23 Jul 2020

A “V”-shaped recovery may see GDP growth of 5.2% in 2021 but policy reform is needed for a better medium-term growth trajectory. Where investments are concerned, we expect +6% real equity return over next 5 years.

22 July 2020: South Africa’s economy could still enjoy a watershed year in 2020 provided growth-oriented policy reform is implemented (as promised) for improved medium-term growth, says Old Mutual Investment Group (OMIG).

While a global “V-shaped” recovery is happening now and SA’s economy could follow suit, both OMIG Chief Economist Johann Els and Portfolio Manager John Orford say economic and earnings growth is in desperate need of investor-friendly policy change.

“Without requisite policy reform, the future gets a lot less positive, and we will be headed straight for a prolonged low-growth trap,” cautions Orford.

While foreign investors have been selling SA assets for some time, the COVID-19 shock accelerated the selling pressure. “As a result, SA asset prices are attractive, but SA will need to fix its growth trajectory and become more investor-friendly if it is to attract more investment into SA,” says Orford.

Els points out that the economic situation in SA remains dire and more job losses are likely than the 860,000 losses SA experienced during the 2008/9 Global Financial Crisis. Debt stabilisation and fiscal consolidation are now critical but difficult without growth enhancingpolicy reforms.

“Treasury is absolutely correct to propose spending cuts but spending cuts without growth-enhancing reform is also not the correct way,” notes Els.

Policy reform measures already announced include unbundling Eskom and taking other steps to open up energy markets. They also refer to modernising ports and rail infrastructure, licensing spectrum, lowering the cost of doing business, reducing red tape and improving access to development finance for small, medium and micro-enterprises.

Add to this support for agriculture, tourism and other sectors with high job-creation potential, facilitating regional trade and reducing the skills deficit by attracting skilled immigrants.

It would also entail revamping the skills framework and undertaking a range of reforms in basic education and the post-schooling environment to improve outcomes for workers and the firms that can employ them.

“This has all been mentioned before and so it is nothing new but what is positive is that the policy debate is heating up. For instance, the policy proposals from Business for SA and the ANC regarding infrastructure spending and the need for a new social compact are welcome – but they are not enough,” says Els.

Els emphasises there is “no more time to tinker at the edges”.

“Policy reform should be real, structural, substantial. It should include a social compact between government, labour and business – which could also potentially include Quantitative Easing (QE) by the central bank for a limited time – and substantially increased private participation in the economy. Extra government spending is the wrong way to go about it, but policy change should focus on confidence and growth-enhancing measures,” he says.

Ideally, policy reform should include significant transformation of SOE’s – including privatisation, a strong commitment to immediate National Development Plan implementation and labour market deregulation.

Els says that while lower interest rates are urgently needed given the current state of the economy and downside inflation risk – interest rates cannot boost the growth potential of the economy. For this outcome, structural policy is needed. However, given the unprecedented growth collapse and the downside risk to inflation there is room for more rate cuts than the expected 25bp to 50bp rate cuts expected this week.

OMIG expects a 75% probability of a global “V”-shaped recovery if the virus is contained, economies re-open, and this leads to a strong growth rebound.

But Orford says with no growth driver in place, public debt rising and profits under pressure, SA remains in a “low-growth trap”, and this affects the ability for companies to grow earnings and provide sustainable dividends.

However, the global stimulus should benefit South African assets, says Orford, which already price in significant bad news.  He also highlighted a key shift in the investment landscape with interest rates being cut to their lowest level in almost 50 years.

“As a result, money market returns will be much lower going forward. This will encourage assets to shift from cash to riskier but higher return assets including bonds and equities, where despite the low growth environment expected real returns are much higher than cash,” says Orford.

“SA has been a perennial growth laggard since 2008 because it is getting harder to do business in SA, but the oversold nature of the market does mean SA assets are offering better real long-term returns than their peers. Equities are expected to deliver annualised real (after inflation) returns of 6% and bonds 5% for the next five years,” says Orford.

While a global “double-dip” decline, new waves of the infection and a delay in a Covid-19 vaccine pose risks, reform in SA — like fiscal rectitude and a cohesive growth strategy — could improve confidence and deliver an “upside surprise”.

Els says while SA was in a recession prior to COVID-19, his 2021 forecast of +5.2% growth (from -7.6% this year and a global -4.1% this year going to 5.3% in 2021) remains unchanged for now.

Within stocks, Old Mutual Investment Group is overweight in rand hedged stocks through Naspers, British American Tobacco and diversified and platinum group miners.

“We also see value in domestic-facing companies, but the near-term growth outlook is very challenging. We have some exposure to precious metals, including gold and platinum ETF, and also exposure to precious metal mining shares,” says Orford.

The message is to spend cash and buy SA bonds and equities.

“We have added to local equities and are overweight total equity in the balanced portfolio, as well as overweight bonds,” says Orford.

“We recommend investors maintain a diversified portfolio with exposure to local and global assets,” concludes Orford.

  • John Orford
  • media release
  • Johann Els