By Bernard Drotschie
JOHANNESBURG – Many South Africans and businesses will have breathed a sigh of relief after President Cyril Ramaphosa’ s announcement that the country has finally reached level 1 of government’s Covid-19 containment programme.
The impact of the pandemic has been well publicised and has been extremely painful, especially for small-and-medium enterprises and the lower income groups across the country.
Larger publicly listed companies have also been severely affected and many were forced to raise equity (at a significant cost to shareholders) or suspend dividend payments to either reduce debt and/or build cash buffers in order to trade through what has been one of the deepest recessions in history.
Although South Africa is not completely out of the woods, the prospect of a recovery is finally in reach.
Similar to what has been experienced in other countries the sequential improvement from a depressed base will be strong, but will, unfortunately, still leave the economy (in real terms) in a worse state in a year’s time than it found itself before the Covid-19 crisis took hold.
In addition, corruption remains one of the largest bugbears that is facing the country, while government’s debt levels have become unsustainable.
South Africa’s funding requirements and interest bill as a percentage of gross domestic product are one of the highest within the emerging market universe.
And if that wasn’t enough of a dampener on confidence, Eskom has announced power outages would be around for at least another 18 months.
This while the country’s largest state-owned-enterprise performs much-needed maintenance work at its power plants and rectifies design flaws at its Kusile and Medupi power plants, all at a significant cost to the taxpayers and users of electricity.
Although the challenges facing the country are real, it is important to note that the worst is behind us, as the economy has been afforded the opportunity to reopen for business, now that the Covid-19 infection rate has peaked.
Some of the leading economic indicators such as Barclays’ PMI manufacturing Index are already pointing to an improved outlook, while financial conditions have also been improving, albeit still at low levels.
Pent-up demand, restocking and lower interest rates will provide the necessary support to pull the economy out of the recession.
In addition, an improvement in global trade, manufacturing and good rainfall (agriculture) could result in a better outcome than what is currently discounted in domestic asset valuations.
Domestic bonds and domestic orientated stocks provide significant value for long-term investors and any improvement in the growth outlook for the country could quite easily result in a re-rating as confidence recovers from severely depressed levels.
It was, therefore, encouraging when President Cyril Ramaphosa stood up and asserted his political power over the party and state when the national executive committee of the ruling party, the ANC, gathered for its monthly meeting at the end of the last month.
The president has managed to repel internal political challenge to his authority and this victory will afford him political space to govern without unnecessary distractions.
Furthermore, when the supplementary budget was delivered in June, it was mentioned that the Cabinet had agreed in principle to adopt key reforms to rebuild this economy, and these would be tabled in the Medium-Term Budget Speech next month.
This victory would allow for the president to be less politically encumbered to ring in those reforms.
While policymakers globally remain cautious about the growth outlook and are in no mood to withdraw stimulus measures any time soon, risk assets are expected to remain supported.
However, investors need to be selective as not all companies are expected to flourish in a post-Covid19 world.
Consumer spending patterns and behaviour are expected to change (perhaps permanently) and companies will be hesitant to invest aggressively after one of the deepest recessions in history.
Bloated balance sheets will act as a restraint to companies’ ability and willingness to spend on new investments or bulking up their workforce.
Unprecedented support from policymakers has been essential, but this, too, will reverse at some point, and only then will the full impact of the crisis be fully revealed.
From an equity perspective, we will continue to focus on companies with strong balance sheets with secular and structural growth vectors instead of the vagaries associated with economic cycles.
The extreme levels of volatility earlier this year have afforded us an opportunity to increase our exposure to domestic fixed income at very attractive prices and will support the running yield in an environment of exceptionally low interest rates.
Bernard Drotschie is chief investment officer of Melville Douglas.