By Jason Swartz, Portfolio Manager at Old Mutual Investment Group

Outside of the last few weeks of heightened volatility, JSE-listed equities have been on a ‘tear’ recently as positive domestic news flows and local investor sentiment push share prices higher; yet it will take renewed foreign investor interest to push local equities back up to more sustained levels. And currently foreign investors are still taking a wait-and-see approach to local markets.

Despite the recent strong showing by the JSE, South Africa is currently experiencing an underwhelming show of foreign confidence in our stock markets as foreign investors are still exiting the market, with around R95 billion leaving the country year-to-date (to week ending 6^th September 2024). While this flow is somewhat distorted by the inclusion of dual-listeds and ADRs, adjusting for this anomaly still suggests a lacklustre interest by foreigners in our market. This is also despite local equities having weathered recent global market upheavals better than many of its peers.

For the pendulum to truly shift on foreign investor sentiment, they will need to see more movement around improved performance from state-owned enterprises (SOEs), alongside a stable centrist GNU, and sound policymaking, which would unlock value in local financial markets.

A tale of two markets

As the final quarter of 2024 looms, domestic financial markets seem to be caught between two forces. On one front, investors have found hope in the South Africa Inc story thanks to a 175-day-long and counting hiatus in Eskom’s loadshedding intervention, and a mostly positive political outcome following the 2024 National Elections. This upbeat sentiment has been reinforced by some local asset managers reining in some of their offshore exposure in favour of onshore exposure due to concerns of heightened global risks, and excessive valuations.

Equities in the United States (US) and other developed markets experienced a tumultuous July and August 2024 as markets processed a number of weaker-than-expected data points. One of the biggest concerns centres on the global ‘soft landing’ narrative and the increasingly likelihood that the US will enter recession. These fears have recently hit the global markets again in the first week of September.

The Sham rule, which is a strong historic predictor of US economic downturn is sending serious warning signals. And while it is difficult to forecast US recessions with high conviction, recent labour market data and the unwinding of US household balance sheets suggest the risk is high. Whether we see a true recession, or a deep or shallow slowdown remains to be seen. For SA-focused managers, the best protection against such scenarios is to position cautiously. Why? Because recession and ‘risk off’ are not good for South African asset classes.

Resilience in the face of global turmoil

The good news for local investors is that both bond and equity markets – and the rand – are showing resilience in the face of recent global market turmoil. There are also a few ‘tailwinds’ that could insulate domestic asset classes from recession including the upside risk of higher trend GDP growth outlook, the potential for interest rate cuts, and strong turnarounds at SOEs like Eskom and Transnet.

If these improvements persist, then South Africa could once again find a place in global investors’ emerging market portfolios. Local financial markets also have the potential to shrug off the ‘liquid proxy for emerging markets’ tag and emerge as good growth story in their own right – we have to play a different role to the likes of Brazil, China and other emerging market peers.

Another big question mark looming over allocators of capital is the outcome of the November 2024 US Presidential Elections. These elections are notoriously unpredictable, and a few thousand votes could swing the outcome in favour of Harris or Trump – taking the world down two very different paths.

At a basic level, a Trump victory leads back to an ‘America first’ policy, including domestic deregulation, global trade tariffs, and tax cuts, to name a few. It is challenging for asset managers to determine what this basket of factors would mean for the US dollar. If Harris wins, we expect higher taxes and a resulting squeeze on US corporate markets, offset by an improved global market. The only certainty is that whoever wins, the US will have to begin contemplating fiscal constraint to rein in its burgeoning debt-to-GDP ratio, forecast to hit 122% soon.

When Biden was in the race, our base case was for a narrow Trump victory; but with Harris our base case has shifted to ‘too close to call’.

Local allocators of capital are at capacity in South African asset classes and are already heavily invested in local nominal bonds and equities. Within the dual context of regulation 28 and local fund managers’ value bias, SA investors are unlikely to maintain local asset classes at pre-Covid heights based on local improving sentiment alone. The game changer is for improving foreign investor sentiment and their return to domestic markets. We need foreigners to step back in to introduce the levels of liquidity necessary to take the JSE to the next level.

Despite the recent re-rating, South African assets remain undervalued. It is hoped that improved investor sentiment will unlock more value in asset classes through the final quarter of 2024, however this value unlock will also depend hugely on clear signs of local economic reform. OMIG portfolios are currently overweight South African equities and local bonds, reflecting our optimism about the short-term risk-return improvements stemming from the political landscape. With more centrists in government and growth-enhancing, reform-focused policies, we are fairly optimistic that the value unlock will gain momentum.