GNU-Phoria
Time to buy SA Inc?
This short article presents a bullish case for South Africa Inc. stocks, illustrated in 9 charts, with one caveat at the end. (South Africa Inc. refers to companies that generate the majority of their revenue from the South African domestic economy.)
Let’s begin with the global macro picture, focusing primarily on the US, as it is the primary driver of the world economy:
1. Federal Reserve Rate Cuts:
The Fed Funds Futures market indicates that the US Federal Reserve is expected to cut rates soon. The Fed’s dot plot, which shows their own expectations of future rates, also suggests potential rate cuts later this year.
Lower interest rates are beneficial for risk assets like stocks because they reduce the cost of capital, which accelerates investment and growth. Additionally, lower rates decrease the debt servicing costs on existing debt and result in higher valuations in discounted cash flow (DCF) models.
2. Increased Liquidity:
The US Treasury plans to increase T-Bill issuance relative to longer-dated bonds in July, boosting liquidity in the system which is positive for asset prices.
3. Cooling US Inflation:
US inflation continues to cool, adding to the positive economic environment.
4. Economic Growth:
The US economy grew at a healthy real rate of 1.3% in the first quarter of this year. While there are signs of slowing, the economy is still expected to continue doing well in the coming months.
5. Positive Environment for Risk Assets:
With rising liquidity, falling interest rates, decreasing inflation, and positive real economic growth, the environment is highly favorable for risk assets to perform well, enhancing the appeal of even expensive assets. This combination creates an optimal setting for risk assets, which thrive under these conditions.
As investors become more comfortable with risk, there is an increased flow of funds to emerging markets (EM), where higher risks are offset by better-expected returns. This trend has been evident since 2022 when the Fed paused their rate hikes. See the orange line in the chart below.
Note that the conditions described above are meant to illustrate the macro tailwinds for SA stocks and should not necessarily be interpreted as a reason to buy US stocks. While I do not believe the US bull market is over yet, the current rally is extended and in a mature phase.
Now for the local SA story:
6. Relative Valuation:
Despite having been range-bound below its highs for many months, the JSE is trading at its all-time lows in terms of relative valuation to global markets. The chart below shows the ratio of the JSE Top 40 index relative to the MSCI World Equity index.
7. A Shift in Investor Sentiment:
Investor sentiment has turned bullish following positive election outcomes and the formation of a Government of National Unity (GNU) excluding the MK and EFF, which was a very market-friendly and widely unexpected turn of events. The strengthening of the ZAR against the USD (See the chart below) reflects renewed international investor confidence. If support around R18.15 to the dollar breaks decisively, further strengthening to R17/USD is possible. A stronger ZAR will put downward pressure on SA inflation, potentially prompting earlier-than-expected rate cuts by the SARB.
8. Breakout Potential
The chart below illustrates the JSE Top 40 attempting to break out of an 18-month-long consolidation below its highs, driven by the recent bullish sentiment following the formation of the GNU. Historically, a breakout from such an extended consolidation period often results in significant further upside.
9. GNU-Phoria VS Ramaphoria:
One should be cautious of being too optimistic about GNU-Phoria. The chart below shows what happened when Cyril Ramaphosa was first elected as the ANC president in December 2017. Initially, the ZAR strengthened significantly as the market viewed his victory over Jacob Zuma positively. However, after a few months, the euphoria waned, and the currency started reversing against the USD. This historical example underscores the need for caution in assuming sustained positive market sentiment purely based on political developments.
Conclusion
Stars are aligning, but not all is moonshine and roses…
Global macroeconomic, local market, and political dynamics appear to be aligned for explosive growth and multiple expansion of SA Inc equities. However, all the positive factors mentioned above depend critically on the stability of the GNU (Government of National Unity). If the GNU fails to hold and the ANC shows signs of drifting towards far-left radical parties, these favorable conditions could quickly reverse.
The Welcome Rock Core Portfolio:
Given the analysis above, I have increased exposure to SA stocks only moderately in the Welcome Rock Core Portfolio through the SA Equity Long/Short Strategy. This strategy is designed to benefit from accelerated growth in SA stocks while protecting against downside risk through short exposure. (Please read the disclaimer below)
For more information on the Welcome Rock Investment Fund, click below.
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Good luck out there.
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Disclaimer
The views expressed in this article are my own and do not constitute financial advice. Investing in financial markets involves risk, including the risk of losing capital. Past performance is not indicative of future results. Always do your own research and consider your financial situation and goals before making any investment decisions.
The Welcome Rock Investment Fund is a private fund and is not available for investment by the public. Please note that this fund is restricted to Limited Partners of the LP and does not solicit or accept investments from the general public.
