So far 2018 has been a turbulent ride and businesses and citizens alike are being put to the test. There is no doubt that we are in a hiatus period as a country as, collectively, we try to assess the damage done during the Zuma years – and whether or not we have the ability and the integrity to recover.
The first quarter of this year was characterised by strong, positive sentiment as the market rode the wave of Ramaphoria caused by the election of Cyril Ramaphosa as head of the ANC. Domestic businesses rallied. SA Inc. benefitted from a further appreciation of the rand and a surge in business and consumer confidence as the newly elected president took definitive starting steps to dismantle and prosecute corruption found to be rife in practically every state institution - the details of which we are still learning.
Sadly, much of this unwound in the second quarter as an appreciation for the enormity of this task and some doubt around its eventual success grew. It became increasingly clear that there would be no quick-fix and this would be further delayed if the very perpetrators of the problems continued to hold powerful positions in government.
Domestic concerns intensified through ongoing disappointments in economic activity data and more recently the track back in sentiment surveys. Added to this in the third quarter, is the continued utter lack of certainty or direction on crucial state and socio-economic policy issues – for example: state policy on land expropriation without compensation; a perpetually incomplete Mining Charter as well as the long unresolved matters of poor education; labour inflexibility; the never-ending demands for greater BEE transformation and the overwhelming cost of the state employee base and social welfare burden on the tax base. A cynic may conclude that as we have already for example had 3 BEE charters since 2000, the goalposts are always moving, so in effect South African authorities are incapable of providing policy certainty over the medium term, and have thereby sterilised the economy from getting the benefit of large scale investment.
So while the news that South Africa had entered a technical recession a few weeks ago was disappointing and concerning, it was no surprise. The question we are now faced with is: which road will South Africa take? The high road, or the low road?
The High Road
In this scenario we can expect some economic growth. This must be at least higher than 2% if we are to absorb new entrants to the employment pool every year. It needs to be higher than 2% if we are to start to absorb all those who have been dumped back into the unemployment pool as a result of the multi-year Zuma recession. Realistically, we do not see much evidence of this outcome currently. However, should economic growth manifest itself, it will drive volume recovery coupled with some inflation to produce revenue growth.
Assuming this occurs, in the environment of continued tightly controlled costs now largely a well-established business practise by corporate SA, profit margins will experience some expansion and all factors should combine to deliver earnings growth in excess of 20%.
The Low Road
This scenario is concerningly easier to visualise at the moment - characterised by indefinite policy uncertainty and political wrangling, failure to address the issues of corruption and mal-administration and a perpetuation of incompetent policy, SoE, economic and municipal management and no recovery in infrastructure spending. The high tax (and possibly still higher) tax incidence burden will further exacerbate the problem.
Unrealistic labour demands further undermine the recovery. A failure to address the issues at SOEs may, most worryingly, see the effective failure of Eskom and a diminished capacity for power output will only add to the crippling burden of debt faced by government. The economy will contract and we will enter a phase of low to no investment and growth, rising tax burdens and failing tax receipts. Earnings will fall, the rand will weaken and in general we will be facing a very negative environment for South Africa Inc.
But we are not quite there yet. There have been undeniable signs of progress and we must hope that the rot can be cleaned out. South African business managers in the private sector are also very adaptable and are used to operating in uncertain and unsupportive macro environments. In fact, many business leaders have managed to survive these conditions and run their businesses - and in some cases, even generate decent returns and grow.
Under these uncertain circumstances investors are understandably worried and concerned. There is still so much at stake and so much that could spiral out of control.
Given this backdrop, we are faced with a variety of potential outcomes. Currently, our analysis of South Africa’s trajectory is inconclusive as to whether we will follow the High or the Low Road and we are therefore positioned with a balanced portfolio. But we will continue is monitor the landscape and adjust the portfolios as we get clarity on which outcome is more likely - ensuring that in all outcomes, the portfolio is positioned to take advantage of any upside while staying protected in the worst case. For now, investing in a balanced and diversified portfolio is crucial and stock-picking remains very important.
I am reminded of a quote (although I am not sure who to attribute it to) that seems particularly on point now: “South Africa: it’s never as good as you hope, but never as bad as you fear!”