By Brian Butchart, Managing Director
The rand’s recent strength is not a reflection on any home-grown improvements, but rather international factors playing out, redirecting foreign capital to higher yielding emerging markets such as South Africa.
There is no doubt that the recent municipal elections have been the most exciting for years, with the possibility of change and hope for a better future.
The ANC has been accustomed to securing over 60% of the electorate voting in its favour in past elections. This time however, the ANC was given a run for its money. Although it was widely expected that the ANC would probably drop below 60% in the most recent election, very few expected it to be below 55% .
In turn this has been very uplifting for opposition parties who have gained stronger support from the electorate and is very positive for a young democracy such as South Africa.
This has also given South Africans a much needed boost of confidence for our battered and bruised psyche, especially after being bombarded over the past few years with bad news after bad news. Whether it was falling commodity prices, electricity shortages, the drought, political scandals, high unemployment numbers, or Nenegate there hasn’t been much to be elated about till now.
In addition the rand has recently strengthened to its best level since 2013 against the dollar to R13.19 at one stage. Since December 2015 the rand has vacillated uncontrollably between R13 and R17 making any decision to buy other currencies almost impossible.
See below the rand’s movement against the US Dollar from December 2015 to the beginning of August 2016:
Some commentators have suggested the recent election results have bolstered the rand and although it may have been supportive, nothing fundamentally or with immediacy has changed in SA to concur this theory. Instead international factors at play have had a more meaningful influence on the local currency of late.
While foreigners continue to buy our bonds – this, we believe, is more as a result of renewed global search for yield, rather than as a direct result of the election. The US is unlikely to hike rates aggressively (despite good jobs numbers recently), the UK cutting rates and increasing QE as well as Japan stepping up QE are having a bigger impact on the “renewed search for yield” of which SA received some of these flows (10y bond yield at decent levels – foreigners are buying, supporting the Rand).
South Africa’s interest rates remain very attractive to foreign investors while global interest rates remain benign.
In addition on the 29th of July 2016, SAB Miller announced the pre-conditions and agreed timetable with Anheuser-Busch Inbev for the combination of the two companies which if successful should be finalized by mid-October 2016. The deal is worth approximately $104 billion which will translate into a sizeable flow of capital into the SA market which may also be influencing current exchange rates.
Most emerging market currencies have strengthened against all other major currencies as the renewed search for yield is evident after the recent decision from the Bank of England to reduce interest rates to 0.25%, and is therefore not isolated to South Africa.
These capital inflows however in the past have been very fickle on the back of any political risk or uncertainty. Any perceived risk and just as quickly as these funds flowed in, they flow out. This in turn has an impact on the balance of payments which affects the exchange rate.
Analyst at Landesbank Baden-Wuertemberg, Mathias Krieger, the rand’s best forecaster in a recent Bloomberg survey suggested the rand is overvalued and has little chance of strengthening in the next year due to the deteriorating competitiveness of South Africa and the “populist” policies of President Jacob Zuma and his government. Instead he says it may weaken to R17 to the dollar.
The ANC party may have been wounded by the recent elections, but have no intention of handing over power to opposition parties without a fight. The jostling for coalitions in the bigger metros has not yet been determined, but in the interim Zuma remains in power and the ANC remains the majority party until the next general elections in 2019. Will he remain in power until then and will there be a change in ANC policy? Who knows? Time will tell! What we do know is the impact he has had till now.
Just to jog your memory, not so long ago earlier this year in fact, SA averted a downgrade to junk status by ratings agencies and this risk too seems to have been forgotten.
Although Pravin Gordhan managed to avert a downgrade in June this year, the ratings agencies issued stern warnings to government to start implementing promised policy reform, which included amongst others cutting back on spending, privatisation or part privatisation of state entities and creating employment amongst others in order to encourage growth, and GROWTH is the very ingredient ratings agencies are looking for in order to avert a downgrade come December 2016.
What has been done to date? Nothing!
SAA remains in the control of a board who caused its woes in the first place and has just recently also been given control of Mango. Unemployment numbers recently reported are as high as 27% with no talk in the recent run up to elections as to how the ANC plans to improve this situation. Although the ANC indicated its commitment to cut spending, the very next day after we averted the downgrade, Zuma’s plans for a new jet hit the headlines.
At the last MPC meeting the Reserve Bank downgraded their growth expectations from 0.6% to 0% for 2016, so the risk of sub-investment grade come December 2016 or early 2017 has not dissipated. Not at all!
This reminds me of how short term our memory is, how fickle capital inflows are and how vulnerable the rand actually is.
So, as advisors, how do we read the current situation? And how as an investor should you be reacting?
Brenthurst Wealth for many years now has been advocating global investment exposure within our clients portfolio’s and those that heeded our advice have been rewarded handsomely, especially those who invested several years ago.
In 2011 the rand was at R6.60 to the US Dollar and even after the recent strengthening had you purchased dollars at R6.60, would have achieved more than 100% return on currency alone.
However our motivation for advising clients to invest offshore was never currency alone, but rather to protect their wealth from the fortunes of one country such as South Africa and the risks it poses to your long term wealth creation as well as to expose your portfolio to opportunities which may not be available in South Africa.
Almost all technology and bio-technology stocks for example can only be bought internationally. Geographic specific exposure to Indian markets and global property stocks have offered fantastic investment opportunities and excellent US Dollar based returns over the past few years despite the recent global volatility.
Although the MSCI word index delivered a dismal return of -3.73% in US Dollars over 12 months to end June 2016, a lot of which had to do with Brexit towards the end of the period in question, most international funds Brenthurst Wealth has been using in the construction of offshore portfolios have done very well over longer periods of time and most recently over the last 6 and 3 month periods despite the global volatility.
Please find below the MSCI World Index, the S&P 500 and other international indices vs the JSE ALSI in order to illustrate how well international markets faired against the local market:
In US Dollar
The longer term trend as is clearly evident from the above is that international markets have managed to deliver exceptional returns to South African investors when compared to the local bourse over longer periods of time in both US Dollar and rand.
For those investors who recently purchased US Dollars, the timing perhaps may not have been ideal, but an offshore investment is a long term investment of at least 5 years or more.
The rand’s longer term trend has been a depreciating currency for many years.
Whatever exchange rate you may have purchased at recently, may seem like a bargain 5 or more years from now if the trend continues to decline, which we believe it will.
Investment and wealth creation is a long term commitment that requires a strategy and patience which rewards the disciplined investor.
The recent election results are exciting and reason to be optimistic for the future democracy of South Africa. However there is a lot to be done by both ruling and opposition parties in the next few years before the next general election and will take time to build and repair the difficulties we currently face. In the interim we maintain that the rand remains vulnerable to local SA risks despite the recent strengthening of the currency which stems from the search for yield as international interest rates remain benign.
Any perceived uncertainty or risk of populist politics will put the rand under pressure.
If you were considering buying Dollars or investing offshore, now might be a very opportune time to do so.