South Africa: Is Ramaphosa Changing the Game?...In The Big Picture – Part 2.1 South Africa the Frail State (15 January, 2019) I outlined four major features of de-development: 1

www.etmmacro.com • Macro Research • Copyright © 2019 ETM Macro Advisors (Pty) Ltd

South Africa: Is Ramaphosa Changing the Game?

(Update)

Russell Lamberti, Strategist: [email protected]

Bottom Line ........................................................ 2

Narrative Repair ................................................ 3

Marginal Outperformance? ....................... 11

The Rand ........................................................... 16

Is it 2002 again? .............................................. 19

Summary & Investment Implications .... 20

_______________________________________________________________________________

Clients and Associates,

Just over a year ago, I published South Africa: Is Ramaphosa Changing the

Game? (2 November 2018). The note asked whether, after discounting ex-

treme "Ramaphoria", South Africa might be poised for a period of relative

improvement compared to its recent past and the rest of the world. The

piece posited that relative political improvement compared to the Zuma

era, and a lack of cyclical boom excess could relatively cushion the SA

economy as the global economy slowed in 2019, as well as buffer the

rand.

One year on, I briefly review some of the key insights and predictions from

that note to offer updated guidance on SA's political economy.

http://www.etmmacro.com/

mailto:[email protected]

https://etmmacro.com/article/south-africa-is-ramaphosa-changing-the-game/

https://etmmacro.com/article/south-africa-is-ramaphosa-changing-the-game/

SA Political Economy • November 2019


Bottom Line

So, is Ramaphosa changing the game? On the surface, yes, but

not much deeper than that. Failing to address the systemic

sword of Damocles that is Eskom meaningfully - and the deeper

systemic rot that Eskom implies - is proving decisive. The reality

is that much of South Africa's political life is now out of the presi-

dent's control and cannot be contained by a mere constitutional

document or the window dressing of institutions and procedures.

Investment and business confidence has cratered in 2019. In prac-

tice, Mboweni has let the deficit get almost unbelievably big in just a

few short months. The SARB holds the line, but the SARB Wars are

simmering, not going away. Meaningful macro and micro reforms

can't seem to break through the ANC's ideological fog and union

placation. The rand seems to imply that Ramaphosa's political

rescue efforts are half-baked, perhaps the inevitable result of

the Nasrec compromise.

Equally, we should avoid being too deterministic. Politics is a

strange and unpredictable art. Some of the deep discounts in SA as-

sets warrant leaving some chips on the table in the event that just

the slightest positive arc allows businesses priced for near-

bankruptcy to show some earnings growth. Countries do not devel-

op or de-develop in a straight line. The global cyclical headwinds of

2019 may be alleviating somewhat.

SA asset allocation: we continue to advocate an underweight equi-

ty allocation, neutral bonds, and overweight cash. Within equities,

stay underweight property while allocating into weakness in large,

liquid quality businesses that have begun to offer value (Shoprite,

Imperial), and consider putting on small tail-risk bets on some of the

heavily beaten-down, illiquid sectors. On bonds, favour the shorter

end of the yield curve in anticipation of curve steepeners. This leaves

a real income heavy domestic SA portfolio, limiting exposure to a

fragile SA corporate sector but gaining exposure to asymmetric up-

side in unloved sectors/companies.




Narrative Repair

The core feature of that note was "Narrative Repair", in which I argued that

between the October mini-budget of 2018, Ramaphosa's investment

summit, and SARB policy signals, the macro-management trifecta (presi-

dency, treasury and SARB) seemed to be meaningfully - if off a stagger-

ingly low base - repairing South Africa's shattered investment confidence

or at least stemming the bleeding.

The absolutely critical fulcrum of Narrative for SA is this: Is South Africa a

conventionally investable country?

I call this key question South Africa's meta-narrative.

A year ago, I argued that,

As long as this narrative prevails, you evaluate SA macro and investment

opportunities for your portfolio in largely linear terms. If this narrative

breaks, then non-linearity is in play.

I also argued that, while the narrative is important, the "hard data MUST

follow eventually to validate the trend."

Investment Confidence

The chart I showed a year ago was this one, from the BER, which is fixed

investment confidence among manufacturers. My pink arrow implied that

some sort of choppy bottoming out of confidence was underway.




Since then, the BER series has been backwardly revised, for what I gather is

the desire to create a less volatile series and part of a broader historical

revision of BER data. The revised series is substantially different than the

old one in the 2012-2018 period. While one might still have been able to

draw the 'bottoming out' arrow on the new series, what subsequently

happened to manufacturing investment confidence in 2019 is not evi-

dence of a bottoming out, but of a bloodbath.




The first obvious lesson is: don't put too fine a point on BER survey data.

But the second is that domestic manufacturing investment confidence has

collapsed in 2019 despite Ramaphosa trumpeting his great investment

summit successes. This result is from survey rather than hard data and co-

incides with a fairly steep decline in global manufacturing output in 2019,

but it nonetheless shows the extent of the loss of industrial confidence in

SA this year.

Fiscal Policy

This is the SA budget balance chart I showed a year ago. At the time, the

deficit was under R200 billion (annualised), and Mboweni had budgeted it

worsening to R250 billion by 2022. In our view (not our prediction), his

task was to get it quickly under R100 billion.




A year down the track and the deficit has ballooned to over R300 billion. If

there is fiscal reform being planned, it clearly hasn't arrived yet. Rather, the

fiscal system shows signs of spinning out of control.




Monetary Policy

Then, we spoke of the well-managed SARB and showed that it was prepar-

ing the market for a relatively hawkish rate outlook. Even though it was

unlikely actually to hike in this way, it was the message it sent to the mar-

ket of monetary prudence.

A year later, and the SARB did hike once before cutting again, leaving repo

about 50bp below its forward guidance level. Never underestimate how

much the SARB just follows the Fed.




Despite this, the SARB remains a well-managed central bank overseeing a

well-managed banking and financial system. This continues to weigh in

South Africa's favour, though even this financial system creaks under the

strain of an increasingly dysfunctional (often non-functional) economy.

So does this mean narrative repair is DOA?

I think what's going on is the realisation that whatever Ramaphosa's inten-

tions - and it's not clear his intentions are as noble as many hoped - the

realpolitik on the ground is conspiring against him. Sure, he wants to re-

store respectability to the ANC and SA Inc, but he doesn't show signs of

wanting to reverse the core features of de-development meaningfully. Or

if he does, he doesn't know how to.

In The Big Picture – Part 2.1 South Africa the Frail State (15 January, 2019) I

outlined four major features of de-development:

1. A broken guiding ideology - Socialist ruling ideology and its

plethora of statist, interventionist social and economic policy

2. A bad social equilibrium - Anti-meritocratic cadre deployment,

state sector bloat, state debt, and welfare addiction

3. Crime - A breakdown in policing and trust in law enforcement

4. Exodus - Emigration of skilled people and their capital; High net-

worth exodus

The ANC added millions to the state payroll since 1994 and onto the rolls

of the defined benefit pension scheme. Now it must try to placate this un-

ionised monster it created. Mboweni, for all his bluster, has let the annual-

ised deficit balloon to over R300bn. Investor confidence has seemingly

slumped to record-equaling lows. Few believe anymore that the ANC can

self-correct. There's a sense in which this ship is too big to turn around.


https://etmmacro.com/article/the-big-picture-part-2-1-south-africa-the-frail-state/



Here is a key point:

The data has to validate the narrative, or the narrative dies, and the

data only improves (sustainably) when real and meaningful reform

happens. This reform, if it is happening at all, is happening at a gla-

cial pace and is bogged down in toxic and intractable domestic real-

politik. South Africa lurches closer toward a moment of reckoning.

But note, we've never thought the Ramaphosa administration was a true

reforming one. As I said a year ago, this pivot by the ANC is,

...the attempt to repair not so much the meta-narrative as an end in itself,

but as a means to restore the credibility of the ANC and its NDR.

...I don’t think we are witnessing a liberal counter-revolution within the

ANC but rather a change in the complexion of its statism from one with a

more overtly Left-socialist, even totalitarian flavour, to one with a more

conservative-socialist, perhaps authoritarian flavour.

...This shift may seem subtle, but it may matter quite a lot at the margin.

More fascistic-flavoured management has always been far less economi-

cally damaging than its Leninist-flavoured alternative. It retains central

control and authoritative planning of the commanding heights with a big

focus on centrally sanctioned public infrastructure. It tends to allow more

space for markets to breathe outside of the commanding heights. It values

monetary stability because of its more conservative nature and is naturally

uncomfortable with currency debasement and price fluctuations.

Nothing about the new ANC leadership complexion guarantees any real

tackling of de-development forces. But it does seem to realise increasingly

that union power is standing in the way of any real reform efforts.

SAA showdown

The government is now in rather direct conflict with the unions over re-

structuring at SAA. SAA doesn't mean much economically, but symbolical-

ly it is a meaningful crossroads. If Ramaphosa can't face off against the




unions in a mid-sized, non-essential SOE, then he certainly won't do it at

Eskom. But if he can, and SAA is partly or fully privatised and bailouts end,

it will be a narrative win for Ramaphosa and may provide a spark of confi-

dence.

We await the results.

For now, however, narrative repair efforts are proving to be stunted by

stubborn political facts on the ground. So, what became of South Africa's

ability to outperform the rest of the world in 2019 marginally?




Marginal Outperformance?

A year ago, I showed this chart and posited that SA's manufacturing PMI

would converge toward US PMI.

This happened, as US PMI fell sharply while the SA PMI continued to per-

form poorly below 50 - yet without plunging.




I argued a similar dynamic was in store for SA vs US truck sales, but this

has not proven to be so with US logistics still buoyant.

Nonetheless, SA truck sales have held steady despite the rapid loss of in-

vestment confidence in 2019. Freight tonnage according to Stats SA held

steady over the year to August, while the BER transport capacity survey

shows spare trucking capacity is being used up.




I also said that oil in rand terms, which had spiked sharply in Q3 2018, was

poised to decline meaningfully from those highs, and that this would pro-

vide some relief to SA Inc. I showed this chart:




The rand price of oil pulled back 33% by the end of 2018, reaching the an-

ticipated 25% y/y decline by October 2019.

I posited the potential for significant SA fuel price relief in the order of

R3/litre. So far, it has been R1/litre, conferring around 0.6% of GDP worth

of household and business stimulus. But this is not terribly meaningful

given the already high price of fuel for households, layered as it is with

taxes and levies.

SA relative real GDP growth has improved, but painfully slowly. And it re-

mains in the bottom quintile.




Yes, there has been a slump in European and Asian industrial production,

but South Africa has been a notable underperformer. Whatever the rheto-

ric, this is a massive indictment on Ramaphosa's economic record so far.

No doubt, Eskom is a key bottleneck that simply won't go away overnight

unless the government takes decisive and hard reform action.




The Rand

In last year's note, I pointed out that the rand was experiencing its weakest

real recovery since the 2016 crash of the four major crash-recovery epi-

sodes of the last 35 years, largely due to political risk. I argued that if this

risk dissipates, the currency had the potential to strengthen back in line

with the previous recovery episodes. I posted this chart in early November

2018.

For the following three months, this looked increasingly plausible as the

rand gained 13% in real terms. But the appreciation stalled into 2019 and

the currency remains on par with its real levels of a year ago and taking on

a very similar shape to the previous rand crisis-and-recovery episodes.




I argued that if political reform was significant, fair value for the USDZAR

was around 12.50, but that it was likely 16.00 in a political decay world.

That the rand has ranged between 13.80 and 15.40 since then probably

highlights that Ramaphosa's political renewal is seen as half-baked -

avoiding the calamitous Zuma trajectory, but also failing to drive home

meaningful policy repair.

Updated USDZAR fair value scenarios are around 13.00 in a political repair

world and 16.50 in a political decay world. PPP fair value is around

13.50/14.00. I therefore still expect the rand to respond favourably to po-

litical reform efforts if they actually are planted and bear fruit, but equally

has space to depreciate meaningfully on political jitters, especially given

its historical propensity for overshooting. That is another way of saying the

rand is trading with those two risks somewhat evenly weighted and await-

ing more definitive signals.







Is it 2002 again?

The contrarian is quick to point out that things often seem darkest before

the dawn. Does South Africa not represent a value opportunity similar to

the early 2000s when the rand was weak, stocks were cheap, locals were

exporting their wealth and emigrating, and sentiment was in the dol-

drums? I will tackle this question specifically in a forthcoming note before

the end of the year, comparing conditions for deep value opportunity now

compared to the early 2000s.

I will, however, make a few brief observations about this.

1. The broad 'cheapness' of assets is a condition subject to macro vali-

dation - that is, tailwinds from policy, leverage, global growth poten-

tial, capital availability, state capacity and efficiency, and migration

flows. This validation is critical to the realisation of value.

2. South Africa has changed significantly in the past 20 years - these

changes need to be honestly reckoned with in any comparison.

3. Eskom, other SOEs, and government fiscal collapse are systemic

threats that they weren't (yet) in 2002.

I will not jump to conclusions about that forthcoming study, suffice to say

that beaten-down asset prices and gloomy sentiment aren't sufficient to

guarantee a good SA Inc buying opportunity. More importantly for this

note, the political and policy reform trajectory under Ramaphosa is so far

proving considerably less impressive than it might have been and the po-

litical constraints more stubborn than the Ramaphoria peddlers thought.

Macro validation has not been forthcoming, leaving the uncomfortable

risk lurking that cheap assets may be forced to get even cheaper.

Look out for the forthcoming note "South Africa: Is it 2002 again?"




Summary & Investment Implications

So, is Ramaphosa changing the game? It has to be said, only a

little. Failing to address the systemic sword of Damocles that is

Eskom meaningfully - and the deeper systemic rot that Eskom

implies - is proving decisive. Rhetoric and show are not enough.

The real-life data now has to change.

The tough talk from National Treasury and the SARB is indeed there.

The ethos is 'hands off the SARB', and there's far less pervasive and

divisive talk of radical economic transformation conjured up under

the Zuma administration. Brazen looting has less 'official' licence

than it once did, though hard evidence of less actual corruption and

crony profiteering is yet to emerge. Even the land expropriation is-

sue has been moved into the shadows, probably deliberately by

Ramaphosa. The rand has - all things considered - remained re-

silient in the face of considerable global recession and stock

market fears in 2019, as well as domestic investment weakness.

There's a belief that the finance minister understands the gravity of

the fiscal problem and is agitating for real fiscal reform (though his

actual budgeted forecasts betray a rather limpwristed command of

state finances).

But - at risk of putting it mildly - considerable doubts remain.

Investment and business confidence has cratered in 2019. In prac-

tice, Mboweni has let the deficit get almost unbelievably big in just a

few short months. The SARB holds the line, but it backtracked quick-

ly from its hawkish outlook the minute the Fed changed tack. Now

EFF leader Malema wants to introduce a SARB nationalisation bill in-

to parliament. The SARB Wars are simmering, not going away.

Meaningful macro and micro reforms can't seem to break through

the ANC's ideological fog and union placation, despite attempts by

National Treasury to move the conversation along a few inches. Off-

shore economies, by and large, remain so much more dynamic than

South Africa's - and Eskom continues to ensure that SA can barely

grow even if it wanted to. The rand seems to imply that Rama-


http://www.treasury.gov.za/comm_media/press/2019/Towards%20an%20Economic%20Strategy%20for%20SA.pdf



phosa's political rescue efforts are half-baked, perhaps the inev-

itable result of the Nasrec compromise.

In short, Ramaphosa has managed to change the style and even

rhetoric of the government, but he's not managed to start imple-

menting his more conservative socialist reforms meaningfully -

the reforms at SARS, for example, don't strike at the heart of SA's

dysfunction. He's failed to instil confidence among capital alloca-

tors by not moving decisively on the country's biggest growth

bottleneck, Eskom. Forces have been unleashed that Mr Rama-

phosa cannot simply bottle back up. SAA is a glimpse of the possible

showdowns that may occur if Ramaphosa and his conservative so-

cialists exert reform pressure on the radical socialists. But while these

factions mock-spar and go around in circles, the SA economy simply

keeps regressing. There's no hard evidence that Mr Ramaphosa, a

man politically born in unionism, Mr Mboweni, the man who crafted

SA's absurd labour laws, and Mr Gordhan, a man who spent his adult

life as a member of the Communist Party, are able and willing to

produce a 'Thatcher moment' with the labour unions.

Can Ramaphosa yet meaningfully change the game? At this

stage, the answer would seem to be no. He appears either too

compromised, too unwilling, or some combination of both. We did

not expect him to tackle the real causes of de-development, but

even the little reform one might have thought plausible is proving

largely out of reach. The reality is that much of South Africa's politi-

cal life is now out of the president's control and cannot be contained

by a mere constitutional document or the window dressing of insti-

tutions and procedures.

Equally, we should be careful of being too deterministically

bearish. Politics is a strange and unpredictable art. Some of the

deep discounts in SA assets warrant leaving some chips on the table

in the event that just the slightest positive arc allows businesses

priced for near-bankruptcy to show some earnings growth. Coun-

tries do not develop or de-develop in a straight line. The global cy-




clical headwinds of 2019 may be alleviating somewhat, which pro-

vide some impetus for domestic exports and capital flows into EMs.

SA asset allocation: we continue to advocate an underweight equi-

ty allocation, neutral bonds, and overweight cash. Within equities,

stay underweight property while allocating into weakness in large,

liquid quality businesses that have begun to offer value (Shoprite,

Imperial), and consider putting on small tail-risk bets on some of the

heavily beaten-down, illiquid sectors. On bonds, favour the shorter

end of the yield curve in anticipation of curve steepeners. This leaves

a real income heavy domestic SA portfolio, limiting exposure to a

fragile SA corporate sector but gaining exposure to asymmetric up-

side in unloved sectors/companies. For now, SARB rate hike risk

seems low, diminishing the loss potential on the shorter end of the

yield curve. SA fiscal risks seem to be more a problem for the belly

and long end of the curve, than the short end.

Best

Russell Lamberti

Founder & Analyst


http://etmmacro.com/wp-content/uploads/2017/01/Signature_grey.png

http://etmmacro.com/wp-content/uploads/2017/01/Signature_grey.png


Copyright 2019, ETM Macro Advisors (Pty) Ltd. All rights reserved.

ETM Macro Advisors (Pty) Ltd obtains information for its analyses from sources, which it

considers reliable, but ETM does not guarantee the accuracy or completeness of its analyses or

any information contained therein. ETM makes no warranties, expressed or implied, as to the

results obtained by any person or entity from use of its information and analyses, and makes

no warranties of merchantability or fitness for a particular purpose. In no event shall ETM be

liable for indirect or incidental, special or consequential damages, regardless of whether such

damages were foreseen or unforeseen. ETM shall be indemnified and held harmless from any

actions, claims, proceedings, or liabilities with respect to its information and analysis.

Legal Notice:

This document is confidential and intended solely for the use of the individual to who it is

addressed. Disclosing, copying or distributing the contents of this document is prohibited.

Anyone who does not abide by this could be in breach of the copyright and possibly the

contract signed between ETM and the party concerned.

More macro analysis at www.etmmacro.com



Documents

South Africa: Is Ramaphosa Changing the Game?...In The Big Picture – Part 2.1 South Africa the Frail State (15 January, 2019) I outlined four major features of de-development: 1