If we look back on the year so far, the market has faced a number of obstacles from regional bank failures, escalating tensions between China and the U.S., continuation of the war in Ukraine, to a surge in AI-related technology. While at the same time, central banks continue to raise interest rates trying to fight stubborn inflation.

Despite all these complexities, the S&P 500 and Nasdaq 100 have performed well – up 17% and 40% year-to-date, respectively. However, these gains have been lopsided, with a handful of mega-cap tech companies accounting for the majority of the outperformance and distorting valuations.

As we approach the backend of the year, let’s have a look at our mid-year scorecard; reflecting back on our offshore outlook  that we gave at the beginning of the year.

Wide Gap Between Economic and Personal Perceptions

The chart below shows how consumers are exceptionally bearish towards the macroeconomic outlook of our economy versus the outlook for their own financial positions. In other words, consumers feel their own household finances are slightly under pressure while their view of the outlook for the economy is far worse. This gap has widened over time and is at its largest level yet. 

Consumers very bearish about the economy

Source: Standard Bank Research

Supporting this outlook is the business confidence index currently at 3-month lows. Business citing “persistent load shedding, rising interest rates and cost pressures weighing on profitability” being unsupportive of confidence.

The IMF forecast South Africa’s GDP for FY23 to come in at 0.3% rebounding further to 1.7% in FY24. While this is an improvement on earlier forecasts, the number is still very low. The impact of the constrained environment is suffocating, with the largest constraints being loadshedding, inflation and interest rates.

Loadshedding – Less is More

The financial impact from not having a consistent source of energy is enormous on both the consumer and business. At the start of 2023 we discussed how the tipping point between the cost of self-generation versus the cost of relying on Eskom was suddenly being reached and more and more evidence is supporting this view. The number of batteries and solar panels imported into the country for example, has skyrocketed.

Spike in solar panel imports in March-April reflects a rapid expansion in private-sector electricity-generation capacity

Source: SARS, Quantec, Standard Bank Research

Eskom has calculated that as much as 4,550MW of private solar generation capacity has been added in the past three years. This figure is expected to expand by a further 2,300MW this year alone and has potential to double in 2024. Supporting this, Government continues to increase generation from renewables, with 6,280MW of capacity installed by the end of 2022 and various bid windows expected to add to the grid in time.

June experienced a sudden reprieve from loadshedding on the back of decreased demand from the grid. Self-generation was named as the largest contributor to the decreased demand which in turn reduced the level of unplanned maintenance and ultimately reduced loadshedding. While we have already seen loadshedding return to higher stages in July and Aug, the important take away is the significance of business and households moving off the grid and just how quickly it has started to make a difference.

Loadshedding relief…

Source: Eskom

The market is forecasting lower levels of loadshedding as early as 2024. Is the power crisis over? No, but a step down to consistent stage 1 and 2 loadshedding will make a world of a difference. The cost savings this creates will have an immediate impact on earnings and the reprieve will allow Eskom the space to address the crisis more effectively.

On a side note, Transnet Port Terminals has entered into a Joint Venture with Singapore’s International Container Terminal Services Incorporated who will run and expand Durban’s Terminal Pier 2. This partial privatisation is a huge step in the right direction and opens the door to further involvement by the private sector in an area previously not available to them.

The IMF have forecast South Africa’s GDP could go up to 2.5%-3%, “If all the structural things are tackled” namely the fraying transport network and Eskom.

Inflation Back Within its Bracket

Average wage growth in 2022 was around 6%, food inflation ramped up towards 15% while fuel was increasing up to 60% towards the end of last year. It is very clear how a 6% increase in wages was unable to cope with the sudden increase in the cost of living. 

South Africa has now hit peak inflation. Our latest CPI prints show we are comfortably within our 3%-6% target bracket with expectations for FY23 inflation to come in at 6%. Fuel inflation has reduced drastically with food inflation trending down to more normalised levels. Consumers and businesses will find 2023’s inflation far easier to digest with expectations for this to reduce further into 2024.

Peak of the Interest Rate Cycle

In order to protect our currency and keep inflation under control the sharp increase in interest rates over 2022 and into 2023 was a necessary evil. Debt service costs relative to disposable incomes increased and SA Banks showed evidence of strain with credit loss ratios moving to the upper ends of guided ranges and increased impairments. Despite the strain, SA Consumers and businesses were resilient, and the banks expect an improvement as early as the second half of 2023.

We now find ourselves at the peak of the interest rate cycle with expectations for interest rates to start trending lower as early as next year, hitting around 7% in 2025.

Rate Cuts – Who Moves First?

Equity markets are proactive and as such the market is already starting to take note of the above factors to position itself accordingly. History has shown that 3-6 months before a rate cut, banks and real estate begin to move. Over the past 3 months we have seen strong price movement in both the banking and listed property sectors. The market is acknowledging the changing environment and starting to adjust. It is important for investors to take note and position themselves accordingly.  

SA sectoral performance around SARB rate-cuts

Source: Bloomberg

Point of Maximum Pain

In our opinion, we are at the point of maximum pain. The current environment is not supportive of business or individuals, yet the pressure is already showing signs of abating sooner rather than later. Loadshedding is anticipated to become less onerous, inflation is forecast to remain within the target bracket and interest rates will begin to ease. Adding to this is the global context which is on the precipice of recovery. Market expectations show that we have reached the peak of the interest rate cycle in the US. When this starts to ease it will provide further support for global equity and the local market will be a beneficiary.

From a valuation perspective the local equity market looks cheap and continues to trade at a discount relative to other emerging and developed market.

MCI 12m forward P/E ratio

Source: MSCI, FactSet, SBG Securities analysis

The tough operating environment saw earnings growth deteriorate as topline revenue growth slowed but costs continued to rise. During this period forward PE valuations dropped, and consensus earnings expectations moved lower. It takes time for management teams to get on top of these costs but when they do and we start to see earnings expectations bottom there is potential for multiple expansion. Representing this graphically, forward PE multiples tend to bottom before we see earnings expectations bottom. In the example of Mr Price below, Forward PE’s (purple) are off their lows while earnings expectations (green) remain low.

Have Earnings Bottomed?

Looking at earnings revisions over the past few months in the last 2-4 weeks analyst forecast expectations for earnings are showing signs of turning. Positive earnings revisions from here will indicate earnings have bottomed and will lead to multiple expansion.

Time to Jump in?

The difference between an individuals’ perception of their own financial position versus their expectation for economic growth in South Africa is where the opportunity lies. We are at the point of maximum pain with negative sentiment leaving the market attractively priced. As conditions begin to improve, earnings expectations will recover, and earnings multiples will adjust for this. At present the opportunity remains but the market is forward looking, and this gap will close. You need to be invested in the market to gain on the big up days so if you were looking to add to your local equity portfolio, it might be time to take the plunge.