Over time, there is one single factor that drives investment returns. That is company earnings.
“In the short term there is sentiment and volatility, but in the long run fundamentals is all that matters,” says Andrew Dittberner, the chief investment officer at Old Mutual Wealth Private Client Securities.
He points out that if one looks at the MSCI World Index over an extended period, there is an over 80% correlation between the index and the earnings of its constituents. In South Africa, that correlation is even stronger.
“There is a 93% correlation between the JSE All Share Index and company earnings,” Dittberner explains. “That doesn’t mean that we can predict what will happen in the short term, but ultimately earnings and the index follow one another.”
For investors, this naturally leads you to ask what then drives earnings. At an individual company level, things like good management, a strong brand and market share may have an influence, but there is a greater over-arching determinant.
“The key ingredient that drives corporate earnings is economic growth,” says Dittberner. “It’s as simple as that. If you have growth, earnings will follow.”
Globally, there is a 60% correlation between growth and the earnings of listed companies. In South Africa, the correlation is 81%.
“And that might help us to understand the problem we have today,” says Dittberner. “It explains why local facing, or ‘SA Inc’ companies, are battling to grow earnings.”
Since the mid-1990s there was a clear correlation between South African and global growth. As the country opened up and became integrated into the world economy, its fortunes were closely linked to the rest of the globe.
“Since 1998, 75% of South Africa’s growth is explained by global growth,” says Dittberner. “But in the last three years we’ve seen a breakdown in this relationship, and that is the big issue today. As global growth has recovered, South Africa’s growth has pulled back.”
He pointed out that if this correlation to the global economy had remained in place, the country would currently be growing its GDP at over 2%.
“Last year alone we lost 2.1%,” Dittbnerner argues. “That’s $7 billion, or R90 billion. That is equivalent to the cost of one Nkandla every day.”
Lessons to be learnt
To correct this economic stagnation, Dittberner suggests that the country should look at what drove the economic miracles of the last century in countries such as South Korea, Singapore and Chile. What factors do they have in common that allowed them to grow as they did?
The first is high savings levels. Higher savings means more investment into the economy, and this is something South Africa desperately needs.
“Fixed investment into the economy has been stagnant over the last 10 years,” Dittberner points out. “People think that if the rand weakens we become more competitive and can export more, and while that’s true in the short term what ultimately matters is your productivity. If you don’t invest you can’t be competitive in the long run, and so your exports will fall.”
Secondly, policies that support growth and strong, robust institutions are vital. Economies cannot prosper when there is systemic uncertainty and weak support from government.
A country also needs demographics in its favour, with a young and growing population. But that must be supported by robust ‘soft infrastructure’ in the form of education and healthcare.
“And lastly, there must be openness and connectedness, specifically within your region” says Dittberner. “South Africa is the most connected African country to the rest of the world, but the problem is we remain very disconnected from our region. We live in a fantastic neighbourhood in sub-Saharan Africa, where the expected growth over the next ten years is above 5%. We need to find a way to connect to that.”
He points to two African countries that have dramatically changed their economic fortunes in recent years – Rwanda and Ethiopia. In both cases, they have significantly opened up their economies, which has encouraged the movement of information, capital, goods and people.
South Africa needs to learn from these examples. The country’s persistent challenges of poverty and unemployment have the same root cause – an economy that isn’t growing fast enough to become more inclusive.
One of the consequences of this is that South Africa has been unable to bring down its levels of inequality. The country’s Gini coefficient remains one of the highest in the world.
“Other countries like Ecuador, Uruguay and Cambodia have brought theirs down,” notes Dittberner. “How? Through economic growth. Economic growth will reduce inequality and that’s what we need to do.”
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