The JSE has started 2023 on the front foot, hitting record highs on 13 January with mining stocks and Naspers/Prosus leading the gains. This follows a difficult 2022, in which the JSE ended negative in dollar terms, but nonetheless outperformed global markets. The local bourse held its own as inflationary pressures, rising interest rates and the war in Ukraine put equities in both developed and developing markets under significant pressure.
This, for many investors, raises the question of whether the JSE will represent a preferred investment destination should global inflation continue to fall and the current cycle of rate hikes ends. The answer to this question is nuanced, but we believe that there are still better opportunities offshore versus those on the JSE. Let’s go through our thinking, starting by identifying and evaluating the positive factors that are supportive of outsized returns from the JSE going forward.
For many analysts and fund managers, it’s all about the price. There is a sentiment among some market commentors that the JSE is so cheap on a risk-and-reward basis that it looks undervalued compared to many of its emerging and developed market peers. As such, should major global markets deliver a year of strong returns, these JSE bulls believe that that our local index will display high beta characteristics and outperform its competitors.
It’s certainly noteworthy that South African bonds and equities are currently preferred to many other emerging markets such as Russia, China and Turkey. Against this backdrop, South Africa may well benefit disproportionately when an appetite for risk returns and global investors start to accelerate flows back into emerging markets.
In such a scenario, we would see the US dollar reverse some of its 2022 gains and the rand strengthen. While this could hurt the JSE’s many rand hedge shares in local currency terms, it would enhance the returns of companies focused on the domestic economy in dollar terms, as their performance would not be eroded by a stronger exchange rate.
South Africa-specific risk weighs down the JSE
Turning to the negatives, there would be a strong argument for investing in the JSE if the South African economy was to be expanding at a required run rate in the order of 4-5% per annum. However, South African GDP has been tepid for many years. Although looking ahead, there will admittedly be some large cap winners in the domestic market, these outperformers can most likely only grow their earnings meaningfully in a stagnant economy by “eating their competitors’ lunch”. The market as a whole cannot deliver outperformance on a sustainable basis if the economy is not improving to a very meaningful extent.
There are few signs that this picture will change any time soon. The South African Reserve Bank forecasts annual GDP growth of less than 2% over the next three years. GDP per capita, arguably as important a metric as GDP, peaked in 2015 and has been declining ever since. The majority of South Africans and the nation they live in are becoming increasingly poor.
Sadly, there is a long list of structural reasons for South Africa’s weak economic performance, and few signs that the government has the capability or will to address them. Eskom load shedding has now become a daily reality, with 200 days of load shedding experienced in 2022 alone. This affects every economic sector, from services such as telecoms, to mining and manufacturing.
It’s not just the power infrastructure that holds South Africa back. A lack of maintenance and underinvestment means that railways, ports and water facilities are in a dire state. Even with high export demand for our fruit and coal, companies face challenges getting their products to port and then shipped timeously out of the country.
South Africa’s problems don’t end there
If that’s not enough, South Africa still faces high levels of strike action and political uncertainty. President Cyril Ramaphosa’s decisive victory at the ANC’s electoral conference may help to calm the political waters a bit, but the opposing factions within the Party will use all means at their disposal to try to unseat him. Turbulent times can also be expected ahead of the 2024 elections as making the correct policy decisions in the country’s best interest may alienate the ANC’s own voter base.
Another point is that in addition to domestically focused companies, the JSE comprises a range of so-called rand hedges that are largely isolated from the political and currency risks faced by companies that focus on the South African market. Some of these companies, like Naspers/Prosus have delivered fantastic returns over the longer-term. Yet the performance of companies such as these should be measured against their global counterparts.
The universe of investable companies on the JSE is minuscule compared to the thousands of listed companies on the New York Stock Exchange, Nasdaq and various European and Asian equities markets. Plus, the JSE offers few options in growth sectors such as technology and pharmaceuticals. Focusing too much on the JSE means missing out on the vast majority of leading edge investment opportunities in a global universe.
Performance is the bottom line
Although the JSE performed relatively well in 2022, returns look less impressive when we zoom out for the longer-term picture. Over the last decade, the JSE has delivered an annualised US dollar return of 2.4% compared to 9.4% for the MCSI World Index and 12.6% for the S&P 500. We see no evidence to support the notion that the JSE will outperform global peers in the next decade.
Analysis from Dr Lance Vogel—a member of our investment committee—indicates that metrics which suggest the JSE is severely undervalued are based on South Africa being investment grade. Since we have been downgraded to junk, we should command a higher risk premium on equites and bonds and the JSE is not cheap relative to other sub-investment grade markets when evaluated on this basis.
Offshore still looks more attractive
While we acknowledge that there are still some great companies on the JSE and a few good opportunities in South Africa, we believe that overall, the risks outweigh the potential gains. It is our conviction that the opportunity set offshore remains much more attractive. This is especially the case with 2022 leading to much lower global valuations, especially on profitable tech companies that could be positioned for a bounce when risk-on returns.