Momentum Investments backs South African assets

South African investors should look towards local asset classes rather than offshore assets this year due to more appealing valuations and the potential for rand appreciation.

This is the view of Momentum Investments economist Sanisha Packirisamy, who said the valuation metrics of the local equity market have reset to consistently lower levels since the Covid-19 pandemic.

She explained that a 25% long-term average dividend yield premium of South African equities to emerging markets (EM) has been in place over time.

However, the current 46% premium is significantly higher. 

Similarly, South Africa’s current 24% forward price-to-earnings (P/E) discount to EM is meaningfully more than the 2% long-term discount. 

UBS shows that although South Africa’s current return on equity relative to EM is slightly above its historical average – and at almost a 20% premium to EM.

However, the country’s relative price-to-book (PB) ratio that investors pay for this premium profitability is at all-time lows and at a 10% discount to EM.

Furthermore, the South African equity market forward P/E is now trading at more than one standard deviation below its average since 1999, even assuming a conservative below-consensus 9% profit growth in the next year. 

The local equity market has consistently traded around the one standard deviation cheap level in its history since mid-2021. 

“South African equities thus don’t only look very cheap against the global universe as stated earlier, but also against their history,” Packirisamy said.

She added that there are many reasons for the significant risk premium attached to the South African equity market in recent years.

The biggest reason is the view that the dwindling growth performance trend from the South African economy in recent years, facilitated by the inconsistency of electricity supply and the degradation of the transport network, will continue unabated into the future. 

“While only around 30% of the operational performance of the South Africa equity market is dependent on the internal economy, there is nevertheless a large sentiment discount attached to all local-listed companies due to a poor economic growth expectation,” she said. 

“For the valuation discount to narrow, a better-than-expected outcome than the anticipated dire scenario has to be forthcoming. Some rerating could also follow if a global risk-on environment takes hold.”

Packirisamy said local equities remain very under-owned by local and global portfolio managers.

This implies that there is no overhang in these asset classes, enhancing its rerating potential should there be positive surprises on the domestic economic growth front. 

SBG Securities noted that domestic multi-asset fund managers’ 38.8% local equity weighting in the fourth quarter of 2023 is close to historical lows. 

“South Africa is also the fifth most under-owned market within global EM equity funds and should have meaningful rerating potential from current cheap valuations whenever global risk appetite improves,” she said.

Packirisamy pointed to Deutsche Bank research, which shows how significantly the local equity market punches below its weight globally.

This research revealed that although the local equity market produces roughly the same amount of profit as Amazon, the company’s market capitalisation is around six times that of the whole South African equity market.

“For South African investors, our preference remains tilted towards domestic asset classes over their global counterparts in the upcoming year due to more appealing valuations and the potential for rand appreciation,” Packirisamy said.