By Magnus Heystek – Director and Investment Strategist
It is generally accepted that the global commodity cycle, which started in January 2002 on the back of the rise of China as a global economic influence ended in around September 2011. Since then the prices of all major commodities have plunged by between 40 and 70% on world markets.
It was inevitable that South Africa, which benefitted greatly from the upward movement in commodity prices and volumes, was going to feel the pain of the downturn. But the downturn so far has lasted much longer and has been much deeper than expected and is causing major havoc for commodity producing countries, especially emerging market economies such as Brazil, Russia and also South Africa.
It is also having the greatest economic effect on countries which did not make structural changes to their underlying economies during the good times to reduce their dependence on the extraction and sale of commodities. South Africa is particularly guilty of this offence and is now feeling the pain in the form of rising unemployment, declining export revenues and substantial pressure on the balance of payments and the collection of taxes. It is also having an effect on the personal wealth of every South African, from the very poor to even the very rich.
It’s having an effect on the stock market, the property market, the inflation rate and the value of the currency. In short: it is making us all poorer. The greatest impact is on those who prefer to ignore the warnings and continue investing as they did in the past. Other commodity producing countries, such as Australia, while also affected, did not fall into the same trap and have escaped a recession, unlike Brazil and Russia.
South Africa’s economic growth has plunged in recent years and, while technically not in a recession, has one of the highest unemployment rates in the world, with unemployment amongst men below the age of 30 at more than 50%.
The SA economy has also been battered by policy uncertainty and declining business and consumer confidence as a result of a wide range of political events, such as the Nenegate, Guptagate and the attempts by pres. Jacob Zuma to gain greater control over the Treasury and SA Reserve Bank. The result has been an investment strike by the private sector who are increasingly looking offshore to grow their respective businesses.
Substantial foreign money, essential to finance the deficit on the balance of payments, has also been flowing out of the local equity market, which is increasingly reflecting below inflation growth.
Over the past two years the returns of the JSE All share index has not beaten the inflation rate.
If one adds this poor performance to that of the negative returns of cash, fixed deposits and the residential property market, negative in real terms now for six years, then one can see a period of substantial wealth destruction unfolding. Middle class wealth is slowly but surely being squeezed by rising taxes, household expenses and slower than inflation, salaries and wages.
Without some form of offshore investments, which have been the best asset class for the past five years, investors are getting poorer, in some cases substantially.
Brenthurst Wealth has been recommending OFFSHORE INVESTMENTS FOR MORE THAN FIVE YEARS, long before it become popular to do so.
This investment strategy has benefitted our clients greatly, especially over the last three years, and has been the only portion of their overall investment portfolio that has shown some growth in real terms.
Some of our “early mover” clients have made spectacular returns, especially those who also had an exposure to biotechnology and technology.
The relative underperformance of JSE versus global markets over the past five years is nothing short of spectacular. Please refer to the graph to see just how poorly the JSE has really done when compared to the major investment regions of the world.
Probably you will not see this graph anywhere else as SA’s large financial institutions will never publish such a graph, as it will highlight a serious underperformance developing in our markets, perhaps permanent.
And this won’t be good for local business, will it now?
Most regions of the investment world have doubled the returns of the JSE while the S&P500, the broadest index of the US stock market, has more than trebled the returns earned on the local market.
There is sometimes an opinion that this out-performance is just a function of the rand weakening, which is not the case.
Although the weakening currency did, no doubt play a role, this viewpoint overlooks the fact that other markets have outperformed the JSE in dollar terms as well.
Investors who shunned offshore investments and stuck to the traditional “one third cash, one third property and one third equities” without any off-shore exposure have suffered a substantial decline in real wealth and purchasing power.
Such investors and consumers are increasingly feeling the pinch when it comes to keeping up with the soaring cost of imported goods and services, many which form the cornerstone of a modern day society.
Consider the soaring prices of new motor cars, cell phones, laptops, IPads and overseas travel which immediately reflect the poor purchasing power of the local currency on global markets. It is also not easily measured for JSE investments that are not faring well against global competitors at the moment. At least certain listed companies have the attraction of having some offshore earnings potential. Other rand based investments are doing substantially worse when it is measured in terms of global purchasing power.
THE END OF THE COMMODITY CYCLE
TIME SPAN: 08/31/2006- 08/31/2016 CURRENCY: USD PRICE CHANGE: -51.56% ANNUAL EQ: -6.99%
PRICES STILL DOWN 20% IN REAL TERMS
Residential property prices have, after the 20% col-lapse in real terms during the Great Financial Crash of 2008/09 not yet recovered. In real terms property prices have not increased in almost seven years while in US dollar terms local property prices have now declined by about 50% on average over five years. Property prices across the board have been affected by declining business, consumer confidence, rising pressure on wages and salaries, higher electricity costs as well as a lack of mortgage finance. The latest figures from Absa, SA’s largest bank, shows that residential property prices have declined by 1,7% in nominal terms during the second quarter of this year. In real terms this is a massive decline of almost 8%, if the inflation rate of 6% is used as a benchmark.
At BRENTHURST we expect this trend to continue, with the exception of property prices in certain pockets in the Western Cape.
Prices in the Western Cape have performed much better than the rest of the country, with an increase of about 11% (YoY) in the second quarter of the year. This performance is driven by the stream of wealthy investors from upcountry who are relocating to the Western Cape in droves.
Technology has made running a business from anywhere very feasible and practical. This was not possible as recently as ten or twenty years ago. Expect this trend to continue.
This is impacting on residential prices in two ways: FIRST by increasing the stock for sale in Gauteng, thereby driving down prices, and SECONDLY by increasing the demand in the Western Cape, which already suffers from a shortage of suitable land to build.
FNB HOUSING MARKET
TIME SPAN: JANUARY 2001 TO JANUARY 2015
Another factor contributing to a structural decline in the prices of residential property, perhaps permanently, is the divergent trend in the racial demographics in South Africa.
According to the latest figures from Statistics SA the white population is now declining in real numbers, by 100 000, when compared to the Census done in 2011. People regarded as whites now number less than 4,5 million, representing about 8% of the total population. The black population has increased by more than 4 million people over the same period of time. There are today more black children under the age of four than the entire white population.
If the current birth rate continues, then the white population as a percentage of the overall population will decline to less than 3% over the next 15 years.
It would be foolish and downright unwise not to consider what economic impact such a dramatic change in the demographic make-up of the country will have. One impact, in our view, is that the demand and affordability of housing in the former “white” areas will decline over time, and hence prices.
This is a function of the remaining whites getting older and downscaling their housing needs (retirement homes versus large homes with gardens and pools) while large black families do not as yet not have the purchasing power and cap-ital to buy the larger homes put on the market by retiring and semi-grating whites.
This trend is already evident in many larger smaller towns in Gauteng, Northwest province, Mpumalanga and Limpopo. The value of the housing stock in many such towns are in terminal decline due to the fact that the departing white families are not able to sell these properties for much. In many of these towns the housing market has almost ceased to exist in the sense that banks have withdrawn and are not prepared to give loans. You cannot track the value of an asset if you cannot measure it and you cannot measure something if it does not move.
This trend has now also reached the larger towns and cities of eight of the nine provinces in South Africa. The wealth that was locked up in those properties many years ago have simply vanished, leading to great poverty for the owners.
BUY-TO-LET BECOMES BUY-TO-REGRET
The Buy-to-Let boom has also come to a screeching halt in most parts of the country. In many respects it has become a Buy-to-Regret situation.
In the boom times of the property market from 2004-2007 investment purchases made up almost 25% of total sales. These were sales not for personal occupation but as an investment which was rented out to tenants in order to provide a rising income stream to the owners thereof.
The investment model was so simple: use mortgage finance from the bank, together with a small amount of personal capital, and hey presto!, you had some individual, not as smart as you, paying off your bond.
This percentage has since declined to below 5% of total sales, according to FNB, and is mostly limited to certain areas in the Western Cape, Sandton and the northern suburbs of JHB and eastern suburbs in Pretoria. Getting bond finance to indulge in Buy-to-Let outside of these areas is becoming very difficult, if not impossible. In the meantime investors who still hold rental properties are increasingly being squeezed by rising bond costs, higher rates and taxes as well as the maintenance cost.
The other side of the equation is not looking much better as tenants are unable or unwilling to increase their rentals due to their own personal finance pressures.
According to Tenant Profile Network (TPN), a company that measures the rental market in SA in great detail, the incidence of late and non-paying tenants is close to record levels. In June 2016 only 77% of all tenants countrywide were paying their rent on time or in full.
Property owners are also not enjoying anywhere close to inflation-adjusted rental increases, as rent-als have gone ex-growth and in some areas rentals are now also declining in real and in nominal terms.
We have been advising our clients for many years to sell their non-performing physical properties and instead, if there was an affinity towards property, to do so via listed property investments, which have been a fantastic investment over many years.
“Zuma’s assault on national treasury has now virtual guaranteed that we will be downgraded to junk status by year-end. In the space of seven years the man has taken us from a decent, mid-tier country with prospects to basket-case status.”- Justice Malala, foremost political commentator writing in his column in the Financial Mail, September 2016.
The economic and financial performance of SA under the leadership has been a disaster. There is no other way to describe it.
A weakening currency, plunging growth rates and rising unemployment has led to massive rise in government expenditure.
This could be bad news for emerging market currencies and financial markets. Large amounts of money have been invested in emerging markets in search for higher-yielding instruments. Any increase in US interest rates could lead to much of that money being repatriated placing pressure of local currency and bond markets.
The second event that could spoil Christmas this year is the possible downgrade of SA’s foreign currency and bond markets by one or more of the global ratings agencies. Two of the largest ones, S&P Global Ratings and Moody’s, have indicated that they will be announcing their respective ratings on South Africa early in December.
One, or worse, both of these events could trigger a sell-off in the currency, bond and equity markets.
A rand at R17 to the US Dollar is very much on the cards if this was to happen.