The all-encompassing theme behind the outlook for world markets in 2024 is the decreasing interest rate cycle. South Africa, like the rest of the world, will follow the lead of the U.S. Fed on when it begins its cutting cycle. While markets continue to adjust expectations for the first cut between March, May and June, ultimately, the 1H24 should see world rates begin to decline.
South African equity has seen consistent outflows of foreign capital for a number of years. Economic constraints in the form of Eskom and Transnet have been a detractor from investment and with global rate hiking cycles, funds have naturally moved away from higher risk assets. Our economic handbrakes are nothing new, and SA equity is priced accordingly. Relative to developed and other emerging markets, SA equity offers significant value.
GDP growth of 1.2% is forecast for 2024 versus the 0.8% in 2023 with loadshedding expected to improve, inflation to remain in line with targets and interest rates to decrease. While the number may appear small, a 0.4% increase represents a favourable change in economic growth, which is supportive of local equity.
As an asset class, equity gains when rate cutting begins. The “when” is incredibly important for world markets, as decreasing interest rate cycles are bullish for economic growth and in turn earnings forecasts and equity markets. Historically, we have seen strong market reactions both prior to and after the first rate cut, and investors need to be in the market before cuts take place to maximise the potential upside.
Given our attractive valuation which has a lot of the “bad” priced in, domestic fundamentals improving with rate cuts on the horizon, presents a catalyst for strong local market performance in 2024.
SARB Restrictive Monetary Policy Successful
The action taken by the SARB’s MPC over the course of 2022/2023 has succeeded in controlling inflation. Under restrictive monetary conditions, South Africa’s CPI has fallen comfortably within the 3-6% target band and is forecast to remain within these limits, settling around 4.5% towards the end of 2024. True to form, GDP slowed as the economy felt the squeeze of higher interest rates amidst preexisting power and logistical constraints. Private sector credit extension has declined, retail sales have slowed, but the consumer remains resilient despite the added pressure.
The economy has slowed accordingly, and inflation is back on track; South Africa is now poised for a decreasing interest rate cycle. However, we are unlikely to see the MPC shift rates lower until the US Fed begins to cut. Outside of inflation control and economic growth, the MPC needs to protect the value of the ZAR, and our interest rate relative to the US plays a major role in this.
SA Macro Conditions Weigh, Small Improvements Matter
SA equity and bonds have experienced consistent outflows of foreign funds. The global climate has not provided support for risky emerging market assets and our domestic economic constraints have added to the risk profile of our equity and bond offerings, leading to these outflows.
This challenging backdrop has weighed on the confidence of business. The two biggest drags being Eskom and Transnet.
Loadshedding Remains but Relief is on the Horizon
South Africa’s power crisis hit new highs in 2023 with over 6,800 hours shed throughout the year. Almost double that seen in 2022 and the highest on record. Is loadshedding going away in 2024? No, absolutely not. However, it is anticipated to improve on last year. Economists forecast loadshedding to average 1.5 stages lower in 1H24 and reduce by another 1-1.5 stages on average in 2H24. Due to the aged fleet, there may be periodic bouts of higher levels, but these are likely to be short in duration.
To put this into perspective, Shoprite’s diesel cost to power generators throughout 2023 totalled R1.3bn. Even a small reduction in loadshedding immediately reduces operating costs, increasing earnings of SA Inc. While the power crisis remains a significant restraint on economic growth potential, even a small improvement will be immensely beneficial to earnings and economic growth.
Renewable energy continues to provide Eskom with breathing room as more and more businesses and households remove themselves from the grid. Mid-2025, a number of REIPPP projects will come online, providing enough relief to see sustainably lower levels of loadshedding, below stage 4.
Transnet’s Adversity Brings Opportunity
While all eyes have been focused on Eskom, Transnet has also been a limiting factor to growth. In 2023, commodities were unable to reach the ports due to a breakdown in the rail system, and backlogs at the ports halted the movement of goods. Lead times increased, impacting inventory levels, sales and ultimately costs.
Transnet’s inefficiency is believed to have cost the economy R411bn or 5% in real economic growth in 2022, with the total impact on 2023 still to be accounted for. This amount is not trivial and highlights the easy wins to boost South Africa’s economic growth. Even small improvements translate into large gains for the economy.
Historically, the government has not allowed private sector involvement. Transnet’s collapse and the significant cost to the economy created the necessary pressure required to force change. Last year, for the first time, a private company was allowed to run the Durban Container Terminal 2. Allowing the private sector a foot in the door is a massive win. If current engagements prove timely and successful, it opens the door for more.
The SA Consumer – Conditions are Tough and beginning to Weigh but Resilience Remains
The SA Consumer, once again, remains resilient despite the added pressure of the increased cost of living. Debt levels remain manageable and while servicing debt has become more onerous, defaults are not significant.
Less consumers are seeking and being approved for credit, noted in the dip in our private sector credit extension and retail sales have slowed but not to concerning levels.
Earnings (Salary and Wages) continue to grow ahead of inflation at 6.5% versus 5.4% and the number of persons employed now exceeds pre-Covid levels, supporting consumer spending.
Consumer confidence is showing that households remain positive about their finanical outlook despite the tough conditions, but are negative on the outlooks of others and the country as a whole. In other words, households, in their own opinion, are getting by but they believe others are not, and this difference is the largest seen in years. With all evidence suggesting the consumer is managing to keep afloat, this difference between opinion and reality creates an opportunity. The worst is being priced in, and investors can benefit when this corrects.
SA Market Valuation Remains Attractive
Emerging markets have staged a recovery over the past two years, leaving South African assets behind. The tough economic climate is to blame for the decreased demand and our underperformance over time. Given this, on a valuation basis South African equity is attractively priced versus our emerging market peers. In our opinion, a lot of the negatives are priced in, and investors are being more than compensated for the increased risk SA assets present.
Excluding materials, earnings growth forecasts for FY24 averages around 13%, while the All-Share Index trades on an undemanding 12-month forward PE ratio of under 10x. Any improvement in the level of loadshedding or the efficiency of our logistics chain will provide further support to earnings growth.
We are heading into 2024 with a lot of the negatives, and only a few of the positives priced in. While business confidence remains low, conditions look to improve in 2024. The consumer remains resilient despite the added pressure, and valuation on the equity market remains undemanding. This leaves the local equity market well placed to benefit from the changing interest rate cycle.
Positioning is Key
While reduced rates are supportive of equity, some areas benefit more than others. Correct positioning is necessary to maximise return potential.
- Decreasing rate cycles primarily benefit banks through the increased demand for loans and the uptick in business activity.
- Valuations remain undemanding and below pre-covid levels giving the sector the potential to re-rate.
- Historically when dividend yields cross Price-to-Earnings ratios at the end of a monetary tightening cycle, SA banks have rerated. This is being noted at current valuations, increasing the likelihood of multiple expansion.
SA Listed Property
- REIT yields have tracked SA bond yields. If this relationship persists, decreasing interest rates will automatically support SA listed property pricing.
- Reduced interest expense through rate cuts immediately assists earnings growth.
- Fundamentals have seen much improvement with decreased loan-to-values and vacancies, and rental reversions turning positive; yet pricing does not reflect this.
- The market has taken notice, with the SA Property Index providing the strongest total return performance for 2023 when compared to the MSCI SA, SA Bonds and Cash.
- Sasol’s beta relative to decreasing bond yields is very high. In other words, when bond yields decrease, historically, Sasol’s share price has increased. Therefore, as the demand for SA bonds increases, so does the demand for Sasol. This is purely tied to economic growth and Sasol’s prospects in a less restrictive monetary environment.
- The chemicals sector is on the brink of an inventory restocking cycle. Following the pandemic, supply chain constraints led to increasing chemical stockpiles across the industry. These have been worked through and as such, Sasol’s chemical’s business stands to benefit from increased demand. 47% of Sasol’s EBITDA originates from chemicals.
- The oil price has been largely supported of late and with the expectation of increased global growth on the back of the decreasing interest rate cycle; the oil price should remain supported. Escalation of current global conflicts would drive oil prices higher.
- Sasol trades on a forward PE under 4x, with a forecast dividend of 11%. Given its attractive valuation and potential to re-rate in a changing rate environment, Sasol remains a core holding in our portfolios.
Bumps in the Road
2024 has a number of potential market moving events.
The Year of Elections
54 democracies head to the polls in 2024. In the South African context, we believe the market may experience short term volatility to election based ‘noise’, but it will not be the primary driver behind market performance. This being said, historically, the local market has benefitted during election years in South Africa.
We will be watching this space closely and will provide more detailed updates as the year progresses.
Potential for a Strong El Nino Event
Ocean temperatures are already exceeding the threshold which indicates the potential for a strong El Nino event. With this, comes below-normal levels of rainfall and above-normal temperatures in Southern Africa. Previous strong El Nino events have had a negative impact on agriculture, with aggregate Maize output dropping. If conditions deteriorate enough, there is potential for a shortage; prices will rise, ultimately impacting inflation.
The severity of the El Nino event remains to be seen but given the potential consequences, we are watching its progression closely.
The South African equity market is unlikely to be impacted by the ongoing geopolitical tensions, unless conflict spills over into neighbouring areas, impacting global oil supply. Currently this seems unlikely.
There are concerns that if the disruption in the flow of container vessels through the Red Sea is protracted, it may cause increased inflation, unhinging the global narrative of decreasing interest rates. However, this is unlikely as the financial impact is surprisingly marginal. Freight rates remain below pandemic peaks and transport costs on average equate to 4%-5% of price of goods. It is estimated that it will not have a measurable impact on the inflation outlook in the US, calculated as a potential 0.5% increase in core inflation.
The China Conundrum
Activity indicators are beginning to suggest the Chinese economy may be bottoming out. While forecasts are indicating 5% GDP growth, the beleaguered property market does not seem to support the potential for a sudden Chinese recovery story. Expectations for a large stimulus package are now very low but to put it plainly, there is very little certainty on what might happen. In the event China does surprise on the upside, it presents an opportunity for the SA market as this has not been priced in.
Our economy has felt the pinch of the restrictive conditions, exuberated by the challenging business environment. Despite this, South Africa remains resilient. The economic constraints are well known and priced into SA equities, leaving market valuations undemanding and cheap relative to other emerging markets.
While the context for 2024 has many moving parts and some which may surprise, the primary driver for SA equity, along with global equities, is the start of the decreasing interest rate cycle. Equity markets flourish in decreasing interest rate environments and being invested before cuts are announced will maximise return potential.