South Africa is facing an economic storm, but there may be a silver lining

The International Monetary Fund’s (IMF) latest World Economic Outlook implied a potential contraction of 8% in South Africa’s economy in 2020 but the current rates of recovery of various sectors due to government lockdowns could see a contraction of as much as 10% in the country’s GDP this year.

South Africa’s emergence from one of the most stringent lockdowns in the world has seen the economy currently running at around 80% of its pre-COVID capacity.

Unfortunately, many models are predicting a peak in virus infection rates in late July or early August. There is still a wide range of possible outcomes as some offshore markets have started to react to a second wave of infections which has caused some concern regarding the shape of our recovery. Speculation is rife as to the shape of recovery, from a W to a V, to an L or even a hockey stick recovery.

THE GOOD

The topic of prescribed assets has caused some concern among many investors. The investment community gained a little more clarity in this regard as was highlighted by Finance Minister Mobweni’s Supplementary Budget in which he said there is not a large enough savings pool in SA to meet Government’s spending requirements and no mention was made regarding the revising of the current limits of Regulation 28 of the Pension Funds Act.

THE BAD

The impact of government lockdown regulations was severe, especially on industries such as construction, which took a 14% hit and tourism which fell by 30%. Spending has been more defensive in recent weeks raising questions around behavioural change which could actually see a higher proportion of savings. While there was pre-emptive buying in March, and some pent-up demand coming through as lockdown restrictions ease, trade could still be hit by a decline of around 10-15%, through a combination of lockdown and weakened offshore demand.

THE UNCERTAINTY

While the Finance Minister’s Supplementary Budget was ambitious, it was accompanied by a vagueness surrounding how we will fund longer-term needs. Having said this, the statement that the cabinet has endorsed debt consolidation and fiscal responsibility which will accelerate reform, was well received.

THE SILVER LININGS

One of the silver linings of a recession will be that the current account deficit will narrow dramatically, or even realise a small surplus. At the same time, lower demand for foreign funding could signal some stability in exchange rates, with the weak Rand actually helping South Africa’s competitiveness.

With central banks providing the anchor for recoveries across the world, the SARB has provided around R300 billion in support to date, albeit some of it being temporary, while rate cuts have contributed an estimated R80 billion in stimulus, placing money in consumers’ hands.

Gold has benefited significantly from the collapse in real interest rates in the US which has benefited South African gold miners whilst other South African equities remain cheap. Cash in South Africa is no longer “king” as the series of rate cuts have led to a significant decrease in money market rates. South African bond yields have increased and remain one of the more attractive bond markets in the world. Bonds have a long history of being vital sources of capital preservation and income in investment portfolios, particularly for retirees.

DESTINY AT 30 JUNE 2020

Equity markets can behave strangely and in a manner which is disconnected from their underlying economies. The rebound in the local equity indices through Q2 of 2020 has again brought this conundrum to the fore. With the JSE only a few points away from where it was at the beginning of 2020, one wonders whether Covid-19 is playing out in a parallel universe. Here are some reasons to explain this rally borne in the throes of a pandemic:

• Fiscal and Monetary stimuli are limiting the damage to corporate earnings.

• With developed markets’ bond yields near zero, global equities remain the preferred asset class and make South African Bonds attractive.

• Better treatment protocols are reducing Covid-19 death rates, bolstering consumer confidence and economic activity.

• Gold miners benefiting from a strong gold price as geo-political tensions drive investors to safe havens.

The abovementioned has played a role in the exceptional rebound of the Destiny Portfolios:

Destiny’s participation in the bounce during Q2 was largely as a result of holding onto our local pro-growth positions such as Naspers, Prosus and Mining stocks. However, noteworthy performance was also achieved due to our weighting in global assets (generous enough to be a strong contributor to the Destiny Portfolios’ overall growth by the Rand’s initial weakening in the quarter).

CHANGES TO THE DESTINY PORTFOLIOS

Through careful deliberation and debate, the GIB Investment Committee has decided to implement changes to the asset allocation of the Destiny Portfolios to ensure consistent growth through these changing times.

The committee is of the view that cash’s ability to yield return has been compromised by the recent 2.75% reduction in the repo rate, however, its ability to preserve capital is still intact. In contrast, government bonds’ ability to yield return has increased. Therefore, a decrease in cash and an increase in bonds has been applied.

The outlook in developed global economies is more favourable than that of South Africa’s due to our well-known underlying challenges. Therefore, in order to capitalise on the recent strengthening of the Rand (currently R16.50/USD) an increase in offshore equities with the concomitant decrease in local equities has been executed.

IN CONCLUSION

Despite the economic storm on the horizon, there is still hope for a silver lining. The GIB Investment Team is steadfast in its philosophy and is confident that the positioning of the Destiny portfolios will meet the objective of long term retirement investing for its members.