STUART THEOBALD: Surging investor interest pays immediate dividends

In my column a fortnight ago, I argued that SA asset prices weren’t yet reflecting the probability of a market-friendly outcome to coalition negotiations. All that changed last week when there was a sudden sentiment shift and foreign investors came rushing for SA assets.

The JSE’s top 40 index rallied more than 5% when the market opened after the Youth Day public holiday, making it the world’s best-performing market on the day. The rand strengthened about 3% through the week, so in dollar terms investors got 7% on their SA equities, the biggest week of the year so far, while the MSCI world index returned barely 1%.

The weekly government bond auction attracted stronger-than-usual interest. It had bids of more than R19bn whereas it typically gets about R15bn. The bigger indicator was the yields, which fell about 100 basis points across the three instruments auctioned. To put that in numbers: a month ago for the R3.75bn in debt the government raised it would have had to pay R443m in interest a year. Last week, the same R3.75bn debt will cost it R412m, a saving of R31m a year. The government raised R1bn two days later through inflation-linked bonds, which also showed a material drop in interest rates.

Foreigners had been net sellers of shares for 25 days leading up to last week, which spiked immediately after the election when the ANC’s weak showing sparked fears of a populist turn. Foreign net selling had totalled $4.7bn so far this year, according to data compiled by Bloomberg. Foreign interest in government bonds has been drifting downward for several years to about a quarter of the total (though it is often missed that in nominal terms, foreign interest has remained steady). The strength of the rand last week shows there was considerable foreign buying of SA assets broadly.

The key question is whether this renewed interest can hold. SA assets have been markedly undervalued since about mid-2020, when a clear gap opened between SA-listed shares and global averages. In 2010-16, SA stocks traded at a premium book ratio to shares in the MSCI world index, but now trade at a 50% discount. There is also a 50% discount on dividend yields (DY), and about 40% from a price-earnings (PE) perspective. The DY and PE discounts opened during 2020 and haven’t recovered. SA is also at a discount against emerging-market averages — about 44% on DY and 32% on PE.

Sustainable improvements

This sharp discount might be justified from a relative growth perspective. At just 1% growth, SA’s GDP outlook is decidedly bleaker than the global average of 3.2% for this year and 4.2% for emerging markets. But JSE-listed shares are biased towards hard currency earnings and global performance rather than the domestic economy, so local economic performance has never been the full story to the valuation gap.

Similarly, improvements in the government’s fiscal position have not yet translated into a sustainable improvement in relative yields. The country has faced negative investor sentiment that begun with Covid-19 and the loss of the country’s last investment-grade rating, and was then compounded by its greylisting by the Financial Action Task Force last year. There has been no positive shock to turn that sentiment, until now.

Last week had all the signs of a trigger to unwind the discount. Big global investment banks published research with buy recommendations on SA assets — including JPMorgan, which published a double upgrade.

But the sudden surge could easily reverse. As I write, fraught negotiations about who will get which cabinet portfolio continue. The upward sentiment surge has occurred because the market perceives that the DA will be positive for momentum on the structural reform agenda that the ANC has been gradually implementing and will work to improve market functioning. But things can easily go wrong in the negotiations, with the DA at risk of pulling out if it doesn’t get its way on cabinet posts. There will be a sharp reversal should that happen.

I am optimistic, however, that the government of national unity will hold, with the DA in it. (I say it aware I could be eating my words by the time you read this.) But if the sentiment shift holds, it will be critical to see how this new cabinet actually works. If we end up with parties trying to outdo one another by blocking each other’s success, we could end up with a dysfunctional mess. Similarly, if the coalition can’t hold and we have a merry-go-round of resignations from cabinet and swings of parliamentary control, it will not maintain investor confidence.

It will take considerable maturity for parties to put aside their differences and competitive instincts,  especially as local government elections approach in 2026. But if they succeed, last week could mark the moment of a sustained sentiment shift that will put the financial winds in the sails of the new administration.