President Jacob Zuma last night announced a vast cabinet reshuffle which will be widely interpreted as an attempt at squashing any remaining dissent toward his agendas from within his government and the ANC at large. These changes included the removal of widely-respected Finance Minister Pravin Gordhan (replaced with Malusi Gigaba), Health Minister Aaron Motsoaledi and a number of others.
To be clear, we regard this is as a devastating turn of events for South Africa which can be only interpreted as serving the interests of the rent-seekers at the expense of political and fiscal stability which is so necessary to ensure South Africa can return to a sustainable growth path. That it would come at a time when the country should be reaping the benefits – and taking advantage – of rising global growth, creating tailwinds for emerging market countries, their currencies and assets is even more regrettable.
The Rand has already responded swiftly, weakening by over 2% overnight but we believe more weakness could follow, depending on the response to these actions from the rest of the ANC leadership in the days and weeks to follow.
This morning, investors should expect the following to transpire on SA financial markets:
- Shares of banks, retailers and listed property will come under significant pressure, with losses of 5% or more highly likely.
- Bond yields will sell off
- Share prices of Rand hedge stocks will increase, the extent of which will depend on whether their businesses have leverage to a weaker Rand (ie they have dollar revenues and Rand costs, eg platinum miners), or simply own businesses offshore (eg Steinhoff).
The net effect of the above may be a surprisingly muted outcome at an index level given the extent of Rand hedge exposure on the JSE, which we estimate at more than 50%. As shown in the figure below, we estimate the top twenty companies comprising the SWIX index – excluding diversified miners – derive approximately 60% of their value from non-Rand sources of earnings:
So what should you do and how are we positioned?
We do not know what will transpire in the coming days, but we have for some time retained what we regard as an appropriate balance in our portfolio construction between companies that can benefit from a stronger Rand (which would be driven by global factors; see our recent Rand note: “The Rand revisited”; 20th March) and Rand hedge stocks and direct offshore (where mandates permit) – predominantly leading global franchise – companies. The latter has predominantly been to take advantage of these excellent companies’ fundamentals which are not available on the JSE, but also serves as a hedge in times of domestic political turbulence such as is currently being experienced. This positioning has cost our clients performance in recent times, but proves invaluable at times like these. Our flagship Anchor BCI equity fund currently has 16% direct offshore equity exposure, and on a net basis, we believe retains a tilt to benefit from Rand weakness. We will continue to monitor the appropriateness of this position as events unfold and financial markets reprice assets accordingly.
What recent history has taught many market participants, however, is that knee-jerk reactions at times like this can prove extremely costly as volatility is likely to remain high and permanent value destruction could be the end outcome from drastic changes to portfolio positions at inopportune valuations. This is especially true when the outcomes are so uncertain. Specifically, one possible scenario which could play out from these changes may well be the split of the ANC into two, with possible mass resignations of key cabinet members not aligned to Zuma. This could, in time, strengthen democracy in SA and possibly usher in a new era of structural reform – although we cannot say this with any certainty, and the timing would be equally unclear, this would prove good for the Rand and South African assets in the long term.
As much as we need to retain cool heads when evaluating portfolio management decisions, we would encourage clients to do the same with respect to personal financial decisions pertaining to their long term retirement assets.
As always, feel free to get in touch with any of us at Anchor to discuss your specific concerns and ideas.
Sean Ashton, CFA Chief Investment Officer Anchor Capital Research 31.03.2017