Have South African's Missed The US Recovery

The COVID-19 crisis lends itself to hyperbole (meaning exaggerated statements or claims not meant to be taken literally). However, in the case of COVID, many hyperbolic statements should be taken literally, particularly in financial markets. The chart below plots the significant US market depressions going back to the 1920s, the green line marks the significant fall and unprecedented rise in the US market since the 23 March lows.

The sell-off in the S&P 500 Index in March 2020 was the fastest and one of the most severe declines that we have seen in history. The recovery has also been spectacular with the S&P 500 Index now printing all-time highs a mere five months after the 23 March 2020 trough. Much has been written about it in newsletters as market participants clamber to justify the speed of the recovery. Voluminous commentaries have been written about the drivers of that recovery; acronyms have been made up to describe the companies that have driven the performance. A good example is FAANGs – Facebook, Amazon, Apple, Netflix and Google.

However, there has been very little written about and no real commentary on the performance of the South African market since the March 23 lows. South Africans have been observed to be one of the most pessimistic nations in the world (Ipsos MORI’s 2016 “Perils of Perceptions” survey), perhaps it is the naturally negative outlook that has caused many market participants and commentators to focus on the dire economic situation that has been exacerbated by the COVID-19 crisis – the forecasts of huge drops in GDP; the weakening of the rand; the increase in unemployment; plunging consumer and business confidence; and the list goes on.

With all this negativity around, it has been hard to take notice of the return that the local markets have delivered. Interestingly, as I write this on Friday, 29 August 2020, in rand terms, the FTSE JSE All Share Index has generated exactly the same returns from the 23 March 2020 low as the S&P500, both having returned 47% from the lows.

So how is it that the return of the SA market is matching that of the US market? We don’t have any of the stocks that the US market has that have experienced the COVID-19 crisis as a tailwind. Netflix, Amazon and Apple all saw positive changes in their fortunes, (online sales at the apex of the crisis were growing at 26.3% while bricks and mortar were contracting at -17.7%) as COVID-19 gripped the world and forced it into an adoption of tech at a pace which has never been seen before. As a result, share prices were driven to new highs, pushing the level of the US’s mostly widely followed index, the S&P 500, to all-time highs.The reality is that the South African equity market has become much less influenced by the heartbeat of South Africa and way more aligned to what’s happening in the rest of the world. The following are key reasons for this phenomenon:

       
• International shares that just happen to be listed on the JSE. There are many of these – British American Tobacco, Anheuser Busch and Richemont are obvious examples. We would argue that Naspers and Prosus fit into this bucket too, with their fortunes inextricably linked to their largest asset, Tencent.
       
• So-called rand hedge counters. They derive their value from predominantly non-South African sources, and examples of these would be Impala Platinum, whose valuation is driven more by the Rand Platinum Group Metals price than the heartbeat of South Africa.
       
• Some South African companies that have invested abroad. If you disaggregate the vale drivers of these companies, you will find that they are not driven entirely by South Africa. There are some interesting examples in this bucket. A company like the Foschini Group (TFG), which most South Africans would think of as purely South African exposed, with their well-known South African brands such as Foschini and Sportscene. It is important to note that TFG has close to 30% of its revenue derived from outside South Africa, in the UK and Australia mainly.

If, as part of a research process, one would spend time disaggregating the country “factors” that drive the valuation of the companies owned in a portfolio. By way of example, we would analyse a company like TFG and place a percentage of the value we ascribe to it to various “factor” buckets. Given that they have a UK business and an Australian business, these are both “factors” that we would disaggregate TFG into in addition to the large remaining “SA Inc.” bucket. Clearly, the businesses that just happen to be listed here and those rand hedge businesses mentioned above have very little exposure to the “SA Inc” factor and are exposed mainly to other international factors. If then we would replicate this process across all the stocks owned in a portfolio and all the companies in the index that are covered, which then gives a picture of the SA Inc. exposure at an index level. One would find that in the FTSE JSE All Share Index, the broadest measure of the SA market that the SA Inc., the value driver is only 21.1% of the index.

South Africa is in a precarious economic position and was so before the COVID-19 crisis hit. Although the COVID-19 crisis dragged us closer to the economic abyss, the broader market has performed well since the day of the national lockdown was declared. The chart below shows the drivers of those returns. The SA Inc. component of our market, a proprietary market cap weighted index of companies whose value is mainly driven by the “heartbeat” of South Africa, has performed poorly, regaining only 18% since the March lows. However, if we graph a market-cap weighted basket of international stocks that happen to be listed in South Africa (which have generated a 54% return in ZAR since the lows) and then add to them the rand hedge component, the basket’s return increases to 60%. The weighting of these components in the All share has offset the far more muted recovery of the SA Inc. component and helped the All Share to exactly the same percentage recovery (in Rand terms) as the much-celebrated S&P500 Index.

South Africa has its well-documented problems and there is a huge amount of uncertainty around how these problems will be solved. However, we are fortunate that the SA equity market has good geographical diversity and that even with the negative outlook for the “heartbeat” of South Africa, there have been and will continue to be, opportunities in the rest of the market. Glacier Research would like to thank Brian Thomas for his contribution to this week’s Funds on Friday.