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Five Reasons to Remain Optimistic about South Africa's Market Outlook

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As we celebrate the Government of National Unity’s 100-day milestone and recent positive economic milestones, there is a renewed sense of optimism in South Africa’s market outlook. Strong fundamentals indicate that robust performance is likely to continue over the next 18 months. Key economic indicators such as improved currency strength and lower inflation are creating a conducive environment for investment. This is especially true within the fixed income sector, where we are witnessing unprecedented outperformance.

As interest rates are still hovering at elevated levels by historic standards and the landscape for bonds becomes increasingly favourable, investors have a compelling case to focus on fixed income assets that promise both stability and attractive returns. Let’s explore five key reasons to remain optimistic about South Africa’s future.

1. Strength of the South African rand

Since the elections, the South African rand has demonstrated remarkable resilience, almost dipping below R17.00 against the US dollar recently. This reflects a significant recovery from earlier this year when it hovered above R19.20. The relative strength of almost R2.00 is not just a statistic; it has real implications for the economy. A stronger currency contributes to lower import costs and mitigates inflationary pressures, creating a more stable environment for both consumers and businesses. As the currency appreciates, it is expected to feed through to local inflation rates, which were recently reported at 4.4% year-on-year for August 2024, below the mid-point of 4.5% when considering the South African Reserve Bank’s target band of 3-6%. Price stability, or indeed contained inflation, is a key component of helping to foster a stable and growing economy. The current situation supports a stable economic outlook, fostering confidence among investors.

2. Favourable fixed income landscape

The current fixed income environment is arguably the most favourable we have seen in years. Bond yields are at historic highs, with cash remaining relatively cheap. This provides an attractive yield across various asset classes, creating opportunities for savvy investors.

  • Nominal bonds: Despite a recent rally of almost 200 points on the government bond curve, bonds remain undervalued. They are trading at more attractive levels than they have in over a decade, in fact it could be argued some of the most attractive levels in almost two decades, indicating potential for further appreciation.
  • Inflation-linked bonds (ILBs): ILBs are currently trading at a real yield of between 4-5% throughout the curve. This positions them as a critical component of the fixed income universe, offering protection against inflation, and indeed unexpected inflation, while at the same time trading at levels that suggest attractive prospective returns.
  • Cash investments: With the repo rate currently at 8.0% after the most recent cut in September, and local CPI inflation most recently printing at 4.4% year-on-year, the real policy rate remains well above 3%. This exceptionally high figure makes cash an attractive option for income funds and fixed-income strategies, especially those with a significant floating rate note component. This dynamic is beneficial for investors looking for stable, income-generating assets.

3. Encouraging outlook for policy rate adjustments

The combination of lower inflation figures, bolstered by a stronger currency, supports the process of policy rate adjustments in South Africa. The current repo rate is at the highest level in almost 20 years. As inflation remains contained and likely to surprise us on the downside, it will help pave the way for cuts in the repo rate, further stimulating economic activity. This shift would enhance the appeal of fixed-income investments and create a more accommodating environment for borrowers, which could translate into higher growth across sectors.

4. Strong performance of fixed income funds

The *SIM Enhanced Yield Fund exemplifies the benefits of this robust environment. The fund has delivered exceptionally high returns compared to the broader peer group and its own well-established performance history. It posted a rarely seen double-digit return of over 11% for the 12 months ending September 2024, significantly exceeding the cash rates available at banks and outperforming traditional money market funds. In contrast, the fund’s benchmark, SteFI +0.5%, delivered just above 9% during the same period. This underscores the fund's strong positioning in the current market and highlights the attractiveness of enhanced yield and income funds in a low-interest-rate environment.

5. Positive valuation trends across asset classes

As we assess the broader market context, it’s crucial to note that valuations across South African asset classes – ranging from bonds to property to equities – have been depressed for several years. The recent performance uptick, though impressive, stems from a rebound from a low base. Importantly, this suggests that South African assets remain attractive when compared to historical benchmarks, as well as relative to emerging market peers and developed markets. The valuations indicate potential for further growth and recovery in the coming months, which is a promising sign for investors looking to capitalise on South Africa’s evolving economic landscape.

As we move forward, investors should remain vigilant and consider the broader implications of these developments on their strategies. South Africa, with its unique attributes and improving metrics, is well positioned to offer significant opportunities for those willing to navigate the complexities of the current market landscape.

*The full registered name of the portfolio is the Sanlam Investment Management Enhanced Yield Fund.

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