South Africa on a tightrope

South Africa is currently walking on a tightrope, with optimism from the formation of the Government of National Unity (GNU) fading and investors looking for evidence of enhanced reform implementation. 

Some of the country’s largest asset managers, including Allan Gray and Coronation, have warned of a Ramaphoria repeat. 

This refers to a period in 2017 when financial markets rallied on the back of Cyril Ramaphosa’s election as ANC president. 

The rally continued after Ramaphosa was sworn in as president a year later. However, this optimism was short-lived as the depth of destruction under his predecessor became clear. 

Furthermore, the implementation of Ramaphosa’s stated reform programme was slow, and investors ultimately lost patience while waiting for evidence of fundamental change. 

Allan Gray’s Thalia Petousis said Ramaphoria saw the 20-year bond spread versus US Treasuries decline from 725 basis points to 560 basis points, or roughly a 13% capital return over just three months. 

“Casting one’s eye one year forward from Ramaphoria to December 2018, yields were again wider, and the capital gain versus pre-Ramaphoria collapsed to just 3%, with the rand weaker alongside it,” Petousis said. 

“A lesson to be learned from this experience is that given the interwoven nature of the global economy and consumed goods, the path of interest rates can struggle to sustainably decline if global inflation misbehaves.”

“A more imperative takeaway from the Ramaphoria period is that political goodwill alone cannot change the path of our country.”

For this time to be different, South Africa needs capable leaders to execute their mandates effectively after many years of decline in key government departments. 

Only the right mix of ingenuity and skill can improve South Africa’s growth prospects and ultimately reduce unemployment.

Strong leaders in the right roles in key departments could have a tangible impact, as we saw when SARS commissioner Edward Kieswetter turned the revenue service around after state capture had eroded its operational ability and institutional integrity. 

South Africa may be in a similar situation now, Old Mutual Wealth investment strategist Izak Odendaal said. 

Odendaal explained that this time is different as the implementation of reform is not only dependent on the ANC but also on the process that is already underway. 

Odendaal did caution against thinking this would last, with coalition politics being new to South Africa at the national level and several teething problems appearing.

Despite this, the parties in the GNU agreed on a cabinet, and broad agreements were reached. 

While the GNU includes parties that have long opposed one another and disagree deeply over some issues, it is based on a set of core principles that all parties recognise. 

Importantly, these include respect for the Constitution, the need for faster economic growth and social upliftment, evidence-based policymaking, and the establishment of an impartial and professional civil service. 

“The importance of the last point cannot be overstated. Getting the right people in the right positions is crucial,” Odendaal said. 

The positivity surrounding the GNU has greatly strengthened South African assets, particularly the rand. 

“It is notable that South African investments have held up relatively well. Usually, South African assets are “high beta” to global markets, meaning they fall by more in times of stress.”

“The rand, in particular, is basically flat against the dollar in 2024, almost unheard of in a time of global market anxiety.”

Odendaal explained that South African government bond yields have also declined because the credit risk premium on bonds has been lower since the formation of the GNU and its commitment to sensible economic policy. 

This can be seen in the graph below. 

However, Odendaal said South Africa is still on a tightrope because its small and open economy makes it highly vulnerable to external shocks. 

If the US was to enter a recession, it would have a much greater market impact than the volatility of the past two weeks and be more important than local economic data for South African assets. 

Periods of market calm can lead to complacency and the ratcheting up of risk-taking by investors, Odendaal warned. 

Investors do have the ability to protect themselves by altering the makeup of their portfolios and avoiding overvalued assets. 

“A diversified asset allocation does not avoid market volatility altogether but offers balance. It remains difficult to completely avoid the trade-off between risk and return,” Odendaal said. 

“Markets usually recover from big selloffs. However, how long it takes depends on the extent of the decline and economic conditions.”

“Usually, what turns a correction into a prolonged bear market is a recession in the US. Therefore, the US economic outlook remains key. “

This remains a significant risk to South Africa’s economic turnaround and is something completely out of the government’s hands.