The war in Ukraine has shifted. The Russians have given up their efforts to take Kyiv and are now concentrating in the Eastern “Donbas” region where their lines of communication are shorter. Clearly, this has been a major set-back for them and a huge boost for the morale of the Ukrainians. It is becoming apparent that the Russians have committed a much larger proportion of their army to this second, less ambitious, attack from the East, but it does not appear that they have changed their tactics or strategy in any significant way. They are still apparently adopting a World War II “blitzkrieg” approach, hoping to overcome their more agile enemy by sheer weight of numbers and firepower. The Ukrainian army, despite the destruction of some of their cities, has gained enormously from its experiences over the past two months. It has been systematically re-armed by NATO, with the addition of heavy weapons, and now has a formidable force of well-armed and experienced fighters and is clearly capable of making strikes inside Russia. Thus far the battles in the Donbas have been intense and involved heavy losses on both sides. Aside from a few small concessions, Ukraine has hardly lost any ground and something of a stalemate appears to have come about. It remains our view that time is on the side of the Ukrainians. The Russians cannot really afford a long-drawn-out war of attrition.
The Russianis taking enormous strain from the double cost of the war and the which it is enduring. Its ability to continue this war for a significant period must be seriously in doubt. The probability of Russia facing an internal insurrection of some sort is rising as the effects of the war begin to be felt more and more acutely by its population. In our opinion, the re-grouping of the Russian army in the Eastern Donbas region and its renewed attacks represent its final effort to displace Zelensky and gain control of Ukraine. If they fail for a second time, which seems inevitable, given their tactics and the mounting economic pressure on them, then not only will they lose their hold on Ukraine, but Putin will almost certainly loose his control over Russia itself.
There is the possibility that the situation will settle into a position where Russia returns to the situation which existed before the war began but with some small territorial gains, especially on the Black Sea. We believe that this scenario would not be sustainable for Russia because Western economic sanctions will remain in place and their economy (which is only about the size of the American state of Texas) will inevitably collapse, especially if Europe can wean itself off Russianand .
Our view is that eventually Putin will be ousted from power – probably by someone from within his inner circle. There are already questions around his health and the events in Ukraine have certainly damaged his image as an absolute dictator. What looks now like his inevitable demise will probably be followed by a period of fairly chaotic adjustment, but inevitably, Russia will continue on the path that it was on before this conflict began – that of becoming a modern and ultimately democratic,European economy. We even see the possibility of it joining the and NATO once the dust has settled sufficiently. In other words, we see this war in Ukraine as probably the final kick in the Soviet authoritarian anachronism.
There is, of course, the outside possibility that the situation could escalate into a nuclear war between Russia and the NATO alliance. Russia’s minister of foreign affairs, Sergey Lavrov has recently been talking about the increased danger of nuclear war. In our view, this is “sabre rattling” and a sign that Russia is becoming increasingly desperate about its chances of obtaining any significant gains in the conventional war. A nuclear war would result in the immediate, complete and utter annihilation of Russia. No doubt, Europe and America would also suffer some horrendous damage, but nothing to compare with that sustained by the Russians. It is impossible to make any reasonable predictions for this scenario. We can only hope that there are those in positions of power within Russia who can see the utter futility of such a course of action and take effective steps to ensure that it does not happen.
In our view, the Ukraine situation has already been substantiallyed into the financial of the world and the . Unless there is some unforeseen escalation (such as NATO entering the war directly with “boots on the ground”), we suggest that most on the JSE will be impacted less and less by developments. The primary effects for South Africa are probably going to be the raised price of fuel, countered by the benefits to our from rising prices.
The comments of the governor of the(the Fed), Jerome Powell, concerning a 50- rise in in the US at the (MPC) meeting in May, combined with the Fed’s intention to reduce the size of its by $95bn a month amount to a significant and rapid shift in US .
It is clear now that the US has been “behind the curve” because it persisted with the idea that the rise into above 5% late last year was a temporary phenomenon. Now that inflation has risen in March 2022 to 8,5% it is apparent that the Fed needs to take radical action to contain it.
St. Louis Federal Reserve President, James Bullard, said the U.S.'s short-term policy rate should reach 3.5% later this year. For that to happen there will have to be a series of 50-basis-point hikes in interest rates in the coming months. At the same time, Fed officials have "generally agreed" to cut up to $95 billion a month from the central bank's holdings – a process which is known as (QT) and is the opposite of (QE). Investors are now projecting a 90% likelihood of a 50 basis-point rate hike at the central bank's meeting this month, followed by further 50-basis-point hikes during the rest of 2022. That perception is the main underlying cause of the current ness on .
At the same time,on are expecting ' to have grown 6.4% in the March quarter and so far, they have been exceeding that forecast comfortably.
Nearly a third of the companies on the S&P 500 have reportedthis week. Overall, earnings have been better than expected, with nearly 80% of the 176 companies in the S&P 500 that have reported so far beating Wall Street expectations.
From aperspective, the bitter fighting in the Donbas region of Ukraine added additional to a market that was already falling because of the stance of the US Federal Reserve Bank (the Fed) and on Friday last week that finally carried the S&P500 down through the level at 4170. Consider the :
The above chart shows the progress of the majorin the S&P500 index this year. After the “ ” in early March 2022 we thought that the correction had seen its lowest closing level, but we did not count on two developments – firstly that the Fed’s governor, Jerome Powell, would come out with an overtly bearish remark and secondly that the fighting in Ukraine would reach a new level of intensity in the Donbas. These two events have combined to take the down through 4170 to a new . However, you will note that the low is still slightly above the intraday low of 4114 which was made on 24th February 2022.
Given the better-than expected quarterly results coming out of those S&P500 companies that have reported so far and the current strength of the US economy, we believe that the S&P will recover. However, it is worth remembering that in our Confidential Report published on 3rd November 2021 we predicted this correction 2 months before it started and said that it could take the S&P down to as low as 3680. At this time, we certainly do not see the S&P falling that far – but given the break down through support at 4170 it could certainly fall further.
Despite this, we still remain confident that this is a correction and not the start of a new. For this reason, we continue to see it as a .
Before looking at developments in the economy this month, we thought it constructive to consider its progress in the light of internationally accepted standards for the reform of. We believe that after 28 years in power, most of them with a significant majority, the ANC has had plenty of opportunity to implement economic reforms.
The Washington Consensus
In 1989, an English economist, John Williamson, came up with a set of ten principals for the reform of emerging markets and developing economies which became known as thebecause they were very widely accepted by those international institutions based in Washington (such as the , the and the US Treasury). At the time that Williamson put forward these ideas, the USSR was busy unraveling with the collapse of the Berlin Wall and the reforms were seen as the best mechanism for Russia to become a thriving capitalist economy.
It is useful and interesting to consider the ten principals of the Washington Consensus as they apply to the South African economy. The effectiveness of the reform process has a direct impact on the performance of the JSE. The steadily declining number ofover the past ten years is an overt symptom of .
The ten Washington Consensus principals of economic reform are:
- Fiscal policy discipline, with avoidance of large fiscal deficits relative to GDP.
discipline was excellent in South Africa while Trevor Manuel was the Minister of Finance, but since his departure levels have been allowed to rise, especially during the Zuma years and with the systematic looting of state coffers through state capture. Since the advent of the Ramaphosa administration enormous efforts have been made to bring the down and with the help of the tax bonanza from the it is now coming back under control.
- Redirection of public spending from subsidies ("especially indiscriminate subsidies") toward broad-based provision of key pro-growth, pro-poor services like primary education, primary health care and infrastructure investment.
Since the ANC came into power 28 years ago, the pro-growth, pro-poor services mentioned above have suffered. Health care, education and infrastructure development have been set aside in favour of the five social relief grants (i.e., subsidies) which absorb some 60% of the government’s non-interest spending. In effect the government is subsidising people who do not or cannot work instead of empowering them with education and proper health care.
- Tax reform, broadening the tax base and adopting moderate marginal tax rates.
There can be little doubt that since the Ramaphosa administration took over a significant effort has been made to improve the collection of taxes and undo the damage done by Tom Moyane and state capture, but there is a long way to go. The remains narrow with a massive and growing “ ” – which is really a euphemism for tax evasion. The tax rate has been reduced and tax collections have improved mainly due to the commodity bonanza that the country is currently enjoying.
- Interest rates that are market determined and positive (but moderate) in real terms.
stability has been probably the single greatest achievement of the ANC government over the past 28 years and right through the Zuma period of state capture. Indeed, the and the Judiciary are almost the only two organs of state that were not captured. The low level of inflation and relative stability of the rand are the envy of other emerging economies and have helped us to weather the storm of . The rand remains one of only five emerging market currencies that have actually appreciated against the US dollar this year.
- Competitive exchange rates.
This factor is connected to the effective monetary policy mentioned above. The benefits of having a that is stable against currencies cannot be over-emphasised. A stable currency instils confidence in the economy for both local and overseas . If our currency was subject to rampant inflation and falling against overseas currencies, we would be unable to attract (FDI) and the economy would be spiralling down in the same way as many African economies. Our currency is traded in a very free and competitive market which has made it the benchmark emerging market currency.
- Trade liberalization: liberalization of imports, with particular emphasis on elimination of quantitative restrictions (licensing, etc.); any trade protection to be provided by low and relatively uniform tariffs.
This is a thorny subject. Opening the economy to is obviously ideal from an economic point of view. However, the South African government has seen fit to impose on imported chicken, cement, and to name just three products. These are high bulk, relatively low value products which are expensive to from other countries – and yet the Pakistanis are able to produce and transport cement here more cheaply than we can make it here. The same applies to chicken. Obviously if you apply tariffs to an import, you immediately make that product more expensive for local consumers. Since chicken is the primary source of protein in this country the government should allow it in -free and if local producers cannot compete, they should be allowed to go out of business.
- Liberalization of inward foreign direct investment.
President Ramaphosa has made this his personal mission with a fair degree of success. Through his annual conferences, he has managed to attract considerable investment. But the policies of and the onerous abour laws which are skewed heavily in favour of employees have tended to keep investors away. Obviously, the stability of the rand has been a major positive factor as is the very well-developed and stable commercial ing .
- Privatisation of state enterprises.
This is another political “hot potato” to the extent that the very term “ ” has become taboo in government circles. Despite this there is a recognition that certain of the (SOE) would be better off if they were partially or completely financed and managed by . The example of Telkom, which is managed privately, but in which the government still effectively holds a stake is important. It shows that private enterprise generally manages large organisations better than government. More recently, SAA is in the process of being taken over by private enterprise, with significant government support. The principal is that if it is at all possible for an enterprise to be privately owned and managed rather than in government hands – it should be. A number of examples of inefficient SOEs come to mind – the Post Office, Denel, the SABC and so on. Privatisation can also result in an inflow of funds into the which could be used to reduce the government .
- Deregulation: abolition of regulations that impede market entry or restrict competition, except for those justified on safety, environmental and consumer protection grounds, and prudential oversight of financial institutions.
Since it took control of South Africa the ANC has presided over a deluge of legislation much of which is openly ignored and some of which impedes business. Efforts have been made to reduce legislation and eliminate red tape and the entire informal sector operates substantially outside the law. However, establishing a small business and complying with all the rules in South Africa remains onerous. Small business is the largest employer in the economy and should obviously be encouraged. The consensus identifies four areas where legislation is justified – safety, environmental protection, consumer protection and prudential oversight. It is clear that legislation in South Africa goes well beyond this at a significant cost to the economy and .
- Legal security for property rights.
The distribution of land in this country is highly contentious and has been the subject of much rhetoric. For an economy to grow it is important that property rights be seen as sacrosanct. The attempts to enable are seen by overseas investors as highly negative. They work against Ramaphosa’s efforts to encourage .
The South African economy over the Zuma period has also suffered from a toxic combination of indolence, corruption and incompetence which fed heavily into state capture. In our view, the failure to adhere to the full spectrum of the Washington Consensus has certainly impeded progress and economic prosperity in South Africa, while those principals which have been adhered to have saved this country from following so many African economies and becoming a “banana republic.”
Consumer prices (inflation) rose to 5,9% in March 2022 – which is very close to the upper end of the Reserve Bank’s
The latest report of the
are a very good indication of economic growth. Consumers and businesses can always put off buying a new car when cash flow is constrained – so a jump in new car sales is an indication that confidence is returning. In March 2022 new car sales were more than 50600 – that’s up 16,5% on the same month last year and the best sales level since October 2019. Obviously, despite the three 0,25% rises in the interest rates and the prospect of further rises, rates are still on the low side and that encourages people to finance vehicle purchases. Motor vehicle exports were down 12,4% but will probably recover as the Ukraine crisis comes under control.
The flooding in Natal comes on top of the impact of the
The theft of metal
Mining which used to be the backbone of the economy has shrunk substantially since the ANC took power. The unfriendly empowerment regulations are added to an erratic and expensive electricity supply and Transnet’s frequent inability to get minerals to port for export. The combination of the factors has made South Africa one of the least attractive destinations for mining investment in the world – and even in Africa. There is a backlog of more than 4000 applications for mining licences which have not been processed due to government inefficiency and bureaucracy. At a time when the country faces an official
Eskom’s fleet of-fired power stations is now 43 years old on average, which means that it is subject to unscheduled breakdowns on a regular basis. In the year to the end of March 2022, Eskom spent R7bn to run diesel turbines to compensate for its inefficient fleet of power stations which are only able to manage a 60% availability. The return to stage 4 loadshedding in April 2022 is a blow to the economy which is just recovering from COVID-19 and the impact of the July 2021 civil unrest. Over the next three years it is estimated that about 8 gigawatts of power will be added to the grid from sources – and it is apparent that Eskom is relying on this new supply. The current supply shortfall is about 6 gigawatts. By 2025 when the additional capacity may be available, the demand for Eskom’s electricity may be considerably lower as consumers and businesses find alternative solutions. The regular price hikes from Eskom are also pricing it out of the market. In our view, Eskom will probably cease to exist as a power generation entity by the end of this decade. Frustration with the new bout of load-shedding has led to public spats between Eskom board members and the Standing Committee on Public Accounts (SCOPA). President Ramaphosa has had to intervene to calm the situation. At the same time, the Department of Mineral and Energy Affairs has postponed, for the fifth time, the deadline for financial commitment to the winning bidders in the emergency power procurement program. This means that the deadline is now a year behind its original date.
In the week between 14th and 22nd April 2022, the rand took a beating falling almost 6% – mainly because of the remarks of US Federal Reserve Bank chair, Jerome Powell. Alarmed by a 40-year high in inflation which hit 8,5% in America in March 2022, Powell indicated that interest rates would rise by 50 basis points at the next monetary policy committee (MPC) meeting in May 2022. This has caused a shift towards “
You can see that prior to the civil unrest in July 2021 the rand had been strengthening against the US dollar. The riots sparked a period of weakness which lasted until December and then a new strengthening trend began. When the war in Ukraine broke out, the rand weakened a little in response to new, but basically held its ground. Only when the US Federal Reserve Bank began to get seriously worried about inflation did the rand fall heavily.
Right now, the investment community is busy digesting the new, much more hawkish stance of the Fed sohave fallen and the rand is treading water at weaker levels. We expect it to strengthen as the news is more fully discounted.
The government’s decision to force all government departments to use the South African Post Office’s (SAPO) services wherever possible is counter-productive. It is well known that SAPO is hugely inefficient and has completely lost its market in thedue to poor performance. To force government departments to use its services in order to rescue SAPO financially will simply make those departments less efficient than they already are. It is a retrogressive step and shows a comprehensive misunderstanding of how a modern economy works. Postnet and various courier companies have grown precisely because of the inefficiencies of the Post Office just as Curro and other companies have grown because of the sharp decline in the quality of education at government schools. In our opinion, SAPO, Denel, the SABC and SAA should all cease to exist – because they are incapable of competing and are costing the taxpayer money unnecessarily.
It is difficult to know whether we can take the ANC’s “discussion document” leaked to the Business Day on 25th April 2022 seriously. Along with some populist rhetoric, the paper proposes that business acquire a stake in certain key state owned enterprises in what looks very much like a degree of privatization. It seems that the government has become aware that its efforts to create jobs from within government are counter-productive and it would do better to get private enterprise involved. The document is to be tabled at the ANC’s conference later in 2022 and is perhaps an indication of President Ramaphosa’s confidence that he will not be recalled or seriously opposed at that meeting.
The(SRD) of R350 per month which was given to indigent people following COVID-19 and then extended for a year at a cost of R44bn to taxpayers has been found to have been subject to rampant fraud. More than 25000 fraudulent payments been made, including more than 5800 to government employees. This is part of a pattern of corruption which plagues every aspect of government activity and which is a serious burden to the country. It seems that whatever program the government decides to undertake, there is going to be a large fraudulent component. Obviously, fraud costs the taxpayer heavily and acts as a disincentive to projects like the SRD.
Finance Minister, Enoch Godongwana’s approval of an investigation into the running of the Cape Town metropolitan rail system is a significant shift in ANC policy. Until now the government has blocked efforts by Cape Town’s provincial government to take over the management of the rail system for political reasons. But that system has virtually collapsed with only 33 working train sets, down from 95 train sets in 1995. Godongwana is apparently in favour of removing the state-owned enterprise (SOE), Prasa from an important function which it has performed so badly for decades. The shift is also a boost for the city of Cape Town because it means that an effective efficient rail transport system can be implemented, but it is also a major step towards the government reducing its size and showing a willingness to let go of functions for which it is not well suited.
In our view, the war in Ukraine is likely to be relatively short-term, if only because Russia cannot afford to continue prosecuting a war while enduring extremely heavy sanctions. Already it is apparent that the oil price has probably topped out and is now falling back to more reasonable levels. We expect this “normalization” to continue.
You can see in this chart ofthat following the advent of COVID-19 in April 2020, the price of oil began to rise steadily in a clearly defined channel that was broken on the upside by the Ukraine crisis in March 2022. The price reached a peak of $125 per barrel and has since been trending down. Russia’s supply of oil to world markets is being steadily replaced by supply from the Middle East. Most European countries and especially Germany are actively trying to reduce their dependence on Russian supply. We expect the oil price to remain volatile, but to continue declining.
The Association of Mineworkers and Construction Union (AMCU) and the National Union of Mineworkers (NUM) have been onat Sibanye’s gold mines since 9th March 2022 – which has so far cost miners more than R1bn in lost wages. Now the , seeing that they not getting a positive response from management have given notice of extending the strike to Sibanye’s (PGM) operations in a so-called “sympathy strike”. Obviously, the loss of gold production is costing Sibanye, but its gold mining operation in South Africa only accounts for about 7% of its total . Extending the strike to its PGM operations will certainly increase the cost to Sibanye – provided, of course, that the PGM workers are willing to forgo their wages to assist their colleagues in the gold industry which doesn’t seem likely. The unions have rejected a sweetened offer by Sibanye and vowed to continue their strike. They justify this by pointing to Neal Froneman’s recently announced massive R300m annual earnings. The offer by Sibanye to unions now beats inflation by a wide margin, but they have become fixated on Froneman’s earnings and the enormous disparity which exists between the highest and lowest paid workers in the company. Notably, at the same time that this is going on, the bus drivers have just accepted a 6% wage increase – which is well below what the Sibanye workers are being offered. It is a fact that, in a capitalist economy, remuneration levels vary substantially depending on the work done, the worker’s qualifications and experience as well as the relative scarcity of that type of employee. The socialist concept of everyone earning more-or-less the same has never been a part of capitalism. Consider the chart:
As you can see here Sibanye has been in a strongfor the past 4 years with the share rising from just over R7 to current levels around R55. Clearly, the strike is not having a major impact on investor perceptions. We expect this share to continue rising over time.
The Clicksfor the six months to 28th February 2022 were excellent as usual. The company reported group up 9% and (HEPS) up 26%. The company returned R1,3bn to in and share s. The company said, " Retail sales grew by 13.6%, with selling price inflation of 3.7%. Distribution turnover increased by 0.6%, with price inflation of 1.9% for the first half. Inventory levels were well managed and group inventory days reduced to 78 days (H1 2021: 83 days). Retail inventory days improved from 85 to 81 days and UPD from 56 to 49 days". We urge you, once again, to buy this share on any weakness and include it in your long-term . The share at 590c on 11th March 2002. Today it trades for over R310 per share – and during that 20-year period it has given regular returns to shareholders culminating in the R1,3bn given in this latest six months. Consider the exponential chart:
Just over ten years ago on 9th January 2012, I bought a parcel of Coronation (CML) shares for R23.20 per share. My reasons were relatively simple – here was a financial services company that was growing rapidly and beginning to attract the attention of. And it was very on a (DY) of 7,41%. Normally, any reasonable quality share on a DY of 5% or more is worth considering. The reason for this is that most quality shares trade on a DY of around 2,5% - which means that a share on a DY of 5% is trading at about half what it could be worth. If course, it must be a quality share with a solid growth in earnings and a substantial of shares changing hand each day, otherwise the big will not be interested. In January 2012, after careful consideration I decided that Coronation was fundamentally undervalued and that sooner or later the big institutions would realise this and begin buying it. Consider the chart:
Over the next three years the share went up consistently, eventually reaching a peak of R115 at the end of 2014. Then the CEO of the company resigned, and the share began to fall. I sold out reluctantly for R94 which was my stop-loss level – and as you can see from the chart above the share has been in a downward trend since then. COVID-19 took it down to aof around R25 in March/April 2020, but it has recovered somewhat since then. The point is that today it is once again trading for a high DY of 8,99%. In any event, if and when the share breaks up through its long-term downward it will certainly be worth considering.
In their latestfor the six months to 31st March 2022, Pepkor estimated that headline earnings per share (HEPS) would increase by between 22,3% and 31,9%. This is a significant achievement in the current economic environment and following the floods in Natal. Pepkor has been an amazing success story over years catering to the low-income group’s clothing needs. Consider the chart:
As you can see here, the share fell heavily along with all retailers during COVID-19 in March 2020. It then movedin an “ ” with strong at R10 per share. Beginning in November 2020 it began to recover and has been moving up since then. We believe that this share will continue to perform well as the economy recovers.
As the commodity boom continues, it is worth considering diversified international mining houses. South 32 (S32) wasof BHP Billiton in 2015 and contained all of BHP's South African coal assets. It is, in its own right, a diversified miner of and minerals such as , , , , lead, and . It operates in South Africa, South America, and Australia. The company has separated out its coal assets in South Africa and especially those which supply Eskom, into a separate entity which was sold on 1st June 2020 to Seriti. At the same time the company has announced that it has bought the remaining 83% of Arizona Mining which it did not already own. Arizona Mining has extensive interests in zinc, manganese and silver described by South 32's CEO, Graham Kerr, as "...one of the most exciting base metal projects in the world". Clearly, this is another international that is distancing itself from South Africa because of the administrative and legislative uncertainty here. Kerr has stated that "...mining exploration is out of the question in South Africa until the new mining charter is finalised". The company is continuing with its $1,4bn share buy-back. The company is working to supply its Hillside smelter with renewable energy and transition away from Eskom over the next 10 years. In its results for the six months to 31st December 2021 the company reported revenue up 61,2% and headline earnings per share (HEPS) of 22,8c compared with 1,8c in the previous period. The company said, "We achieved a record operating margin of 44% and a significant improvement in our Underlying earnings to US$1.0B in the half, following a broad recovery in commodity prices, while also making substantial progress reshaping our portfolio". Consider the chart:
As you can see, following the COVID19 downtrend, this share has been recovering. That recovery was initially slow until September 2021 and then it began to accelerate. This is partly due to the fact that it has new base metal interests, some of which may be very exciting. We consider the share, although, to have further potential.
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