Investors expect South Africa to hit a crisis

South African equities are priced for a crisis, with their valuation relative to global equities at the lowest level since the outbreak of the pandemic and the Great Financial Crisis (GFC). 

This reflects the heightened uncertainty surrounding the country’s economic prospects, with the future of the Government of National Unity (GNU) in question and the imposition of tariffs on South African exports to the United States looming. 

However, it could also represent a significant opportunity for investors to snap up shares of local companies at relatively cheap valuations. 

This does not come without risk, with the local economy suffering from a decade of stagnation and cracks beginning to show in some sectors. 

Any potential good news, such as a trade agreement with the United States, improved economic data, or political stability, may result in a further rally for South African stocks. 

This is feedback from Old Mutual Investment Group’s (OMIG) head of equity, Meryl Pick, who outlined why South African companies are trading at relatively cheap valuations compared to their global peers. 

Pick compared the price-to-earnings (PE) ratio of SA Inc stocks to that of the MSCI All Countries World Index. 

SA Inc stocks comprise companies that earn most of their revenue and profits in South Africa. Therefore, they exclude major multinationals such as Naspers, Prosus, British American Tobacco, and Richemont. 

The index is largely made up of local banks, insurers, and retailers that are heavily exposed to the local economy. 

“When you look at how these equities are priced versus global shares, we see a discount of around 50%, which is roughly where we were during Covid and the GFC,” Pick said. 

“So, the negativity surrounding the local economy is definitely baked into the price. Any form of upbeat expectations could unlock serious value.”

However, Pick said that for any sustained rally to occur, an improvement in expectations and optimism needs to come with faster economic growth. 

Investors need concrete evidence of improved expectations and optimism translating into economic data, with the potential for enhanced earnings for companies. 

The graph below shows the relative value of South African equities compared to their global counterparts. 

Small wins are not enough 

South African equities rallied strongly after the formation of the GNU in June 2024, with investors optimistic about the country’s future. 

The GNU’s formation meant that for the first time, South Africa’s political future was not dependent on a single political party. 

Crucially, the coalition also includes more business-friendly parties, such as the DA, and reaffirmed its commitment to extensive reforms in the electricity and logistics sectors. 

Reforms in these two sectors, coupled with other policy objectives, are expected to result in the private sector playing a significantly larger role in the South African economy. 

Local and foreign investors pumped money into local equities as a result, with SA Inc stocks being particularly favoured as South Africa appeared to be breaking out of its decade of stagnation. 

This was boosted by evidence that these reforms were working, with load-shedding being significantly reduced and Transnet’s performance stabilising. 

However, the reforms appear to have stalled out, with the creation of an open, competitive electricity sector taking more time than expected. 

While Transnet’s performance has stabilised, it remains far below the levels seen prior to the pandemic, with some of South Africa’s ports being ranked among the least efficient in the world. 

The reforms needed to reach the GNU’s 3% economic growth target are progressing relatively slowly, Pick said, with far greater urgency needed. 

As a result of these slow reforms and a lack of dynamism in South Africa’s labour market, Old Mutual’s chief economist, Johann Els, said the country’s economy would never reach 5% GDP growth on a sustained basis. 

Despite improvements at Eskom and Transnet, significant reforms are needed to make South Africa’s labour market more dynamic. 

Other areas of concern for Els include the widening skills mismatch between what is produced by universities and what is demanded by the labour market. 

This constrains the growth of businesses, limits employment opportunities, and places an effective cap on economic activity. 

As a result, investors are increasingly adopting a wait-and-see approach to SA Inc stocks, waiting on economic data to improve before investing more capital into the country.