A rising tide could lift all boats – including those of homeowners.

Well maintained homes in my neighbourhood continue to be demolished at an impressive rate. Demolition in is being ordered so that the land released can be converted to a new residential unit or two or more. A process also well under way widely in the Western Cape. But conspicuous by its absence in much of the rest of SA.

If the demolition is to make economic sense the to be  realised market value of the new units constructed must be expected to exceed the purchase price of the old building, the significant costs of constructing the new units, the demolition costs and the interest income sacrificed on the working capital tied up in the project would have to be covered as would the price paid for the established building demolished or expensively redeveloped. The purchase price paid will be approximately equal to the present value of the future rentals being sacrificed on demolition.

Any extant building survives because a potential re-development of it does not meet this profit test. Most buildings (slowly) survive the test of time.  Look around you. It takes rising rentals, or rental income effectively sacrificed by owner occupiers, to encourage re-development. Escalating rentals add value to homes or commercial buildings and encourage owners to sell up and move on.  And add value, that is additional wealth and spending power for their owners. It takes a growing economy to change the face of the nation.

Sadly, for the average home or building owner in South Africa, or those owning commercial property, the rental tide has been receding, outside of the Cape. The legitimate dreams, based on past performance, of millions of homeowners and landlords of buildings generating hoped for wealth for them, has been frustrated. They should blame the national government for the economic policies that have failed. And moreover, blame local governments who, egregiously, have raised taxes on their homes to deliver far inferior services in exchange. Terrible wealth destroyers they have proved to be.

Between 2010 and 2024, annual returns calculated from owning the average home, including rental income, assumed to have increased at the rate of inflation, and reinvested or used to pay down mortgage debt, was on average 4.2% p.a. Annual average returns from the listed REITS have been an average 5.6% p.a. while the JSE delivered much more, 11.7% p.a. on average, also including dividends reinvested. Even the low-risk money market returned more than homes or listed real estate. Some 6.2% p.a. on average. Inflation averaged 5.1% over the fifteen years. A million rand invested fifteen years ago in the stock market would be worth R5.3m today, the average million rand home then would fetch but R1.84m and an average R1m portfolio of commercial and industrial property would by now have compounded to about R2.5m. That is by about the same increases in the prices of the average basket of consumer goods, up by about 200% in the fifteen years.

Investment Returns; Shares, Real Estate. Cash (Income reinvested) and the CPI. 2010-2024 (2010=100)

Source; OECD, Reserve Bank of South Africa and Investec Wealth and Investment

Consistently, the average increase in mortgage advances since 2010 has averaged but 4.3% p.a. close to the average increase in house prices. Recently this growth rate has fallen further to about 2% p.a. The housing market has not been particularly good for banks- or might one say the banks, especially the Reserve Bank, has not been very good for the housing market, given very expensive mortgage loans. 

Annual growth in house prices and mortgage advances (2010-2024)

Source; OECD, Reserve Bank of South Africa and Investec Wealth and Investment

If, a big IF, you could have rented your dream home fifteen years ago you would have done better renting than owning. Especially if you had saved the difference between the cash rent paid and the mortgage interest rate – say a 5% p.a average yield gap – into the share market.

The total internal investment return on a property is the sum of the initial year one rental yield plus the rate at which the rents are expected to escalate over say the next 15 years. For much of the past 15 years the expectations of rental escalations and consequent capital gains must have been disappointed (outside the Cape) Thus renters rather than owners would have been favoured by the persistent gap between lower rental yields and higher mortgage rates.

What comes next for renters or owners of real estate will depend on the state of the economy and the competence of municipal authorities.  If property prices and rentals continue to rise at their recent pedestrian price, rental yields will rise to compete with punishingly high borrowing costs. Initial rental yields, (Rents/Value) will rise as the expected capital gains owning property fall away. Though rentals themselves may not rise much, given a depressed lack of demand for the space available. As has clearly happened with commercial property and the REITS. Much of the return from their shares is coming in the form  of dividends paid.

Real Estate Investment Trusts on the JSE. Index values and Dividend (net rental) Yields (2010-2024)

Source; OECD, Reserve Bank of South Africa and Investec Wealth and Investment

A revival of the economy and the property market with it could change the trajectory of real estate values, and help create income and wealth for many homeowners. And revive the construction sector in the old-fashioned way. By turning the old into the new to revitalise our cities and suburbs. It can happen with a clear vote for better governance, better policies and their execution. Surely very much possible – as the Cape proves.

Breaking a losing streak on the JSE

The JSE makes a comeback after 2024

Something unusual happened on the share markets over the past 16 months. The JSE has outperformed the S&P 500 Index by a large margin. Improving its rand value by 30.5% (including dividends reinvested) while the US S&P 500 Index valued, also in rands, has gained less, 17.7% up since January 2024.

Fig.1; The S&P 500 and the JSE All Share Index; Total Rand Returns (January 2024=100) Monthly.

Source. Bloomberg and Investec Wealth & Investment.

Fig.2 S&P and JSE Index Earnings per Share (2024.01=100) Month end

Source; Bloomberg and Investec Wealth and Investment

Comparisons after 2010 are odious for South Africa and the JSE

Yet over the past fifteen years the JSE has trailed the S&P by a very large margin. The rand value of the S&P 500 is up by as much 16.5 times since  2010. Compared to a 5.8 times gain for the JSE.

Fig.3; The value of R100 invested on the S&P 500 and the JSE All Share Index. (2010=100) Dividends reinvested.

Source. Bloomberg and Investec Wealth & Investment.

Fundamentals, that is increased earnings, improved economic performance, discounted by generally lower interest rates account for much of the rising value of the S&P Index.  S&P Index Earnings per share in USD have grown by 4.1 times since 2010 while the Index has increased by 5.2 times with much of the re-rating realised after 2023.  Converted to ZAR, S&P earnings have multiplied by 10 times since 2010 while JSE earnings per share have increased by much less, up 4.2 times since 2010.

Fig.4; The S&P 500 and the JSE All Share Index. Index earnings per Share. Rand Values Monthly (2010=100)

Source. Bloomberg and Investec Wealth & Investment.

Annual returns – very different- risks similar

Fig.5; Total Annual Returns in Rands 2010-2025.  S&P 500 JSE All Share Index. Monthly (Average 18.7 Vs 11.9) (SD 10.7 vs 10)

Source. Bloomberg and Investec Wealth & Investment.

Fig 6; Total Annual Returns Rands 2020-2025 Monthly (Average 18.2 Vs 11.7)

Source. Bloomberg and Investec Wealth & Investment.

The S&P rerates in recent years

Fig.7; The S&P 500 Prices and Earnings (USD 2010=100)

Source. Bloomberg and Investec Wealth & Investment.

The JSE has derated

JSE earnings have by contrast grown faster than share values since 2010 – by 4.2 times compared to the Index that has risen by less- 3.4 times. A derating rather than a re-rating. The temporary earnings boom of 2022-23 linked to metal prices and global supply side constraints did little to boost the JSE.

Fig 8; JSE All Share Index. Index values and Earnings Rand Values (2010=100)

Source. Bloomberg and Investec Wealth & Investment.

Equity risk premiums – realised and expected. The unexpected has happened to an extraordinary degree over a fifteen-year period

The US 10 year Treasury Bond has provided an average annual return of 3.9% over the period 2010-2025 –thus providing equity investors with a close to an average 10% p.a. extra returns over bonds. Past performance suggests that an extra 4% p.a. from a well-diversified basket of equities would have been enough to justify the extra risk. The S&P 500 delivered much more than could have been expected, delivering an average 18.7% p.a. rand return since 2010 and 13.6% p.a. in USD.  It surely cannot get much better than it has been for holders of US equities over the past 15 years.

By comparison, the equity risk premium for SA investors has averaged only 2.8% p.a. since 2010. The yield on an RSA bond since has been an average 9.1% p.a. ( the inflation rate was an average 5.1% p.a. providing an impressive real return of 4% p.a. for a low risk asset) while the total return on the JSE averaged 11.9% p.a.

Such exceptional returns as delivered by the S&P 500 over an extended period required a combination of unexpectedly good news. About the operating profits of the listed firm and about the risks attached to these profit flows, that are used to discount these expected flows. South Africa mostly disappointed investors on these metrics. An equity risk premium of 2.8% p.a. does not compensate for the extra risk. At least an extra 4% p.a. would have been expected.

JSE earnings growth accelerates, and risks recede since 2024

Yet recently, over the past 15 months, thanks largely to the increases in the price of gold, and the very strong growth in the earnings reported by the gold mining companies – JSE earnings have outpaced S&P earnings both in rands by about 25%.  In addition, the risks attached to RSA bond yields had also declined thanks to the formation of the Government of National Unity (GNU) in mid-2024. Risks as measured by the spread between RSA dollar denominated bond and their US equivalents. And reduced the cost of capital for SA business, the returns they must exceed to add value for shareholders, regarded here as RSA long bond yields plus an equity risk premium of 4% p.a. The establishment of the GNU reduced SA risk- the budget dissonance has since raised it -while the risk premium and the cost of capital – has declined from its post Budget highs. (see below)

Fig.9; South Africa. Sovereign Risk Premium and the Cost of Capital. Daily Data 2024-2025.

Source. Bloomberg and Investec Wealth & Investment.

Since about 2013 SA risks and cost of capital have risen.

The sovereign risk premium attached to RSA bonds have mostly risen since 2013, driving up long bond yields and the cost of capital. Very slow GDP growth and the threat it poses to the tax base and fiscal stability have raised the SA risk premium and has meant higher required returns from SA bonds and equities and lower valuations. These required returns or hurdle rates for investors and firms rose from about 11% p.a. in 2013 to about 14.5% p.a. today. That is to about 6.5% p.a. higher than the cost of capital for the average US company, using the same 4% equity risk premium. The lack of expenditure on extra productive capacity by SA business, a GDP growth depressor, is easily explained by these baleful facts. (see below)

Fig. 10; SA and US costs of capital and their differences. (Bond Yields + 4% = cost of capital for the average corporate) Daily Data 2010-2025

Source. Bloomberg and Investec Wealth & Investment.

Fig.11; Sovereign risks and the five year carry- the expected movement in the USD/ZAR (% p.a) 2024-2025 Daily Data

Source. Bloomberg and Investec Wealth & Investment.

Fig. 12; Bond Yields; RSA five-year Yankee and US Treasury Bonds 2024-2025 Daily Data

Source. Bloomberg and Investec Wealth & Investment.

Fig 13;The ZAR Vs the USD and the EM Basket (Higher ratios indicate ZAR weakness) Daily data. 2025=100

Source. Bloomberg and Investec Wealth & Investment.

Fig 14; The ZAR in 2025; Daily Data; Lower Numbers indicate ZAR strength

Source. Bloomberg and Investec Wealth & Investment.

The Bottom Line

The JSE, as does the SA economy, desperately needs the stimulus of unexpected growth in listed company earnings and in aggregate real incomes, with less SA risk attached to them. Sustaining the GNU would reduce risks and interest rates. Better, the GNU could help deliver very surprisingly faster growth. That is do more for the economy than merely limit the mistakes the government would otherwise make, as is the prevailing presumption implicit in the very slow forecasts of growth in GDP. The economy has much scope for a growth surprise- off a very undemanding base.

An appendix- taking the story back to 2000- the SA economy and the JSE performed much better until 2010.

It wasn’t always so – the comparison starting with year 2000. The JSE has been very competitive with the S&P on valuations and earnings performance

Fig 15: S&P Vs JSE Total Returns (2000=100)

Source. Bloomberg and Investec Wealth & Investment.

Fig.16; S&P and JSE Index Earnings per Share Rand Values (2000=100)

Source. Bloomberg and Investec Wealth & Investment.

Fig.17: S&P and JSE Index Earnings per Share USD Values (2000=100)

Source. Bloomberg and Investec Wealth & Investment.

Thoughts with which to engage with DJT on tariffs

Any failure of a country or community to escape poverty makes the incentive of the poor to migrate to the richer parts of the world that much stronger. Poverty also means rapid growth in populations and potential work forces in low-income economies and in the unemployed. While in the rich world populations are aging and workforces are declining. And where the need for labour intensive care for the old and infirm  – and for a growing tax base – funded by younger workers – becomes obvious.

Mr.Trump, his team and supporters, know very well that effective controls on immigration are essential to the preservation of the nation state.  That legitimate concern should be widely recognised as justified and legitimate, though very expensive to implement effectively. it should also be well understood that without controls on migration wage rates for similar work, would tend to equalise everywhere, were workers with comparable skills energy and attitudes able to move from low wage to higher wage regions. As they can and have done within the Common European Market and the common US market. One of the great income adding strengths of the US and Europe to date is that they are large common markets with wide growth enhancing freedoms to trade goods and labour services.

Goods widely and freely traded at competitive prices, employing a growing workforce at relatively low wage rates, creates an alternative to migration. It makes it possible for privately owned firms in low-income economies able to pay low wages to scale up their production profitably. And reinvest their profits in additional plant and equipment and increase the local competition for labour. Countries don’t trade, privately firms do so to the mutual advantage of sellers and buyers.

Wages and incomes generally, including tax revenues and welfare benefits, tend to improve with economic growth and the pressures on migration and population growth then tends to subside. Export led growth, firms scaling up to serve a wider market, supplying goods that customers in the richer world willingly buy, is a distinct possibility for many poorer regions or countries of the world that adopt the right income advancing set of policies. But they may need access to global markets to do so.

The Trump team may not have heard of Lesotho – but the people of Lesotho – have heard of the US and have every reason to resent the 50% tariff that will keep their clothes out of the US. The impact of throttling the trade in Lesotho’s clothing on the US trade balance or its GDP will be infinitesimal – but decidedly not vice versa for any small poor community subject to tariffs that will largely prohibit trade. To look at export surpluses with the US in percentage rather than aggregate terms for the purpose of determining tariffs, is not only unusual, also very cruel.

That the generosity of the US with its low tariffs enabled export led growth in Europe, Japan and China, also Vietnam and Korea –all great examples of export led growth should be conceded. And that this tariff rate generosity was not reciprocated with the resultant growth in incomes is a fair point for the US to make. The case can be strongly made and recognised for reciprocal tariff reductions with the US for developed economies with large trade surpluses with the US. And for encouraging imports from the US, including for newly grilled gas and oil.

Hopefully the Trump pressure to deal will lead to a generally growth encouraging lower level of tariffs across the board. But kindness to the poor and downtrodden economies of the world encouraging them to grow faster can and should be exercised, in the interest of the US.  

The source of economic greatness – the efficient use of capital

Brian Kantor and David Holland

March 2025

America has not always been great. In the nineteen sixties America lost the war it fought in Vietnam. Conscripting its badly suffering Army and long overdue attempts to address racism divided the nation in a most ugly way. And in the seventies, inflation took off. It had risen to over 13% in December 1979

And then came a most impressive comeback. Inflation came under control in the eighties after a short sharp recession and the US won the cold war under the inspirational leadership of Ronald Reagan.  And something else, very important for the economy, was under way. The revolution in corporate finance, in theory and practice, came to transform how American business would direct itself and improve its performance. Increasingly managers came to act in the interest of the providers of their all-important capital, their shareholders. Return on capital became the focus of management attention. A discipline that was forced on managers by increasingly active investors, backed by access to credit made available to them on an unprecedented scale.

Shareholders did not need business managers to diversify on their behalf. Conglomeration became a dirty word. The share market could do it for them and big business became more specialised and more efficient and profitable in the true economic sense- earning more than the opportunity cost of the capital they employed.  The bar was being raised for US business and its CEO’s and they responded accordingly by improving the efficiency of their r operations to the great benefit of workers and savers and investors.

The US equity markets tell the story of improved efficiency and enormous amounts of additional wealth creation. Donald Chew, who was there at the beginning in a recently published book, provides an incisive overview.[1] The improvement in the value of US equities and in the strength of household  balance sheets after 1985 has been nothing less than extraordinary.  The value of US household’s investments in business, their equities, adjusted for inflation, was stagnant for as many as 25 years between 1960 and 1985. Put another way the share market was not a source of real wealth creation for about a quarter of a century. Thereafter the market value of US equities held by households took off and is now worth about 18 times more in real terms than it was in 1985. Buoyed increasingly by the gains in the market value of these equities, the ratio of household wealth after debts to household incomes has increased from 4.8 times in 1987 to the current over seven times, even as disposable incomes have risen.

Personal Disposable incomes grew from $3.65 trillion in Q1 1988 to 21.89 trillion by Q4 2024. That is at an average compound growth rate of 4.8% p.a. over the 37 years. The net wealth of US households grew from $18.52 trillion in 1988 to $163.5 trillion by 2024 at a higher average compound growth rate of 5.9% p.a. over the same period, helped largely by the increased value of US businesses.

These wealth gains have been especially large after Covid. Between 2020 and 2024 personal incomes after taxes, assisted by Covid relief, grew from 14 trillion to 22 trillion or by 57%. The net worth of US households grew much faster and extraordinarily from 42.2 trillion in 2020 to 163.5 trillion, by the end of 2024, or by 287%. These wealth effects surely dominated the income effects on spending.

Charting the explosion of wealth in US equities.

The charts below show the trends and how gains in the equity market came to dominate household balance sheets.

Fig.1; Household Wealth to Personal Disposable Incomes; Ratio (1987- 2024)

Fig.2: US Holdings of Equities Adjusted for Inflation. 1960=100

Source; Federal Reserve Bank of St. Louis (Fred) Investec Wealth & Investment

The value of equities in household portfolios has come to dominate much more valuable household balance sheets. A fuller illustration of the trends in household balance sheets after 1990 is also shown below.

Fig 3; US Households Holdings of Equities, Financial Assets and GDP. (1960=100)

Source; Federal Reserve Bank of St. Louis (Fred) Investec Wealth & Investment

Fig 4: US Households Balance Sheet Categories (1987=100)

Source; Federal Reserve Bank of St. Louis (Fred) Investec Wealth & Investment

Fig.5; The value of equities held by US Households and the S&P 500 Index. 1960=100

Source; Federal Reserve Bank of St. Louis (Fred) Investec Wealth & Investment

Fig.6; Annual Increases in Household Wealth and Incomes. USD Billions (2020-2025)

Source; Federal Reserve Bank of St. Louis (Fred) Investec Wealth & Investment

South Africa – a case of capital wasted.

South African business is similarly under pressure from shareholders to generate economic profits for their shareholders. Though the SA economy has offered lesser opportunities for growing businesses than the US economy. An important reason for this failure to grow can be found in the operating performance of the State-Owned Corporations and the terrible waste of the capital that taxpayers have been forced to supply them with. Eskom, the State-owned electricity utility, employs as much as R700 billion of capital in its operations. The return on this capital is at best about 1% p.a. If Eskom were to cover its cost of debt capital (about 11% p.a) it would need to generate and additional R70 billion plus each year from its operations. Or put another way Eskom has been wasting about R70 billion of taxpayers potential income every year. Transnet, the state-owned transport company, employing about 312 billion rand’s worth of capital, at a 11% p.a. charge is similarly wasteful. It would need about R31 billion of extra profit annually to cover its costs of capital. The sacrifice taxpayers have made of potential income had capital had been used efficiently has clearly been enormous.

South Africa urgently needs a revolution in its use of capital. It needs a focus on the return on capital, on the interests of its shareholders in the SOE’s, that is taxpayers that made America great.  Among the most abused shareholders anywhere are surely South African taxpayers. The solution is obvious. The taxpayers should not be throwing good potentially valuable capital after bad. But demand that the hopelessly inefficient operations of the SOE’s be transferred to private operators who must cover their costs of capital to survive. The state can exchange assets or additional capital for a stake in more efficient businesses as Temasek has so successfully managed for Singapore. And the RSA can then look forward to taxing their profits rather than cover their further losses.

A financial appendix.

The tables and workings below summarize the dismal record of Eskom and Transnet.  [2]

[1] Donald H. Chew Jnr, The Making of Modern Corporate Finance, Columbia University Press, 2025.

[2] ROIC= Return on Invested Capital. NOPAT= Net Operating Profit after Taxes. EBITDA=Earnings before Interest, Depreciation and Amortisation.  The fuller work sheet is copied below.

,

In monetary policy doing the obvious makes sense.

I propose a case study in monetary policy. The economy to be investigated is stagnant. Very little growth in GDP is being recorded. Spending on capital goods, plant and equipment is even more subdued than spending by households. The demand for bank credit has not grown in real terms for a number of years. Indeed, is still below pre Covid levels, as is economic activity.  But not all the news is bad. Inflation is well down – indeed prices have hardly increased for six months.

But short-term borrowing costs have lagged well behind the declining inflation rate. The difference between the interbank lending rate for 3 months and annual inflation, real rates, is 4.4% p.a. a level not approached since 2003. It would seem perfectly obvious that the appropriate policy response would be to cut the key repo rates immediately and significantly to stimulate much needed spending growth for which interest rate settings are a significant discouragement.

But as readers will have guessed the economy is South Africa. The charts tell the story. Yet the Reserve Bank has successfully guided the money market to expect little by way of interest rate relief. The Forward Rate Agreements between banks indicate that short rates are expected to decline by no more than 50 b.p. over the next twelve months and that even a cut of 25 b.p. at its meeting this week is considered unlikely. This reluctance of the SARB to do what would be obvious to most is what makes this case study particularly compelling.

Real Bank Credit supplied and demanded by the Private Sector and the Real Economy. Monthly Data (2019=100)

SA; Real Short-term interest rates and Inflation 2020-2025. Monthly Data.

Source; Bloomberg and Investec Wealth & Investment

Some further facts might illuminate the case further. Why it should be asked has inflation come down so dramatically in SA? It is because spending (the demand side) remains depressed and because the supply side of the price equation has been especially helpful over the past year. It must be so given that exports and imports directly affected by the cost or value of foreign exchange are equivalent to 60% of GDP. And the ZAR has been unusually mighty.

Where the exchange rate goes so go prices – as has been the case in recent years. Rand weakness in 2023 led prices and inflation higher – and interest rates followed. Then strength in the rand since early 2024 has helped to largely stabilise the prices of imports and the CPI since mid-2024.

The ZAR Vs the USD and the EM Basket and the CPI. Lower number indicate ZAR strength. August 2024=100. Monthly Data

Source; Bloomberg and Investec Wealth & Investment

Exchange Rates; ZAR Vs the USD, Aussie dollar and EM Basket (Jan 2024=100) Daily Data

Source; Bloomberg and Investec Wealth & Investment

How then does one explain the behaviour of the rand- the single most important influence on the CPI? The introduction of the GNU improved the outlook for structural reforms and faster growth in GDP -and so improved the case for investing in SA to the benefit of capital flows and the rand. The biggest threat to fiscal sustainability in SA and to its bond market and so to the level of longer-term interest rates and debt service costs, is the absence of growth. Slower growth expected means a weaker rand and more inflation and more inflation expected and higher borrowing costs. And vice versa. The Reserve Bank contributes to growth via the influence of its interest rate settings on demand. The exchange rate nor therefore inflation is not under its direct control.

No doubt we will learn from the SARB about the global risks it has to contend with. But these are risks over which it has no predictable influence or the ability to predict confidently. Parliament and its decisions about the allocation of taxpayer’s money, especially to capital expenditure, will dominate the immediate outlook for growth and the ZAR.  Inflation expected has only declined marginally in recent months.  Yet again will be given by the SARB as a reason for not lowering interest rates further. But inflation expected can only recede with persistently lower inflation. That can only come with persistent rand strength. It too is beyond any direct control by the SARB.

The SARB focus should be on managing the demand side of the economy – using its interest rate settings to prevent too much spending that might lead prices higher and avoid too little spending that would depress growth.  Which now means lower interest rates. It is simple logic.

Inequality of wealth is very helpful. The sages agree.

You are only wealthy if you have saved a good proportion of your income over the years and not consumed it all, to sustain an extravagant lifestyle. It is however your wealth that makes your large incomes and consumption tolerated by the wider society. Thus making it possible for the talented and diligent and hard-working and, most important for a growing economy, the enterprising and innovative successful risk takers, to earn their high incomes legitimately and enjoy their consumption and also help create their most useful wealth.

The savings that add to wealth and most important are invested productively by the income seeking business organisation that also saves and borrows and undertakes capex on behalf of their owners. These firms are given the responsibility to manage the capital stock and all the complementary scarce resources that are entrusted to them. Including employing workers and managers whose wages and rewards will depend on the good returns on capital (savings) their employers are able to realise to sustain their enterprise.

The more such capital is created and made available to the economy in the form of plant, equipment, dams, roads and ports etc and the more efficiently they are managed, the higher will be the incomes earned by the poorer households. More capital raises the relative scarcity of labour and improves productivity and incomes. Which makes the people understandably willing to protect the wealth that funds real assets against damage or theft or violent expropriation by local or foreign invaders. The protection and respect for property, that is for capital or wealth, in turn encourages the potentially higher income earners to venture more, to earn more and to save and invest more in the capital stock. Thus serving the essential interests of the wider community.

The consumption of others is not helpful to you- it adds to the competition for scarce resources. Saving, accumulating wealth to fund an investment in real assets is very helpful for the many without much wealth. It is the large-scale waste of capital, extracted by taxes, as has been the case with our SOE’s, that should be condemned.

Such essential willingness to protect property is to be found in the Bible and the rabbinical commentaries on it. As I was pleased to discover at a recent joyous barmitzvah. The substance of the readings that day were the laws and regulations governing the protection of property and compensation for its damage, intentional or accidental. And about laws that also regulated the rights and obligations to an important asset class of those times, the slave. All food for my economist soul.

There was little more I could read that morning about the creation and purpose of wealth. I thought I would ask this question of the Torah and Rabbinical commentary, the Talmud using AI. Rab AI so to speak. Here is a summary of the responses received, with my reactions indicated between brackets.

“The Talmud places a strong emphasis on the importance of hard work and diligence. It acknowledges that while effort and work are important, ultimately, one’s success may also depend on divine blessing. (Unbelievers will call this luck) The Talmud establishes the principle that those who are wealthy have a responsibility to support the less fortunate. The act of giving is seen as a valuable pursuit, and generosity is highly praised. Wealth is viewed as a trust that comes with significant responsibilities – that one should use their wealth not just for personal pleasure but also for the betterment of society. This includes supporting community needs and contributing to public welfare. (My point about the social purpose of wealth being the creation and preservation of the productive capital stock for the benefit of the greater society, has not apparently been recognised)

The Talmud warns against excessive attachment to wealth. A person should not let the pursuit of wealth dominate their life to the detriment of their spiritual and ethical responsibilities, that through work and the creation of wealth, one can achieve personal and communal fulfilment.”

(Ancient wisdom that is clearly consistent with human aspiration and economic development that implicitly recognises inevitable differences in economic outcomes as socially helpful)

Keeping Trump at bay

A large threat to the long-term growth prospects of the SA economy is the loss of essential skills to emigration. Such losses have been a continuous drain on the growth potential of our economy both pre and post our democracy. That Trump saw fit to take the back of white South Africans could be even more damaging to South Africa than he imposing higher tariffs or denying aid. What if the US decided that badly treated South Africans with skills and the right aspirations would be very welcome in the US? A drain of emigration could become a flood. A severe potential loss that could be avoided by seeking the friendship and support of the US rather than so gratuitously incurring its ire and enmity.

How could this be done to the great benefit of South Africa and its growth prospects? I would suggest by doing in SA what Trump aspires for the US. That is for SA to become a truly colour blind and meritocratic society and economy. Which it is not. Our policies have focused on restitution for a black South Africans rather than stimulating growth. Understandable perhaps but self-defeating- making growth that would benefit the many so hard to realise.

Growth rates would surely be greatly enhanced by unfettered competition for jobs and for contracts to supply the State and its agencies. A process that would be particularly helpful to the least advantaged poor of South Africa. In the form of many more well-paid jobs and indirectly in the form of better education and health care that only a prosperous and competitive economy could afford. BEE clearly does not benefit them. There must come a time when the highly educated and talented black elite of South Africa are willing to compete on their own considerable merits with all the competition for the commanding heights of the economy and its governance. The sooner the better for growth and our international standing.

Faster growth may not reduce inequality and moreover, should not be expected to do so. To them that have may well be given. And be resented accordingly when it has a racial or ethnic connotation. But envy should not be allowed to frustrate the realisation of the greater good as it has to date. Higher incomes earned fairly by providing superior service to customers and employers should be applauded not resented. Growth is a positive sum game.

How badly has the South African economy been doing? According to the recent extensive Survey of Income and Expenditure and Income (PO100) of 19,940 SA Households conducted by Stats SA so much worse than could ever have been imagined. It has come up with a literally unbelievable estimates of household income and expenditure and their distribution by race. These estimates of household expenditure and income are also widely different from the national income estimates. And should be rejected.

Between 2006 and 2023, inflation adjusted household consumption expenditure of all SA households is estimated to have declined absolutely by a real 1.9%. Real Black household expenditure, with a 62% share of all spending, is estimated to have risen by an impressive 36.2% over these years. While the household spending of increasingly poor white SA households is estimated to have declined by 21%. Households headed by those with a tertiary qualification did even worse- they apparently saw their expenditures decline by 29.2% between 2006 and 2023. No case for envy here if it were so.

The income story told is less depressing. Black headed households are estimated to have seen their incomes rise by 46% between 2006 and 2023. While white incomes declined by only 7.7%. All household incomes are estimated to have grown by 5% since 2006. Suggesting a completely implausible and unobserved increase in real household savings – the difference between incomes and expenditure.

By contrast the National Income Statistics record that real household disposable income rose by 42% between 2006 and 2023, while real household consumption expenditure increased in line by 37% over the period (see below) Such inexplicable differences in the measures of income and expenditure need reconciliation. And what does it all imply for the reconstruction of the weights in the CPI that depend on the Survey? And for our measures of inflation?

AVI and Shoprite compared. Dividends Vs Growth – getting what you pay for.

My colleague, a formidable stock picker with an impressive market beating record of performance over the past five years and more, (providing average annual returns on his substantial portfolio of SA shares of 20.7% p.a. since 2020) asked an intriguing question about AVI. A listed company that is a mixture of branded food and consumer goods manufacturer, deep sea fisher and fashion retailer. AVI has realised an exceptionally impressive return on the capital it employs. Its internal rate of return (IRR) was as high as 30% in 2024. It has averaged over 25% p.a. since 2015.

Yet after 2020 the total return to AVI shareholder, dividend yield plus capital gains, has averaged but 9.8% p.a. of which dividend payments, provided an average 7.54% p.a. The share price therefore advanced by only an average 2.2% p.a. over the five years not keeping up the JSE All Share Index that delivered an average 11.2% p.a. return over the same period. Why then, it was asked has AVI performed so poorly for its shareholders despite its very high returns on capital?

The market value of AVI is currently about R31b (it peaked at over R35b in 2018) and is now 14 times its reported earnings. About the same P/E rating as the JSE All Share Index. Between interim, final and a special dividend AVI paid out R8.70 of dividends in 2024 – equivalent to a 8.7% dividend yield in 2024. An initial yield – well above the current JSE average of 3.8%. Clearly while generous payouts may matter for shareholders – they may not do much for the share price.

The contrast with retailer Shoprite (SHP) is striking. Since 2020 the SHP internal return on capital has been much lower, less than 12% p.a. Yet SHP is valued at over 23 times its reported earnings. SHP has invested heavily in growing its business and provided much better returns for shareholders. An average 20.6% p.a. total return since 2020 with average share price appreciation of 17.3% over the five years.

AVI by contrast has added very little capex in recent years. SHP invested about half of its cash flow from operations in 2023 and 2024, over R14,4b in total. AVI invested R959m in the two years. Equivalent to only a fifth of its operating cash flow and equal to a mere 1.4% of its market value. SHP invested the equivalent of 5% of its R155b. market value in 2024. Clearly SHP is valued for the growth in revenues and profits expected to follow its capex.  The AVI offer is one of mainly dividends that are not expected to grow rapidly. The high initial dividend yield is therefore much more of an annuity. To be compared with the yield on a long-dated RSA bond, that offers a certain 10% p.a. (see charts below)

We however observe that senior managers in AVI, are granted shares, as a bonus, that vest and can be sold after three years, provided, among other requirements, that the average return on capital employed over the vesting period is ahead of the weighted average cost of capital (WACC) Estimated to be about 11% p.a. Rewarding managers to simply maintain the profit margin, the difference between the return on capital r and the cost of capital c (30-11 for AVI in 2024 ) does not make sense for shareholders. Shareholders benefit from additional flows of economic profits and not only from profit margins. Economic profits are Capex multiplied by the profit margin, which are likely to decline as less profitable, but still cost of capital beating projects are taken on that would raise profits.

These incentives must encourage caution by managers, that is for them to wish to protect profit margin in their own interest, rather than grow profits with additional capex.   AVI shareholders should understand these implications and are advised to seek a remuneration policy that is much better designed to align their  interests of with those of and managers in market value adding growth.

No place to hide. The SA economy is in jeopardy for want of essential services.

by Brian Kantor and David Holland

We hear frequent complaints from state-owned enterprises (SOEs) that they are struggling to meet their debt obligations and need to be recapitalised. Yet the SOEs are simply not generating enough return on capital invested (ROIC) to justify allocating more capital to them.


Let’s take Transnet as an example. Transnet’s return on invested capital (ROIC) was 1.0% in 2024, which is lower than the miserable ROIC of 1.5% posted in 2023. The cost of debt on long-term South African government debt is 11%. This is the bare minimum cost of capital Transnet should meet. Transnet is destroying over 30 billion rand in economic profit every year when the difference between its return on capital and its opportunity cost is considered. A terrible unaffordable waste.


There are two key value drivers that feed into ROIC: operating margin and asset turns. To improve the operating margin, Transnet needs to increase revenue AND bring down operating expenses. To meet an 11% cost of capital, Transnet needs to generate 47 billion rand in annual operating profit on its invested capital. Its profit from operations was 4.3 billion in 2024 (operating profit is before interest expenses). Assets need to be run more efficiently or sold to private parties that can do so.


The large SA state owned enterprises, Eskom and Transnet, among other SOEs including the Post Office and the trading divisions of most municipalities have not remotely met the requirement for an investable credit rating. They have not been able to contain their costs well enough to cover their interest bills let alone their true opportunity cost of capital. Nor have they properly maintained their Plant and Equipment. Fundamentally they have failed because the bottom line, that is an adequate return on invested capital, has had little influence on their behaviour. Without many eye-watering billions of maintenance capex, their ability to continue to supply essential services, indispensable for economic growth, is severely compromised.

The SA government now recognises that the only practical way to secure the supply of these essential services is to raise large investments of private capital. Of which there is no shortage, provided the terms are regarded as acceptable.


And it would only be a private company, with a bottom line that requires a risk-adjusted return on capital, that could realistically hope to control costs and preserve and improve the capital stock, to reliably supply essential services in the future. Any imaginary mythically reformed SOE –capable of containing costs and operating efficiently – but without the right private incentives- is not a viable option. We’ve been down this track too many times.


The agreed terms for private sector engagement would have to recognise the true market value of the plant (PPE) taken over by the new operator of a network or part of it. Given years of neglect, existing assets might have very little value to any new operator. The potential market value could be exchanged for equity held by the government in the new privately controlled suppliers.


The private operator would have to commit the extra capital required to guarantee a flow of essential services over the long run. And such extra capex, would have to be recognised in the tariffs and or charges made for what could be valuable access to the networks.


Complicated calculations or regulations of appropriate charges or tariffs do not have to be a barrier to private entry. Any private company that won a tender to enter a network, with a degree of monopoly power, would be highly conscious of the impact of the prices it could charge on demand, sensitive to degrees of capacity utilisation and so its bottom line. And would be very considerate of its growth prospects. Becoming a reliable supplier at a competitive price with market-related returns would be a valuable outcome for all stakeholders.


The purpose of any private- public partnership or initiative is a simple one. That is to secure the future supply of essential services for SA users without which SA incomes and output must stagnate or decline. This all-important objective, viewed realistically, must be top of officials’ minds engaged in any negotiation with potential private partners.

Some Comments on how AI impacts the actions of the SARB

By Graham Barr

AI uses human actions in the realm of decision making; making judgements. So-called machine learning is central to AI. Optimal human decision making often follows a well determinable sequence in the form of “If this happens do this, otherwise do that” etc etc Machines can learn this best sequence of actions to mimic a human with the best judgement in that situation. Of course, some humans are intelligent to the point that they are known to solve particularly hard problems and are known for their ability to think “out of the box”; those that might solve problems that have never been solved before and thus no solution is recorded as existing to the problem at hand. Notwithstanding this unusual case, typical AI applications are developed with machines that are “trained” to replicate the best solution to a potential problem available. One might surmise that we could soon reach the point where machines could out-think the most creative human thinkers and prove new mathematical theorems and push the boundaries of knowledge. Will AI be able to write brilliant novels and think of ways and (manufacturing processes) to produce faster computer chips? Or think of ways to genetically modify plants so that food production eradicates hunger using a relatively small area of land. At some point, but we aren’t there yet.

AI is sometimes mixed up, I think, with “raw” computer power. Computer power is the straight-forward speed of a computer chip and then (separately) the ever-lower price of computer storage. Computer power is about the speed at which one can do an operation; whether it takes 1 hour or 1 second. And this leads on to whether a computer can process huge amounts of data in a useful amount of time – is a problem solved in an hour worthless, whereas a problem solved in a second is very useful. The rise in computer power over the years has been phenomenal (Moore’s Law) A terabyte of data might be processed in 30 seconds now but have taken 150 years to process 30 years ago. This raw data processing power which affects the time something takes to process is often a key requirement of AI; but should not be confused with AI itself.

Turning to consider clear examples of an AI centred approach which are useful, and not dependent on any significant computer power. The replacement of tellers at supermarkets would constitute a first-stage form of AI. This constitutes replacing a task not requiring much creativity; requiring a fixed pattern of behaviour in a deterministic (reliably set) way – this would be a low-level AI application. This application works quite well through product scanning, but generally requires an overseeing assistant to sort out problems. Bank bots answering questions through text responses to typed questions, exist currently, but appear to be extremely inadequate at answering anything except the simplest of questions.

AI could be used to direct drones to fly over fields of plated crops and look for disease; then if found go and collect an appropriate spray and fly out again and spray the afflicted crop. Or those with a sickness could be checked in through an AI-driven

diagnostic process and then have medication administered. Where appropriate, they may even be operated upon by an AI driven robot.

The “box” of recorded human intelligence is still circumscribed. AI can be taught (machine learning) to write simple essays by reaping bits of seemingly required knowledge from the internet. However, It can’t go further out the box than it has been trained to do.

Forecasting.

I think economic forecasting has always challenged economists. Interestingly, It is not obvious that over the period of the last 30 years, in which computer power has improved by a factor of 1m, that economic forecasting has improved at all. This is in contrast to weather forecasting which is decidedly more scientifically deterministic. Forecasts are determined according to the (short-term, at least) predictable changes in pressure, relative humidity, temperature etc Such forecasts have improved greatly over the same period with increased computer power rather than any clear use of AI.

Economic forecasting is more difficult because it requires capturing both rational and (ex post anyway) seemingly irrational actions of humans. An important point is that humans can perform actions which are irrational (not optimal) because of a short-term emotional response. Machines, in contrast, currently can only perform rationally. Currently, that it. It is conceivable in the future that machines could be trained to capture the emotional reaction to any event at all for each individual person on the planet.

Back to economic forecasting. If one Googled “AI for economic forecasting”, one gets a list of statistical procedures that have been around for 50 years. ARIMA(Box-Jenkins), Trend-Seasonal decomposition forecasting, scenario-based econometric model forecasting etc These processes have little to do with AI as discussed. They do benefit a bit from increased computer power, mainly that they are quicker to estimate and allow more models to be considered within a period of time. But this is not material. In fact, economic-type forecasts have not improved much over 50 years. The most obvious example of this is the fact that “pollsters” got nowhere near to forecasting the results of the recent American election. If anything, one could say that they did a worst forecasting job than has ever been done.

The governor of the Reserve Bank Lesetja Kganyago may be mixing up AI with raw computer power. Increased computer power will allow his scenario-based models to be estimated with many more variables with many more assumptions, giving many more possible forecasts over many more different time periods. This will make his task rather difficult as he tries to decide which possible future set of so-called exogenous variables might pertain in the future. There is no obvious reason that he will do any better than the seemingly-unfathomly-bad forecasts of the American election pollsters.

Is AI able to tell us how to fine tune our SARB economic models so that they will produce better economic forecasts. Probably not. Could one CURRENTLY put an AI powered machine to better manage the monetary policy of the SA Reserve Bank. Unfortunately, it is quite likely.

A tale of two cities – it is the best and the worst of times for home owners.

The differences in the value of residential property in Cape Twon and Gauteng – and in Durban and the upper market suburbs of all the other SA cities are most striking. I learn anecdotally of a modern multi-bedroomed home in a gated estate near Johannesburg, largely grid free, that is municipality free, that has been on the market for six months for an asking price of not much more than three million rand with no takers. The owner wants to move to Cape Town as do so many and the market is flooded with like homes. Palaces that would take R10m or more to build. The same 3 million would have difficulty in securing a well appointed two-bed roomed apartment in Sea Point.

The differences in property outcomes are easily explained. In the Cape property owners in the towns and suburbs get reasonable value for the wealth taxes and service charges they are forced to pay. This adds to rather than subtracts from property values. Unlike the abject failures of service delivery almost everywhere else that destroys demand for homes and valuations.

The sad news is that the hopes of many have been dashed. Those who have responsibly been saving, paying off their mortgages each month expecting that the growing equity in their homes would help fund their retirements when they downsized and cashed in. The expectation now is that the value of their homes has not and will not keep up with inflation.

I am informed by a leading property appraiser that on average commercial real estate in Cape Town is expected to increase in capital value by 6.5% p.a. – ahead of inflation expected – while equivalent property in Johannesburg is expected to gain but 3% p.a. Furthermore, the so-called capitalisation rate at which future rental incomes are discounted is lower for Cape Town property that a similar building in Johannesburg. A value adding  1.25% margin in favour of Cape Town discount rates is estimated.

Recent property transactions confirm this difference. The Table Bay Retail Mall was sold for an initial yield of 7.75% to Hyprop. The Mall of the South in Johannesburg was sold to RMB at a significantly higher initial rental yield of 9.5%. For landlords of residential property in Cape Town initial rental yields (net rents/Market Value) range from about 3% in the most favoured suburbs to about 5-6 percent where there is less competition. All consistent with expensive real estate.

It should be assumed that the total return expected by investors in real estate will be similar everywhere in SA. Flows of mobile capital make it so. But total returns come in two parts- an initial yield – in dividends or net rental income and in capital growth. Thus the more growth expected in net income the lower will be the initial yield for homes of similar quality. For cash strapped migrants relocating to the Cape it may seem easier to rent rather than buy- with expected capital growth conceded to the investor.

The good news for our cousins in the North is that their cost of living is dramatically lower than ours in Cape Town. The bigger and better the home the more consumption power it delivers and such delivery comes much less expensively in Joburg.

The opportunity to live in an inexpensive palace rather than a crowded bed-sitter for the same modest outlay, either in rentals paid or sacrificed by owner- occupiers, should surely be an attraction not to migrate. And enough of a saving to help owner-occupiers go off grid and behind gates. And to run a four by four to negotiate the potholes when off to their bushveld retreats.  

My New Year advice therefore is to buy more of what is cheap. To house up and take advantage of the bargain basement offers. And hope that all the bad news about service delivery is in the already low prices. The best performing asset class in SA in 2024 has been listed property. Residential property might just enjoy a similar rebound should service delivery unexpectedly improve rather than deteriorate further.  (see below)

Total Return To end Dec 2024. Property Vs The All Share Index

Source; Bloomberg and Investec Wealth & Investment

Data dependence – not forecast dependant

Reserve Bank Governor Lesetja Kanyago is hoping that AI will help speed up the updates of its economic forecasts. At a recent media briefing he remarked that “From the time we make assumptions to the time they go and generate a forecast, it could be a couple of weeks,” “But there is emerging evidence that says that AI could help us speed up the forecasting process. So, we might be able to generate forecasts quicker, and that speeds up our own internal processes.”One of the things … we have to look at is to what extent this technology can be utilised to speed up processes and make central banks very efficient.” News 24.

Which reveals an important reality. The forecasts of the SA or indeed any economy will only be as good as the accuracy of the key assumptions made that drive the model. The hoped for internal consistency of the forecasting model is not sufficient to the purpose. Accurate assumptions about the key drivers of the model, the exogenous variables as they are described in model building, are all important for accurate forecasts- and hence may need to be revised frequently

It is always necessary for forecasters to play catch up with changes in the environment. It makes any central bank with influence on a domestic economy data dependent- not forecast dependent. The term data dependent is a constant refrain of the FED and the SARB and inevitable given the forecasting failures.

Not only the SARB but every analyst everywhere will have turned to AI to help their forecasts. And every SA economist will be looking to AI to help predict the interest rate actions, or should we say reactions of the SARB.

They will know, as AI will have digested, that interest rate settings in SA will be little influenced by the current state of the domestic economy. As has been demonstrated again very recently. With lower inflation has come news of a decline in Q3 GDP. Meaning a still very high after inflation Repo rate accompanying a very weak economy and a reluctance to lower interest rates more aggressively. No model of the SA economy would deny that real interest rates influence expenditure, inflation and GDP. But inflation will also depend on what is happening on the supply side of the economy – particularly to the foreign exchange value of the ZAR and the prices attached to imports and exports.  One doubts that AI will make the USD/ZAR exchange rate and hence inflation highly predictable.

If past performance is anything to go by a concern for the state of the economy and the supply side forces acting on inflation will not much influence the SARB. It will defend its narrow mandate – to control inflation- and therefore to have to fight not only inflation but inflation expectations that are thought to feed back to inflation itself. Any model that forecasts inflation using inflation expectations as a driver, must have an equation or two to explain inflation expectations. The influence of the ZAR on inflation and hence inflation expected would have to play their part.

Judged by the interest rate spread between US and RSA five year bonds, the ZAR was predicted last week to lose an average 4.7% p.a. over the next five years. Hardly a backdrop to less inflation expected over the longer run.

Data dependence must remain the SARB mantra given the unpredictability of the ZAR and its weak bias.  Nor should concerns about inflation expected, so difficult to influence, be the fall-back position of the SARB to justify depressingly high interest rates. When the data clearly indicates that aggregate demand is falling below potential supply and the threat to inflation is not domestic in origin, the case for lower interest rates should not be denied. Matching domestic demands with domestic supplies is as much as the SARB could contribute to the control of inflation. Inflationary expectations, not inflation, are largely impervious to the state of the SA economy – as AI would confirm

When Inflation costs you elections- it will be avoided

The Trump Triumph demonstrates why inflation in the US and in much of the developed world is persistently low. Inflation is unpopular- it can cost you the next election – especially when the growth in incomes of the workers, wage and salaries, lag  the increase in prices. Which they have done in the US until recently, despite the high levels of employment.

The recipe for controlling inflation is well known and usually well practiced. Simply put it requires that the increase in the demand for goods and services be closely matched to the increase in the real supply of goods and services that are the source of all incomes. If demand appears to be growing too rapidly in ways that add to the ability of firms to easily raise their prices, the remedy is to raise the cost of credit – raise interest rates to discourage borrowing to spend more. Actions not beyond the with of a modern, data dependent and politically independent central bank.

A temptation not generally avoided in the persistently high inflation economies, Africa provides many examples, of a central bank and its cohort of retail banks, to fund a large proportion of additional government spending. Then consistent increases in the supply of money ( of bank deposits) and bank lending, stimulate demand for goods services and assets and continuously higher prices, inflation persistently in the high teens, are the inevitable rationing mechanism.

Yet this was the classic way inflation ran out of control in the US post the Covid lock down shocks to supply and incomes. The spending of the US government rose dramatically and generously to compensate workers for their enforced idleness. With the strong backing of the Fed and its willingness to buy the extra government bonds being issued, on a huge extra scale. It was classic money creation and a burst of inflation – more demand and less supplied-  followed.  

Seemingly, unforgivingly, to the surprise of the Fed who then had to play catch up with much higher interest rates that naturally were very unpopular with potential house and car buyers. The flow of money into financial assets raised their prices and were much welcomed by the minority of wealthy Americans who have enjoyed a massive improvement in their balance sheets. US household wealth is up by over 50 trillion since Covid. US household incomes have barely increased since then- and are barely highr when adjusted for inflation.

But there is now every reason to expect US inflation to stay down around the 2% p.a level it is falling towards. Even should Fed  Chairman Powell be replaced. The political case for low inflation has been reinforced. Ironically what the responses to Covid took away from the second Trump campaign- gave it all back in the third.

The South African authorities, especially its independent central bank would like to aim at lower, developed world type inflation rates. South Africans would welcome such outcomes. But is it a realistic objective? The inflation outcomes will depend critically and unavoidably on the path of the exchange rate. If for example, the ZAR more or less retains its exchange value with the Aussie dollar- as it has been doing lately – SA could enjoy similarly low Australian type inflation and interest rates. It would then be a very smooth ride to lower inflation.

But the ZAR is clearly not under the control of the Reserve Bank. It is determined by SA politics and the outlook for SA growth. It is the political risks to the growth outlook for the SA economy and the ability to fund government spending without money creation that drives exchange rate weakness and generally higher prices. Too much spending has not been the reason for SA inflation. The exchange rate shocks for our very open economy have driven prices higher and inflation expectations higher. Limiting demand to counter these forcers acting on prices has meant less growth and not much less inflation.

We must hope that the new political dispensation gives SA more growth and more exchange rate stability. If it does persistently low inflation will follow painlessly. If not chasing the inflation tail will just add to economic misery.

Inflation in SA – a story of the mighty ZAR

Inflation in SA has nearly halved since June. From 5.1% p.a then to 2.8 in October. Indeed average consumer prices have hardly risen at all since June. In October they fell marginally, and over the past three months the CPI has hardly budged, and price increases were close to zero.

Inflation and the SA CPI; Monthly Data

One observation that one can make is that such price stability could not have occurred without a very strong rand. A rand that has gained value against a range of low inflation currencies. This year to date the rand is worth four per cent more USD, can buy six per cent more Euros and seven per cent more Aussie dollars. The year before the rand had weakened VS these currencies by over 10%. Its surely no surprise that inflation in SA accelerated in 2023 and has sharply decelerated this year.

The ZAR Vs the USD, the Euro and the Aussie Dollar. Daily Data (2024=100)

One can also conclude that the exchange value of the ZAR drives the direction of prices in SA – rather than the other way round. SA is a very open economy. Flows of exports and imports account each for about 30% of GDP- of total supply and demand in the economy. What we pay in rands for imports and receive for exports helps determine all prices in a systematic way. You can tell as much at the petrol pump.

And so how then can SA achieve currency strength and low inflation? The answer would also seem obvious enough. Form a government of national unity that is expected to raise growth rates, improve the outlook for SA bonds and equities and so more capital will flow in more than out leads to less rand weakness and inflation expected in the future.  Lower long term bond yields, lower costs of capital generally, all reinforce the growth momentum. And with lower inflation short term interest rates decline just as predictably, as they can be expected to rise with rand weakness. Yet expectations of faster growth have to be reinforced with consistent growth enhancing actions. Investors can be encouraged, they can as easily be disappointed.

It is not only in South Africa that politics and the economic policies and outcomes associated with a change in leadership drive the direction of the exchange rate. And depending on the degrees of openness to foreign trade that will then drive the direction of all prices. The exchange rate leads and prices follow, and the exchange moves in response to changes in expectations of returns in the capital market. The exchange value of the USD,  the essential reserve currency, is subject to large changes in direction, persistently so, that have little to do with differences in inflation between the US and its principle trading partners. And everything to do with expected returns on capital invested. But will have a significant impact on the profits and growth prospects of businesses that engage in foreign trade.

The DXY is a weighted Index of the exchange value of the USD Vs the major currencies, the Euro, Yen etc.. It gained nearly 50% additional exchange value between 1995 and 2000. It then declined from an Index value of 120 to 70 by the time of the Global Financial Crisis. The dollar since has been on a mostly upward tack since and clearly has received a boost from the Trump ascendancy. From which the ZAR has not be immune but has behaved broadly in line with all other currencies. Dollar strength will be far more easily managed provided the ZAR holds its own with the other low inflation currencies, as it has been doing.

But for the Trump administration the impact of the potentially stronger dollar on trade flows may be far more important than the impact of higher tariffs on imports and the retaliation that may follow and on prices US consumers will pay. The unpredictability of exchange rates, despite low rates of inflation in the developed world, especially of the exchange value of the USD, is a fundamental flaw of global trade and finance that all economies including SA have to cope with.

The exchange value of the US dollar

Market values secure solvency

I read with some astonishment,  (BD Dineo Faku 22nd September) about the court action taken by shipping company Maersk to overturn the award by Transnet of the Durban Container Port Tender to the Philippine Company International Container Services (ICS) On the grounds that the ICS tender should have been disqualified because it, only it, used its share market value rather than its book value to calculate and report its “solvency ratio”

It would seem obvious that a borrower is solvent when the value of its assets, should they have to be realised, is expected to exceed the value of debts it has incurred. And the closer the ratio of market value to debt the greater the danger that the company would be forced to wind up. If the company is listed its market value is clear and explicit and continuously available. The book value of a private company might be the best initial and readily available estimate of what the assets might realise. If the accountants for the firm have following recommended good practice and have been consistently marking the books to market.

As I write the market value of shipping giant Maersk is 25.9 billion dollars with total debts of 16.7 billion US dollars ( 1.6 times) and that of ICS with a market value of 15 billion dollars, with total debts of 4.16 billion dollars. (3.6 times) The earnings before taxes to interest paid ratio is similar for the two companies 4.5 times for Maersk and 4 times for ICS.

There is a rigorous test of Corporate Default Risk applied to any listed company anywhere, more than 65000 of them, including Maersk and ICS. A test no further away than your nearest Bloomberg Terminal. A click or two calling up the company and the DRSK model will give you an immediate probability of default. And one that will be closely allied with the conventional ratings provided by the debt rating agencies. The Bloomberg model easily downloaded is adapted from the original financial economics of Nobel laureate, Robert C Merton, and is very well known in financial economics. The theory as adapted by the Bloomberg team in 2021 is elegant and is very well tested by the evidence presented of its predictive power. Science, that is theory with predictive power for a large sample is at work here.

The Bloomberg model uses the market value of the assets of a company as the basis of its assets to debt ratios. But with an important proviso. The market value of a company in the model  is adjusted for the volatility of its share price . The market value is estimated as a “down and out” call on the assets with a maturity date. Hence providing a highly realistic estimate of what you might realise the assets for. The more volatility, the less predictable the share prices and the less the company may be expected to fetch

The Bloomberg model gives very similar measures for the very low probability of either Maersk or ICI defaulting over the next twelve months.  (see below) Both companies, as predicted by Bloomberg, would enjoy a comforting Investment Grade rating. The market value of ICS has risen strongly over the past twelve months while that of Maersk has changed little. The volatility of the two share prices- until recently higher for Maersk, is now very similar. The improved value of ICS may well have much to do with winning the tender. It clearly is a valuable contract worth fighting over.

The Maersk and ICI share prices. Daily data (2023-2024) US dollar value.

Source. Bloomberg and Investec Wealth & Investment

Maersk and International Container Services. Probability of Default; over the next 12 months. %

Source. Bloomberg and Investec Wealth & Investment

A South African Case Study Pick N Pay (PIK)

Underperforming companies raising more debt do not necessarily go broke when the market value of their assets approaches the barrier of debt. They may be rescued by shareholders willing to subscribe additional equity capital. When shareholders prove unwilling to provide support a company will go under. Hence the market value of a highly indebted company, close to default, will always reflect the chances of a rescue.

South African retailer Pick ‘n Pay (Pik) has provided a very clear example of the benefits of shareholders coming to the rescue with additional share capital necessary to avert the dangers of a default. The operating performance of the company had deteriorated significantly in recent years. A drain of cash had been funded with much additional debt. Net debt had increased from R3.8 billion in August 2023 to R7.2 billion by January 2024. As the market value of Pik declined from 28.02 billion in January 2023 to R11.48 billion by year end 2023 with elevated daily volatility.

A recapitulation of the business had become essential for the survival of the business and was announced in January 2024. The plan was to raise R4 billion from existing shareholders in the form of a rights issue. To be followed by the listing of and an offering of shares in its profitable subsidiary company Boxer. Bankers also agreed to modify their debt covenants in February 2024.

On the 27th February 2024 the company announced the approval of the capital raising and debt reduction scheme. At which point in time the market value of Pik bottomed out at R8.5b. The rights issue when concluded on July 30th raised the number of shares in issue by as much as 51%.

The market value of Pik is now approximately R19b. Thus, the capital raise of R4 billion must be regarded as having added much value for the shareholders subscribing the extra capital. The value of Pik is now up by approximately R10.7b (19.2-8.5) March 2024 after an investment of R4 billion That is for the initial subscription of R4 billion the shareholders have gained R6.7b. (10.7-4)

Source; Iress and Investec Wealth & Investment

The recent history of Pik – its share price and probability of default as calculated by the Bloomberg model – is shown below. As may be seen the probability of default rose sharply as the share price fell away with heightened volatility. The probability of a default in 12 months has now receded sharply placing Pik debt if it were to be rated in the High Yield category.  (see below)

Pick ‘n Pay Probability of Default and Share Price. Daily data

Source; Bloomberg

Complexity rather than linearity drives share prices in a very good year

In years to come the 2023-24 years will be recognized as very special ones for share owners. Something to toast over what may prove to be an equally special Grand Cru. One that, thanks to the exceptional draw up in market values, has become more affordable to the patient investor. A case of what the wine cognoscenti might describe as linearity- from much extra wealth created to the wine cellar.  Though why a straight uncomplicated line from lips to throat, should be regarded as an attribute of a fine wine escapes me. I thought one pays up for complexity in wines, never simply described.

This past year the S&P 500 delivered the best annual returns this century. Comparable to the recovery from the panic drawdowns of 2008 (GFC) or 2020 (Covid) The Index, up 30 % in the twelve months to September 2024 was very generously valued a year ago -at 21 times earnings. It is now even more expensive and valued at 25 times reported earnings. The average S&P P/E since 2000 has been 19.7 times. Unusually It has not taken a draw down to lead a strong recovery. This time has been different. Strength on Strength.

The S&P 500 Index Annual Returns – calculated monthly 2000-2024

Source; Bloomberg and Investec Wealth and Investment.

The upward direction of the S&P Index recently has been dominated by a few stocks- the so described magnificent seven- making the Index unusually concentrated, less diverse and therefore more risky than usual.  The top three by market value Microsoft Corp., Apple, Inc., and Nvidia Corp., constituted 20% of the S&P 500 this year, while the top seven stocks accounted for 32%. 

Yet while the S&P 500 is up 22% this year to September, the equal-weighted S&P 500, the average listed company, is up by less – a mere 14.9%.  During the first half of the year, the S&P 500 rose by 15.2%, and by 5.9% in Q3, while the equal-weighted S&P 500 increased by only 5% over the same period. This greater than 10% performance gap between the weighted and unweighted indices was the widest in nearly 30 years. Only about a quarter of S&P 500 stocks kept pace with the market’s overall return during the first half of this year, with over a quarter experiencing negative returns. If you did not own the very largest stocks and own them in size, you likely underperformed the indices. Risk (less diversification) and return were as usual well correlated.  

The “magnificent seven” and so the market are valued for the prospective growth in the demand for artificial intelligence that they supply the backbone for. But their investment case so strongly appreciated will only be fully revealed over time. This makes their valuations less dependent on near term earnings and so on the essentially short-term business cycle. They are valued much more idiosyncratically than your average value company on their own recognizances. They have also grown earnings and cash flows at well above the average rate to date. These super growers with impressive track records are allocating truly massive volumes of internally generated cash flows to supplying the essential facilities that the average firm will be drawing upon and hopefully paying up for.  They also have the financial strength to pay dividends and buy back shares. In contrast, the average S&P 500 company is valued more heavily on the short-term outlook for the U.S. economy.  About which there has been and perhaps will always be considerable uncertainty.

The S&P 500 Index, the equally weighted S&P Index and the JSE All Share Index. Total returns to October (2023=100) USD Values

Source; Bloomberg and Investec Wealth and Investment.

The JSE has also enjoyed a very good year. Up by as much as the S&P since October 2023. 40% in USD and still impressively 28% higher in the mighty ZAR. The JSE All Share Index measured has added as much to SA portfolios as would have holding the S&P Index. A wealth adding outcome for old-fashioned reasons. The prospect of faster growth has fired up the share market and the value of RSA bonds and the exchange rate. Less inflation, lower interest rates and faster growth in GDP and government revenues has been very heady stuff. Enough perhaps to add to the prices bid at the Wine Guild Auction and deserving of an early toast to the GNU.

The S&P 500 Index, the equally weighted S&P Index and the JSE All Share Index. Total returns to October (2023=100) Rand Values

Source; Bloomberg and Investec Wealth and Investment.

Looking Back -to Look Forward to the outlook for Monetary Policy and the SA Economy.

Looking back at the economy reminds how tough it has been in recent years for households and businesses dependent on the state of the SA economy. Since those pre-Covid days the economy has hardly grown at all. Compared to Q1 2019 GDP by June 2024 had gained a mere 5% over the five and a half years. (growth of less than 1% p.a)  Households are spending but 6% more than they did then and capital formation is down by about 14% in real terms. How could such a deterioration be allowed to take place?

Vital SA Economic Statistics. Supply and Demand. (2019=100) Quarterly Data.

Source; SA Reserve Bank and Investec Wealth and Investment.

Clearly the supply side of the economy performed poorly – led by the well documented, confidence sapping failures of the State-owned enterprises and of government generally, including those of the provinces and municipalities. But demand management by the Reserve Bank can also be held  responsible for at least some of the weakness. Much of the period since 2021 has been accompanied by much higher interest rates both absolutely and relatively to inflation. That is despite the grave weakness of demand for goods services and labour.

The Reserve Bank’s Monetary Policy Committee provides a full explanation on a regular basis for these interest rate settings. It has been fighting inflation and only inflation that rose after 2021 as the rand weakened so significantly after 2021. The idea of a dual mandate of the US Fed kind – low inflation and employment growth being the combined objective of monetary policy – has been  anathema to our determined inflation fighters.

Shocks to the price level caused by exchange rate weakness – unrelated to immediate monetary policy settings and inflation trends – are clearly not ignored when interest rates are set. Yet such shocks- decidedly not of the Reserve Bank’s doing-  lead inevitably to more inflation – then higher interest rates – and in turn still weaker demand – already under pressure from higher prices. Higher prices have their complex causes- but they also have (rationing effects) on the willingness to spend more- given minimal growth in income

The problem for SA and the Reserve Bank was that the ZAR weakened decidedly after 2021- and weakened against not only the US dollar but also vs other EM and commodity currencies. It was SA specific in nature clearly linked to the failures of government and the failure of the economy to grow that added to SA specific risks. The USD/ZAR, as had the average EM/ZAR and AUD/ZAR had recovered well from the Covid linked risk aversion that brought pressure on the ZAR and the market in SA Bonds. SA appears particularly vulnerable to Global Risk aversion. It may be recalled that the USD/ZAR had recovered to as little as R14 in early 2021. But then the sense of South African failures to realise economic growth took over the currency and Bond markets . And the weaker rand inevitably forced prices higher at a faster rate. Given the MO of the Reserve Bank.

The ZAR Vs the USD, the EM Basket and the Aussie Dollar. Daily Data 2019-2024 (2019=100)

                Source; Stats SA, Bloomberg and Investec Wealth and Investment.

Interest rates and the USD/ZAR 2019-2024. Monthly Data to September 2024

Source; Stats SA, Bloomberg and Investec Wealth and Investment.

The ZAR and Short-term Interest Rates. Daily Data (2019-2024)

Source; Stats SA, Bloomberg and Investec Wealth and Investment.

The connection between the foreign and domestic exchange value of the ZAR and the outlook for the SA economy has never been clearer. The GNU has raised the prospects for growth and the ZAR and the bond and equity markets have responded accordingly. Inflation is therefore on the way down. Over the past three months it has averaged but 2.4% p.a. Interest rates at the short end of the market have come down and will come down further provided the ZAR holds up. Not so much vs the US dollar, that may be getting a Trump boost, but also against the other currencies similarly affected by the USD. We should not expect the Reserve Bank to change its pro-cyclical approach. We should but insist and hope that the supply side weaknesses of the SA economy are well addressed. Raising the GDP growth rates to a modest 3% p.a. will not only promote economic and political stability, it will bring lower interest rates and less inflation.

Retail Therapy – Shopping with purpose

I like to visit the local supermarkets. And not only for the usual reasons. It helps confirm my faith in the power of market forces. Fully evident in the impressively wide range of goods and services on offer.  

The SA retailers very adequately fulfil the all-important task that we have delegated to them. That is to deliver a wide range of goods, including food and medicine essential to life and happiness. The retailers are left mostly alone to manage a highly complex supply chain that involves, farms, ports, roads, trucks and ships, factories and warehouses, banks, landlords and regulators. And they manage the always complicated relations with workers and their supervisors to pack the shelves and fill the checkout counters and increasingly to deliver directly to homes.  

They are serving us well for highly robust reasons. That is to make a living. Mostly modest but some very impressive. Generating incomes for the owners and staff that will bear a close relationship to the difference between the costs of providing the essential service and the revenues generated. To generate profits they will have to prevent the corruption of the supply chain.  

Such profits will also depend on how well the retailer manages the promotion or demotion of managers and workers- including the succession plans for senior executives. The retailer as must any business manage successfully the relationship between the efforts of and rewards for the work force. Providing the right incentives to work harder or smarter remains highly relevant for containing costs, enhancing revenues, and the margins between them. Without which the firm would not survive the competition for the household budget.

The apparent “chasm” between the pay of the CEO and the average worker should be regarded as an important part of the market in action. To be admired rather than resented as representing the natural outcome of the supply and demand for very different capabilities and talents at work. As explaining the wide difference between what Taylor Swift and her hair stylist takes home after a show, given their very different contribution to the bottom line. Such inequalities of rewards  are part of the necessary incentives for the best and brightest to ascend the highly competitive and greasy corporate poles to make a better fist of it.  We can’t all hope to be as good as a Taylor Swift, or an exceptional CEO. Yet whose contribution to the bottom line will never be as obvious as that of a Prima Donna.

Moreover, the resulting flow of profits realised will largely be retained by the owners and invested in the firm to improve the offers to households. Profits are good for customers. But the profits they realise are not fully under the control of the retailer. They depend heavily on the purchasing power of their customers, their incomes, that in turn depend on how well the economy at large is being managed. The SA economy has acted as a serious headwind for the retailers and even more so for their local suppliers. A headwind revealed in the form of declining returns on capital employed, and in goods that move more slowly off the shelves for want of demand. And call for more working capital to back up delays in the ports and distribution centres and by load shedding. The result of which are poorer returns on all the extra capital employed and less invested in new plant and equipment and in the work force.

The failures of the SA economy have much to do with the unwillingness of the economic power brokers to follow the example of the retail sector. As in the persistent but unrealistic, given past performance, faith in a reformed SOE’s and government departments to raise their games. Rather than contracting out much more of production to the private sector- honestly selected and helpfully incentivised to deliver as are our retailers.

They refuse to do so for their selfish reasons, as well as misguided notions of how an economy works best. Yet they must know that the slow growth outcome is a consistent threat to their influence. “As hulle net geweet het wat ek geweet het…”  (if only they knew what I know) learnt shopping with eyes and minds open to the evidence, SA would be, could still be, in a much happier state for retailers and their customers.

Doing penance with purpose

JSE listed companies have been beating down on themselves very heavily. Kabelu Khumalo reports some R250 billion of recent write offs and write downs of assets. (BD August 12th) It will mean that the book values recorded on the balance sheets perhaps will accord more closely with the market value of the company. Yet the cash flows of the business would be unaffected by the action and there are unlikely to be any taxes saved on the losses because they will not be recognised as a business expense. And the bottom line will be even less meaningful.

The prior damage done to cash flows and market value by poor investments or acquisitions will long have been recognised and deducted from the value of the company by investment analysts and the investors they advise. They will have made their own diminished sum of parts calculations of the present value of the divisions of any company. And they may still have a very different view of what the underlying assets might bring shareholders in the future.

Notice something important about these adjustments to the books designed to align book and market value. There is very unlikely to be an equivalent urgency to upvalue the assets on the balance sheets that have proved to be market value adding. The great new mine that has proven to be so valuable to shareholders is likely to remain on the books at something close to its historic costs. Not written up in the books to enhance earnings and equity capital employed and the strength of the balance sheet.  And when an excellent acquisition was made paying above the book value of the company acquired, this goodwill is very likely to be amortised against earnings, so reducing book value and the capital employed by the business. Rather than logically seen as adding to the amount of valuable capital employed by the business.

The benefits of writing off capital employed in a business, rather than writing it up, will show up in an important measure, and that is as Return on Equity Capital employed (ROE) The less capital recognised the better the return on equity all other operating details remaining the same. And the managers of the business are very likely to be rewarded directly on the basis of ROE. Shareholders will benefit when the company they entrust their savings can deliver a return on the capital they employ that exceeds the opportunity cost of capital employed. That is the returns shareholders might expect investing in an alternative company with similar operating risks.

Making poor investment decisions reduces ROE. Recognising past failures will not change past performance. It might however indicate that milk has been spilled, that costs have been sunk, that bygones are bygones and most important that more good money is less likely to be thrown away on lost causes. And if the managers are surprisingly contrite might help add market value by improving expected performance.

But what could be more helpful to an incoming CEO, also to be measured on future ROE’s than to begin a reign with less capital? True kitchen sinking, recognising the mistakes made by predecessors, could be managers wealth enhancing, if future rewards are to be based on higher ROE’s, as indeed they should be.

If the actual capital entrusted to the incoming CEO and the team of operating managers is accurately measured, it is only then that improvements in ROE can be properly recognised and encouraged. And rewarded appropriately in all the operating divisions whose managers can be held responsible for the capital they are given to manage, again accurately estimated.

South African directors of companies now burdened with justifying not only what they pay their senior managers, but with also justifying the absolute difference between the rewards at the top and bottom of the pay scales, may point to the example of Starbucks. Changing their CEO yesterday immediately added over 20 billion dollars to the market value of Starbucks. Paying the right CEO enough, not too much, nor too little, rewards based predominantly on improvements in ROE, properly calibrated and communicated, should be the primary task of any Board of Directors.  And when put into good practice with successful and well and competitively paid CEO’s, will deserve the approval of shareholders.

Perceptions are reality

The financial markets have welcomed the Government of National Unity (GNU) The reactions in the bond market have been particularly favourable. The JSE All Bond Index on August 26th was up by 11.4% since the election of May 2029. The share market was up by 7.1% while the ZAR has gained 4% vs the US dollar and vs other EM currencies. Given the importance of equities and bonds held by SA households in unit trusts and pension plans (some 15.2 trillion rands worth at year end 2023) representing 85% of all the assets held by SA households) such market moves have already had a very significant impact on the wealth of South Africans.

The promise of faster growth has added close to 10% or over 5 trillion rands mutual funds to the SA household balance sheet. Extra real money indeed and helpful for stimulating additional household spending, of which SA has had too little of for many years now. [i]It is not only the supply side constraints that have held back the economy. Demands from households and the firms that serve them have been insufficient to drive growth above an immiserating 1% a year.

The importance of the judgments of the global capital market of SA economic policy for the average South African, their hopes for employment and a comfortable retirement, for which they sacrifice heavily, cannot be underestimated.  

Post election movement in the Financial Markets. Daily Data – May 29th – August 26th 2024. May 29th=100

Source; Bloomberg, Investec Wealth & Investment.

The strength of the ZAR is particularly welcome. It brings with it lower inflation and lower short-term interest rates essential for a recovery in the economy. The positive link between the outlook for growth and the behaviour of the ZAR has again been emphasised, (more growth stronger rand and vice versa) as has the link between a stronger rand and inflation.

There is no room for complacency. The status of RSA debt has improved, but interest rates and the cost of capital remain elevated. Our credit rating remains significantly weaker than it was between 2002 and 2008 when our economy did grow at close to 5% p.a. (see below)

The RSA Credit Rating. The CDS spread between the yield on RSA 5 year USD Denominated Bonds and a 5 year US Treasury Bond

Source; Bloomberg, Investec Wealth & Investment.

There is much room to further impress investors. By taking economic policy decisions now, that by promising faster growth over the longer term, could immediately further strengthen the bond and currency market.

The National Health Initiative, now being actively promoted, does the opposite. It promises more of the same fundamental weaknesses that have infected all the State directed enterprises to date. The direction of health care reforms should also be one of seeking partnerships with the private sector- with private hospitals and practitioners. It calls for experimenting with the private control and management of hospital services. Hospitals currently funded by the State that perform so poorly on all metrics, including the costs of supplying inferior service.

A helpful positive note was offered by the Transnet CEO. Michelle Phillips who said yesterday that  “…the entity’s move to maintain run and invest at Ngqura and the 670km container corridor would be reworked after potential bidders complained that the conditions attached to the tender were too stringent and costly for the private sector to fully participate..” (BD August 28 Thando Maeko)

The public sector in SA, in all its guises, needs to come to realistic terms with the potential providers of private capital and skills that are essential to our economic purpose. Their managers need to fully understand how to deal with potential private sector partners who operate globally.  Such knowledge applies to plans for ports and railways and refineries, for the supply of water and the transmission of electricity. And for bringing minerals, oil and gas to the surface. And to recognise the terms and conditions, no more or less than internationally competitive terms, that would bring potentially abundant and truly economic game changing offshore gas, onshore. Offering credible deals of this kind would be enough to move the markets.  And so immediately, with lower interest rates and a stronger rand and less inflation, would help realise the growth in incomes and employment necessary to re-elect a GNU in 2029.

[i] I am drawing on a recent comprehensive analysis of the SA balance sheets by J.Makoena and K Setshedi published in the SA Reserve Bank Quarterly Bulletin, June 2024. The study shows how very well developed are pension and retirement savings in SA (120% of GDP) are compared to other emerging economies. And so the importance of investor sentiment for SA wealth owners.