Don’t count on South Africa’s economy to get any better as long as the politics remain in flux.
But there is some good news. Once the problems in government settle down there could be some big money to be made.
Lower ratings. In April, Fitch Ratings downgraded South Africa’s credit rating to BB+ from BBB-, saying that “recent political events, including a major cabinet reshuffle, will weaken standards of governance and public finances.” Triple-B ratings are usually considered investment grade, or high quality, bonds, whereas double-B are speculative, or so-called junk debt.
“The cabinet reshuffle has significantly added to uncertainty about South Africa’s economic outlook,” says Jan Friederich, head of Middle-East Africa Sovereigns at Fitch Ratings. “Judging by the manufacturing surveys, the policy environment had been the main factor weighing on activity for a while and the reshuffle means companies will remain nervous about policies.”
The rating downgrade will almost certainly mean higher borrowing costs for the South African government as well as businesses borrowing South Africa’s currency, the rand. It comes amid the run-up to a change in leadership of the country and a poor economic environment.
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President Jacob Zuma’s term ends in 2019, but he’s been accused of corruption and is seeing increasing calls to resign in the wake of the cabinet reshuffle, according to a recent report from the BBC. As if that wasn’t enough bad news, economic growth remains anemic while inflation is elevated by developed world standards. Growth was 0.7 percent in the fourth quarter versus the same period a year earlier, and the consumer price index grew 6.1 percent in the latest reading from earlier this year, according to Statistics South Africa.
Nuclear government spending? “The big fear is that fiscal policy will change dramatically,” says Kieran Curtis, portfolio manager at Standard Life Investments in London. There is nervousness about the desire of the government to build several large nuclear power stations, he says.
As part of this effort, the state-owned electricity company will likely need to seek much larger loan guarantees than it already has from the South African treasury, according to Fitch.
A further problem presents itself. The cost of the nuclear program would likely be paid for by increasing prices on already-expensive electricity, Curtis says. Ultimately, that would push up inflation even higher.
The whole effort begs a question about the prudence of going forward with such an infrastructure plan.
“When you have a lot of coal and sunlight, why do you need a nuclear plant?” says Bill Kennedy, portfolio manager of the Fidelity International Discovery fund (ticker: FIGRX) in London. The fund has an expense ratio of 0.99 percent, or $99 per $10,000 invested annually.
Coal is readily available in the country and solar power doesn’t require the same level of infrastructure spending as does nuclear energy. In short, the government’s desire to pursue a nuclear industry, and its associated costs, seems misguided. It may also reflect some dysfunction in the government.
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There is some good news. South Africa’s trade balance has improved lately in large part due to rebounding commodity prices which hit a bottom in early 2016. The economy is benefiting from better prices for its exports of minerals.
Better still, many of the companies and institutions in the country are very well run. “If you go meet the central bank and ministry of finance, they have strong individuals who are providing the information to the decision makers,” Kennedy says.
He also says that due to high costs of borrowing in South Africa and the limited availability of capital, companies are run with a strict discipline and attention to getting returns from investments.
“The management teams tend to very savvy,” Kennedy says, particularly those in retail, banking and tech industries.
Is it time to invest? “What I am looking for is clarity on the political front,” Kennedy says. “It is a market that not a lot of people are picking through, but if there is some positive political change in South Africa, the combination with [well run] businesses could be powerful.”
Rather than seek out individual stocks, investors who are optimistic about a rebound in the South African economy might want to consider the iShares MSCI South Africa exchange-traded fund ( EZA). It has an expense ratio of 0.64 percent, or $64 per $10,000 invested. But beware that the fund is overbalanced — 27 percent of the EZA is made up of a single stock, Naspers Limited, a South African-based internet and media group. Financial stocks also make up 23 percent of the EZA.
As it is an emerging market, investors in South Africa should expect stocks to behave in a different way than investments in developed markets such as the U.S.
“Emerging markets characteristics mean more volatile prices but also the potential to grow faster than developed markets,” says Steven Wieting, chief investment strategist at Citi Private Bank in New York.
[See: 7 of the Worst Stocks to Buy for 2017.]
The gains will likely be better over time — but the ride may be bumpier.
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South Africa Still Hurting From Turmoil originally appeared on usnews.com
