “The 0.6% contraction is the weakest quarterly growth rate since 2009 and sets us on a growth path of 1.9% for the year, down from 3.6% in 2011.”
GRAPH: Lost mining production and its impact on GDP

She says that the chaos in the mining sector, together with poor growth in the Eurozone, South Africa’s biggest trading partner, has hurt the country’s export growth. “In addition, the more than 40% drop in the rand over the last three years has not stimulated export growth, as South Africa’s competitiveness has been eroded by rising labour costs. At the same time, our imports have grown as the demand for cheap white goods continues unabated and the need for capital equipment for infrastructure projects continues. The combination of disappointing export growth and firm import growth has resulted in a long running trade deficit, now at a record R13 billion.”
GRAPH: Current Account as % of GDP and Gold and Foreign Exchange Reserves

Maritz explains that, against this background, South Africa’s current account deficit remains large at 4.5% of GDP. “This is manageable as long as SA has capital inflows to finance this deficit. The concern is that these flows will reduce as offshore investors become more discerning. The recent credit rating downgrade by Fitch from a stable to negative outlook, and S&P’s full downgrade from BBB to BBB-, puts us on a negative watch-list for global investors. The renewed global search for yield has been our saving grace thus far this year. This will change, however, as interest rates start normalising; or if South Africa loses its investment grade rating. If this occurs, SA will have huge capital outflows, and the country’s balance of payments will have to be far healthier to prevent significant rate hikes.”
GRAPH: Offshore Flows into our Bond market and the Rand

Maritz says that at present, given South Africa’s poor growth, the outlook for interest rates is fairly subdued. “Expectations are that in total, interest rates could be hiked by a further 100 basis points over the medium term, implying a prime rate of 10% within the next 18 months or so. The Reserve Bank has hinted that this could be done by small incremental increases of 0.25 basis points as opposed to big hikes. The upward pressure to rates is being driven by rising headline inflation, which is reflecting the impact of the weak rand, rising food prices and rising electricity prices. Inflation is expected to reach a peak close to 7% later in the year, before retreating to around 6%. Any blowout in the rand and subsequent impact on inflation will trigger bigger rate hikes.”
GRAPH: Inflation set to reach 6.6%

She says that given the poor outlook for the South African economy, Southern Charter favours global assets spread across both global equities and property. “Both these asset classes are benefitting from the improved global growth outlook, the global search for yield and attractive valuations.
“On the local front, we are more cautious as opportunities are limited. Local equities are expensive, but given the stock picking ability of our underlying managers, we are confident that equities will still provide the best return relative to bonds and cash.”

Copyright © Insurance Times and Investments® Vol:27.8 1st August, 2014
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