Although slow, global economic growth is expected to improve through to 2015 – but South Africa lags behind this trend as it lacks a significant growth driver.
This is according to Rian le Roux, chief economist at Old Mutual Investment Group, who says that meaningful policy reforms are necessary to raise both the growth and employment potential and that partial reforms are unlikely to drag SA out of the low growth and employment trap.
Presenting at Old Mutual Investment Group’s Third Quarter Media Briefing, Le Roux says that a only a moderate recovery is expected in late 2014 into 2015 and the longer growth potential will likely be stuck around the 3% level.
“Inflation, in contrast, has recently exited the SARB’s 3% to 6% target range and while it is expected to drift back into range towards year-end, longer term inflation expectations continue to hover around the 6% level.”
Le Roux believes that SA’s economy is facing considerable structural and cyclical headwinds, with the growth forecast for 2014 dropping to about 1,5% compared to about 3% as recently as January.
“South Africa’s economy remains cyclically depressed, with supply disruptions an added depressant. Moreover, a lack of fundamental economic growth drivers such as those seen during the mining/infrastructure booms of the 1950s and 1960s, means that the economy is caught in a low-growth trap,” he explains.
Despite the expected moderate economic recovery, South Africa faces considerable challenges, including still large current account and budget deficits, inflation pressures and depressed consumer and business confidence.
Looking further afield, Le Roux believes that while a global recovery is underway, this is US-led and the remaining regions are seeing slow, erratic and fragile growth.
“This means that US policy normalisation will lead the rest of the world and, despite likely being slow and well-signalled, eventual policy rate increases from around mid-2015 may bring renewed pressures to the Emerging Markets, especially ones with weak fundamentals,” he explains. “This holds renewed risks for South Africa, unless our overall macro-economic outlook has taken a turn for the better by then.”
Also presenting at the briefing, Peter Brooke, head of Old Mutual Investment Group’s MacroSolutions boutique, discussed his team’s views on the current local and global markets landscape, and added that South Africa is seeing a disconnect between the local economy and markets.
“SA’s share of the JSE is small, with roughly one third of sales driven by South Africa,” he says. “And this is shrinking, with even traditional SA-focused companies diversifying their interests offshore. Industrial companies have 35% of sales outside of SA, while financial companies have around 20% of sales outside of our borders.
“Growth in Africa is a big contributor to this and we expect further diversification to occur because SA’s trend growth of 2.5% to 3% is too low. Ultimately, longer term delivery to the National Development Plan is crucial to accelerate private sector capex.”
Talking about his team’s current positioning in the markets, he said that they remain overweight international equities and underweight local equities, based on valuation and risk, rather than the rand’s weakness.
“We continue to look for international drivers of return locally, with pressure on profits due to low demand and high cost inflation. Despite all the bad news the situation is looking better for local bonds than local equities.”
Also presenting at the briefing, Cavan Osborne, African equities manager for the Investment Group’s Old Mutual Equities boutique, unpacked the current economic situation for African regions.
“2014 consensus growth forecasts are softening, looking at GDP across key African regions Ghana, Kenya, Nigeria, Egypt and Morocco,” he points out.
“We expect Nigeria to come off due to erratic gas supplies and the slowing of power reforms – their Q1 figure of 6.5% was well below expectations – while low rain levels in Kenya have led to less irrigation and hydro power, impacting growth. Egypt too is facing further downside given the subsidy reforms announcing in July which could hurt consumers, as well as energy shortages impacting industry and a strong currency hurting exporters.”
However, Osborne highlighted that when it comes to investing in Africa, GDP isn’t always representative of market performance.
“In Africa, it is often common for companies to perform independently of the economy, therefore stock selection is an important part of the investment process,” he explains.
“In Egypt you have a situation where the military own about 30% of the economy, which isn’t reflected in the markets. In the same vein, Botswana’s diamond industry makes up about 30% of the economy, but isn’t included by the markets; while Nigeria’s oil production constitutes 15% of GDP, Agriculture 22% and Telecoms 12% – all excluded from the very limited stock exchange.”
Le Roux also pointed out that inflation may deliver a downside surprise if the rand stabilises.
“We expect the rand to steady as the current account gradually narrows, however key risks remain as an effect of the US rate hikes in 2015,” says Le Roux.
“We are therefore looking towards decisive policy initiatives to address these deficits in the system as well as to raise the growth potential. While we are seeing a move towards some fixes being applied at a policy level, partial reforms are unlikely to drag SA out of its current growth and employment trap. Consequently, we continue to face medium-term risks to social, fiscal and financial stability.”