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Election Direction

At the end of May, South Africans went to the polls to vote for the country’s seventh democratic government. In many ways, the outcome of that process was both expected and unexpected. After a decade of negligible economic growth, widening income inequality and higher unemployment, the African National Congress (ANC) lost the country’s majority vote for the first time. While that may be unsurprising in isolation, the fact that an ANC and Democratic Alliance (DA) led Government of National Unity (GNU) has been formed has been a positive surprise for many investors.

To that end, lets take a look at what has happened, what may happen and what most investment managers expected would happen prior to the election. Ultimately, we could be experiencing one of the most significant shifts in the South African investment case since the 90s, but there is still a lot of ground to cover.

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Election Direction
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The New Political Regime

During the first sitting of the National Assembly last week Friday, Members of Parliament re-elected Cyril Ramaphosa as the country’s president and the ANC’s Thoko Didiza was elected as the National Assembly Speaker. The DA’s Annelie Lotriet was elected as Deputy Speaker. This was one of the first indications that the GNU era is upon us. Before we try and process the implications of Friday’s National Assembly sitting, we need to understand what exactly the GNU is.

A GNU is a type of coalition government that is formed when no single political party holds the majority vote in a country. In many cases, GNU’s incorporate the main opposition party. From 1994 to 1997, South Africa was governed by a GNU, so this isn’t unfamiliar territory for our country. Currently, five political parties including the ANC, Democratic Alliance (DA), the Inkatha Freedom Party (IFP), the Patriotic Alliance and the GOOD Party all form part of the GNU. Collectively, they hold 68% or 273 of the 400 seats in the National Assembly.

Clearly, there is a lot to unpack and there is still a lot which needs to be agreed. In part, this has been driven by just how tight the deadlines have been. Most countries have months to hash out coalition agreements, while South Africa has two weeks. However, if we put the uncertainty aside for a moment, let’s look at what we do know now, which is a lot more than what we knew a month ago. Here is a summary:

  • Stable Transition – The ANC has been South Africa’s only ruling democratic party. The fact that the party has been able to navigate a transition to a new political regime where it is far less supported than it was, and in quite a stable manner, is positive. Changing Political Landscape – The last month has ushered in the most pronounced changes to South Africa’s political landscape since the 90s. Not only has the ANC lost the majority vote, but South Africa’s main opposition party now forms part of the government.

  • New Opposition – In the process, a new cohort of far-left populist political parties in the form of the Economic Freedom Fighters (EFF) and the uMkhonto weSizwe (MK) Party have intentionally and unintentionally assumed the mantle of the opposition.

  • Centrist Alignment – The fact that the GNU consists of both the DA and the ANC is an indication that both parties want to align themselves on moderate centrist values and political views that uphold the country’s constitutional democracy. If this weren’t the case, we would have likely seen some form of an ANC/EFF/MK Party coalition with the latter two parties being more far left aligned than centrist.

  • New Government, Same Problems – The GNU has inherited the same problems that continue to plague the country’s economy. These include very high levels of fiscal debt, low GDP growth, high levels of unemployment and high levels of inequality.

Given what we know, it is also worth briefly summarising what is still to come:

  • Cabinet Selection – After the President is officially inaugurated, he will have the discretion to select his cabinet. This will be something of a balancing act as he will likely need to include representatives from the different parties within the GNU. This week, the IFP’s Thami Nthuli who was elected as the KwaZulu Natal Premier through an ANC/IFP/DA/NFP coalition announced his cabinet. Within it, the DA was given two key departments – Finance and Public Works and Infrastructure. In addition, the IFP has four representatives in the cabinet. Representation across the KZN cabinet is split among the four parties and we may see something similar at a national level when Ramaphosa announces his cabinet.

  • Opening of Parliament – Once the President has assumed office and the cabinet has been selected, the President will need to address the new Parliament for the first time. In this address, he will be expected to outline the government’s agenda including key legislative direction and policies. This is where we will receive further indications of the policy stance the GNU is likely to take going forward.

Clearly, a lot has happened and a lot is yet to happen. To understand how asset managers have been factoring all of this information into their portfolios, we need to understand the different governance scenarios leading up to the election and through the coalition talks.

The Different Governance Scenarios

Leading up to the election, the general consensus among asset managers was that the ANC would continue to lose votes. However, the extent to which it would lose votes and who it would team up with to govern the country should it fail to secure the majority vote remained unknown.

To that end, four prevailing scenarios were put forward as being the most likely outcomes leading up to the election. As things stand today, Scenario 4, which was something of an outlier event, is taking shape. These scenarios present different outcomes for the country’s governance structure and the effect that may have on the price of assets linked to the South African economy. These include bond yields, property prices, equity prices and other risky assets.

Scenario 1 – Status Quo and the Slow Grind

Potential Outcome: Leading up to the election, many funds were positioned for this as the most likely outcome. The ANC loses its majority, but only just and enters into an agreement with a smaller party to retain control. Maintaining the status quo largely with a few minor concessions to accommodate its new partner.

Potential Market Reaction: Likely flat to net negative over the long term. Same ineffectual policies with not much change. Potentially a repeat of the last decade over the next decade. Ultimately, a long-term negative outcome. Fund managers running high offshore exposure as a result.

Scenario 2 – The Double Dip

Potential Outcome: A slightly less market friendly outcome than Scenario 1. The ANC loses its majority vote by a greater margin and enters into a coalition with the EFF to give the party a majority. This leads to a similar but more left aligned and less market friendly regime.

Potential Market Reaction: A negative market reaction in the short term and then a slow but negative reaction in the longer term. Hence, the Double Dip terminology. Some funds positioned aggressively against this as a ‘tail risk’, with maximum offshore exposure and limited domestic assets.

Scenario 3 – The Big Dip

Potential Outcome: The ANC loses a significant amount of its supporter base who turns to the far left and needs to enter into a coalition with both the MK Party and the EFF. Adopts even more radical and less constitutionally friendly policies.

Potential Market Outcome: Very negative on markets initially and over the long term. Some funds positioned aggressively against this as a ‘tail risk’, with maximum offshore exposure and limited domestic assets.

Scenario 4 – The Long Walk to Recovery

Potential Outcome: The ANC loses a significant amount of its majority and enters into a coalition with the DA and other business friendly parties. Implementing market friendly policies which promote economic growth and development over the long term. Only a handful of funds positioned for this scenario, guided by low domestic valuations rather than spot forecasts on the election outcome. SA assets have been very cheap for some time.

Potential Market Outcome: Positive initially and then through sustained evidence, positive over the long term. Fewer asset managers were positioned for this outcome.

Clearly, Scenario 4 is crystalising. This is supported by the fact that all of the major parties in the GNU have signed a statement of intent to run the government in such a manner and secondly, the three positions that were elected in the National Assembly, being the President, Speaker and Deputy Speaker were ANC and DA members supported by all of the members of the GNU.

Market Reaction

The events that have unfolded over the past few days can be seen as a positive shock to markets. The ZAR/USD exchange rate has recently broken through the R18/$ mark, SA Inc stocks (stocks listed on the JSE and linked to the South African economy) have rallied and bond yields have declined indicating an improvement in investor sentiment around domestic risk and thereby reducing government borrowing costs.

Leading up to the elections, many managers adopted a ‘wait-and-see approach’ but were typically erring on the side of caution and were positioned for some combination of the first three scenarios. This can be seen to an extent in the general direction of South Africa’s 10-year bond yields over the last year. As domestic risk increases, bond yields increase and as risk decreases, bond yields decrease. This is shown in Figure 1 below. The increase in bond yields leading up to the election was driven by the uncertainty around which of the four scenarios above would ensue. Once it became clear that the most market friendly scenario was likely, bond yields rallied (decreased) strongly.

Figure 1 – SA 10-Year Government Bond Yield%

The Way Forward

From an investment positioning perspective, there is a lot to digest and we are currently reviewing portfolios to align with the outcome of the past few days. If we look back over the past decade, it has been tough for SA investors, and leading up to the elections SA valuations across a range of assets have been at at very low levels. However, if the GNU operates as it was intended, the opportunity facing SA investors could be material coming off of a low base. It is still early and there is a lot of ground to cover in order to increase economic growth in South Africa and fundamentally change the country’s investment case. From this point forward we will likely need to see the following before the long-term investment case for South Africa becomes more positive:

  • In the short run, the GNU remaining intact and reaching formal agreement;

  • Ministerial appointments which reflect the GNU principles of proportional composition;

  • Evidence of the GNU functioning properly and not being held up with one of the key drawbacks to coalition governments – decision making stagnation as parties fail to reach agreement;

  • Manageable pushback from opposition parties that allows pro-growth decisions to be made;

  • Hopefully, no politically linked disruption where legal structure is challenged and could hold up progress, or even violence which could undermine confidence;

  • Above all, a track record of decision making efficiency, oversight, governance and sustained service delivery which ultimately leads to economic growth.

The past few weeks have been incredibly positive for a country showing signs of a maturing democracy. Although risk does remain and there are a number of attractive opportunities globally, this could be the start of something special for SA investors. However, with ‘Ramaphoria’ in our recent collective memories, it is probable that more evidence of progress will be required this time around before the South African investment case really turns a corner. In the meantime, the risk/return equation for local investments may have reached a tipping point, and that is good news for investors relying on domestic assets for returns.

Analysis courtesy of Fundhouse

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