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Your portfolio is not the same as gross domestic product

A typical SA balanced fund has much smaller exposure to domestic economic growth (or lack thereof) than most realise.
Global events such as those taking place in Beijing, Washington and New York are more likely to impact local investment portfolios, the authors say. Picture: Shutterstock

It was much worse than feared. South Africa’s economy contracted at double the rate expected by most economists in the first quarter. The -3.2% annualised decline in gross domestic product (GDP) from the fourth quarter means year-on-year growth was exactly zero. In real (after inflation) terms, the economy is no bigger than a year ago.

Read: Shock GDP figure undermines Ramaphosa’s reforms

Low inflation nation

In nominal terms, adding back inflation, growth was 4.1% from a year ago, implying that the economy’s inflation rate (for consumers and producers) was around 4%. Nominal growth was the slowest since 2009. Nominal growth matters because it reflects the rand growth in incomes and spending. (Real growth gives an idea of the increased purchasing power of those incomes.) The economy’s nominal wage bill only grew 4.4% year-on-year, for instance, and the private sector’s operating surplus (a proxy for company profits) grew by 3.4%.

Crucially, it means the government’s ability to generate tax revenue is much lower than thought.

National Treasury’s forecast for nominal growth for this year was over 7%. Things would have to improve a lot for that to be realised, or inflation would have to accelerate. Government’s borrowing metrics, the debt and deficit ratios are expressed relative to nominal GDP. A smaller denominator implies higher debt-to-GDP and deficit-to-GDP ratios. Economists are adjusting deficit ratios to 6% of GDP, while government’s debt ratio is likely to breach 60% sooner than expected. All this puts pressure on credit ratings.

Chart 1: Real and nominal year-on-year growth in GDP

Source: Stats SA

Lights out 

So what went wrong in the first quarter? Eskom is the main culprit. The Council for Scientific and Industrial Research estimated that the economy endured 770 gigawatt hours of load shedding in the first three months of the year, several times more than the whole of 2018 and half as much as the whole of 2015, the last time we had severe rolling blackouts. Fortunately, the second quarter has so far not seen a repeat. Load shedding clobbered the mining and manufacturing sectors, with the former also impacted by the extended strike at gold miner Sibanye. Fixing Eskom financially and operationally is the number one short-term requirement for an economic rebound.

Consumer squeeze

Consumer spending accounts for 60% of economic activity and is the ultimate driver of local economic growth. It suffered its first quarterly decline since 2016. Compared to a year ago, consumer spending was only 0.8% higher in real terms.

While households benefit from low inflation, nominal after-tax income growth has also slowed, so there is almost no growth in real purchasing power.

While consumer confidence remains surprisingly robust according to the FNB/BER Consumer Confidence Index, this is primarily a reflection of future expectations, not current conditions. The most recent indicator of consumer spending, May’s new vehicle sales numbers, indicate little appetite for big-ticket spending.

Policy uncertainty leads to low confidence

Depressed business confidence and constrained government finances mean fixed investment declined for the fifth consecutive quarter. Fixed investment growth by private businesses contracted for five of the past seven quarters. Fixed investment not only adds to current demand, but also to future productive capacity and a turnaround is therefore crucial for the economy’s growth prospects.

Chart 2: Growth in domestic real fixed investment spending

Source: Stats SA

Businesses invest in plants, equipment, vehicles, IT and more when they want to grow. This requires a sense of optimism about future sales and an expectation that the economy of the future will be well managed, according to consistent rules. A pick-up in consumer spending is therefore necessary, as well as policy certainty from government’s side. This is the main lever government can pull now, seeing as there is no room for fiscal expansion. (Bailouts for poorly managed state-owned enterprises have eroded its fiscal space completely.)

Read: SA has ‘no choice’ but to increase funding for Eskom

Unfortunately, the announcement that the ANC wants to expand the SA Reserve Bank’s mandate to focus on growth and inflation and that it wants to study “quantity easing” (presumably quantitative easing, or QE) muddied rather than clarified the waters.

Land expropriation and the possibility of prescribed assets are similar sources of uncertainty.

The announcement, which needs to be seen in the context of the ruling party’s internal political battles, was later refuted by the finance minister (a former Reserve Bank governor and staunch defender of its independence) and President Cyril Ramaphosa. In any event, changing the Reserve Bank’s mandate is unnecessary as it already explicitly includes ensuring price stability in the interests of balanced growth and development.

Quantitative easing, which involves a central bank buying assets from the banking system by creating reserves (not by printing money, as it is often described), has been tried in Europe, the US and Japan. It primarily aims to combat the threat of deflation, which is not a condition the local economy suffers from. It has had mixed results.

Banks mostly did not use the excess reserves to boost lending, because growth in credit requires an increase in risk appetite from lenders and borrowers (which is how money is created). The initial round of US QE was probably the most effective, as it helped remove toxic mortgage-backed securities off banks’ books in 2008. The version applied by the European Central Bank (ECB) was a bit upside down, as it bought more German bonds (driving yields to negative territory) rather than buying the bonds of crisis-hit Greece.

Last week’s ECB meeting raised the possibility of restarting QE, a sure sign it did not work the first time. Direct funding of government spending by the central bank is something completely different and has in the past led to hyperinflation, with Zimbabwe and Venezuela being the most recent examples. The Reserve Bank would not allow this as it is mandated by the Constitution to protect the purchasing power of the rand. 

Rate cut a possibility

This is not to say that the Sarb always gets it right. Interest rates have been too high for some time and it is likely that the shock first quarter growth numbers will mean a rate cut is on the cards in July. Inflation is under control and close to the midpoint of the 3% to 6% target range, and global central banks are cutting.

The Reserve Bank of Australia joined the party last week, and reduced its policy rate to 1.25%. Not too long ago it was still talking about rate hikes. The Reserve Bank of India also cut.

Similarly, the US Federal Reserve was still projecting several rate hikes six months ago, but its officials (including its Chair Jerome Powell) are now talking about the possibility of rate cuts, given slowing global growth. The market is already pricing in rate reductions. The Sarb has correctly emphasised that it cannot address the structural factors constraining economic growth. It cannot generate electricity, for instance. Its scope to cut rates is also not unlimited. But a 1% rate reduction over the next year is feasible – real rates would still be positive – and could ease pressure on consumers by reducing interest payments.

A rush of new borrowing in this climate is unlikely.

Ironically, the announcement of the ANC’s national executive committee (NEC) might raise the hurdle for a cut, as the Sarb will be wary of being seen as caving to political pressure. A quick glance at Argentina and Turkey’s currencies over the past 18 months reveals what can happen when the credibility of the central bank of an emerging market is questioned. The Sarb’s legal and de facto independence has been one of the reasons why South Africa’s credit rating has not fallen faster over the past few years. It was thankfully never subject to state capture.

Chart 3: Emerging market currencies against the US dollar, rebased to 100

Source: Refinitiv

Your fund is not the same as GDP 

With the local economy in the doldrums, and political uncertainty still a reality despite the election, it is tempting to make the argument that investors should externalise their entire portfolios. This would be an extreme reaction and go against the principle of diversification (never mind the tax implications). The point is that a typical South African balanced fund has a much smaller exposure to domestic economic growth (or lack thereof) than most realise.

Read: Financial emigration is the new way out 

Most already have 30% direct offshore exposure, while the JSE-listed shares tend to be more global than local. The JSE All Share Index actually rose after the GDP announcement, since the weaker rand boosted the JSE’s global shares, and global markets rose. Shares exposed primarily to the local economy have predictably struggled. High local interest rates constrain the local economy, but they are a fantastic source of low-volatility real returns for local investors.

While it is important that policymakers in Pretoria act quickly to stabilise confidence for the economy to recover, what matters most for your portfolio happens in Beijing, Washington and New York. The global economy is facing a period of uncertainty (mostly around trade) and slower growth, but this does not imply a repeat of the 2008 global recession. With the benefit of lower rates, lower oil and hopefully a thawing of global trade relations, growth could pick up again later this year into next year. While equity volatility is likely to remain elevated for some time, investors are again being confronted with the prospect of zero to negative real yields in fixed income in the developed world, making reasonable-priced equities attractive even in a moderate growth environment. Emerging markets are also likely to stand out for yield-starved investors.

Dave Mohr is chief investment strategist and Izak Odendaal an investment Strategist at Old Mutual Multi-Managers

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I make my living by cultivating the earth and whistling to a sheepdog. As humble a lifestyle as could be. The other day my sheepdog asked me why I invest in all these listed financial companies when none of them performs better than the value of gold. In other words, if I simply bought gold and kept it under my bed over the last 50 years, I would be wealthier than what I am owning unit trusts or shares. Then she said something that really made me think – why do you pay professionals to manage your money in instruments that have underperformed cash(gold) for 50 years. Why do you pay to become poor? she asked.

I looked at my sheepdog with a sheepish grin on my face, and could not answer her. Please help.

Talking Dog? Gold? … must be LSD 😛

A Kruger rand in 2003 cost me R3000. Today an ounce KR costs R20500. And the JSE, pray tell?

Boomgloom: I recall that in 1968 Nedbank Head Office sent to us at Kimberley branch a few hundred Kruger Rands, to sell to the public at roughly R28 a piece. I started by offering them to the tenants in our building. All sophisticated professional people. How many did I sell? Not as single one. People were just not interested, particularly not as an investment.

Dries, that is the point I am trying to make. The standard response to gold investment is that it is “an ancient relic”, it does not pay a dividend and it is not an investment. Ask any investment manager and that is the reply. So, nobody buys gold and everybody buys unit trusts.

Everybody is allowed to have his own opinion, but not his own facts. The facts are the following. You mentioned the year 1968. In that year you would have paid 20 ounces of gold to buy the Dow Jones Index. Today you can buy the Dow for 19.56 ounces of gold. Ok, the Dow paid dividends and gold under the mattress does not, but that dividend is equal to or less than the management fees on the unit trust!

The Eurostox 50 is currently 83% below the value it had in the year 2000, in terms of gold. Gold is not an investment, I agree with that one. Gold is an alternative form of cash. Gold is a superior form of cash because currency devaluation cannot destroy its value. This is my point. Over the last 50 years, the average unit trust did not outperform cash, but it charged a fee for trying.

I am trying to get a debate going here but there are no takers. It gets lonely here on the farm, between all the sheep……

JSE mid 2002 was 11000. Now it is 58500. That’s 5.32 x the level in 2002.
Gold ounce mid 2002 was R3000. Now it is R19700. That’s 6.59 x what it was in 2002.

Why 2002? Cos that’s when I bought my first kilo if gold for US$10000. Today it will cost $43400.

Think about putting 10% of your savings into physical gold.

Look at in UK.

Over the last 30 years an oz of gold went up 268.55% in $ terms. Since 1 Jan 1973 (46,5 years) and oz gold went up 1935.92% in $ terms, so that is close to the 50 years. Anyone that can tell us how the JSE all share (would be helpful if stated in $ terms) did over that time period?

We just can’t going around believing some story about a talking dog and that gold would have outperformed the ALSI, we need facts.

(Source of gold info:

The price of gold and the value of the indexes are published daily, it is no secret. The value of the JSE All Share in terms of gold during 1995 was 3.5 ounces. Today you will spend 3 ounces of gold to buy the All Share, a loss of 14% over that period. Again, I do not see gold as an investment, but as a superior form of cash.

The actual reality is that currency devaluation confuses everybody, precisely what it is intended to do. Currency devaluation hides the poor performance of listed investments.

“There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.” J.M Keynes

See my post above for more info. I would love to hear your opinion.

I want percentage growth of the ALSI (preferably in $ terms) for the past 30 years or 46.5 years, to compare against gold %s over the same period, to test the claim that you would have been better off (wealthier) over 50 years. In black and white it would be worse, better, or the same.

Getting the info is difficult for me without access to paid for systems that can give the historic information, so the daily publishing of unit trust prices are of no use to me.

Dow Jones Insustrial Index 1970: $700 and $25 971 today = 3 610% gain
Gold 1970: $35 and $1 335 today = 3 714% gain
JSE 1995: $1385 and $3 957 today = 185% in USD terms
Gold 1995: $380 and $1 335 today = 251% in USD terms.

Sensei I would recheck those figures if I were you. Over 50 years gold definitely did NOT outperform equity (local and international).

Colson, now we have a debate! thank you. Equity outperformed gold during certain periods and underperformed over certain time frames. The way I see it, and the way I manage my personal funds and client funds is to be in equity when equity outperform gold, and then to sell out of equity when gold outperforms equity. so, when gold outperforms equity is signals a period of devaluation of the currency. We do not want to be in dollars or rands but when the equity market is in a decline, gold is the safe haven.

Google Dow/gold ratio and you will see a picture of the concept. The Dow is still value the 1970 level in terms of gold. No real growth in 50 years.

Before reading an article, first check the authors’ job title then ask:

How do they benefit if I believe them (Annual management fee of 1-2%)?
Do they still benefit if they are wrong (still Annual management fee 1-2%)?
What’s their incentive (to keep me always invested)?
Are they subtly marketing to me? (Yes they are)

Like a casino, they are guaranteed to always win, regardless of the occasional payout they make to you.

The analysis is just interesting sounding white noise.

An once of gold can today buy a big ox. 50 years ago it could buy a big ox and the same ox 100 years ago.

Mmmmm: I think that you totally concur with Sensei above in an oxy way. No devaluation of gold. I then wonder why I have not owned a single Kruger Rand since 1975. (That was a proof! – nogal.)

End of comments.





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