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The current political environment has dampened expectations in South Africa, evidenced by macro-economic data such as business confidence levels that are at generational lows. However, when you look at the SA market’s performance over the last century, perhaps expectations are too low.
From 1900 to end 2016, South African equities were the best-performing in the world, delivering inflation plus 7.2% annually. This according to the 2017 edition of the Credit Suisse Global Investment Returns Yearbook, which compared various asset class returns over the 117-year period for the 21 countries with continuous investment histories.
It might seem hard to believe. Given the country’s political history and economic difficulties, how could SA have been the best-performing stock market in the world since the turn of the 20th century?
Low competition drives potential returns higher
Free markets dictate that companies enjoying high returns on capital attract competition. Rising competition causes the balance of supply and demand to shift, inevitably driving prices of goods and services lower. As industry margins begin to narrow, returns on capital start to fall.
In contrast, a lack of competition allows companies to continue earning excess returns on capital for extended periods of time. For this reason, it is often more important to understand and analyse supply than demand.
A potential reason for South Africa’s equity outperformance over these past 116 years is that there has been less competition for South African companies when compared to many other countries.
This has been due to prolonged periods of political uncertainty, sanctions during much of the apartheid era and a persistent fear that South Africa will suffer a similar fate to Zimbabwe.
Take Santam as an example
The benefit of restricted competition is well illustrated in the case of the short-term insurer, Santam, which has compounded its share price at 18% a year (excluding dividends) from the beginning of 1985 to now.
Headline inflation averaged 8% a year over this period. This is especially impressive when you consider that Santam is a domestically focused company.
Between 1985 and now, SA witnessed the Rubicon speech, narrowly avoided a civil war, weathered four recessions and suffered through 86 months in which the year-on-year decline in the rand was more than 20%.
Despite all this, Santam’s moat, its ability to withstand competition and retain market share, has gone from strength to strength.
Because South Africa has not been viewed as an attractive place to do business, there has been little competition from international heavyweights, which allowed Santam to build scale and make itself increasingly tough to compete with.
The current political environment provides close parallels to the past
Due to heightened perceived risk and the way that corporate decision-making takes place, it is currently more likely for foreign businesses to exit SA than to enter it.
Two recent examples that demonstrate this are Barclays plc deciding to exit its investment in Barclays Africa, and Pioneer Foods disclosing that a large multinational had pulled out of a potential merger with the company.
Similarly, on the back of the release of the new mining charter, we can expect very little new investment in mining, or in companies that supply mining equipment.
We believe that over time, good management teams find ways to win regardless of the macro-economic environment.
In fact, they often shine in times of distress precisely because of the lack of competition. Tough environments result in the strong becoming stronger, as weak players leave the market and allow the winners to grab greater market share.
Mikhail Motala is an equity analyst at PSG Asset Management.
