A different look at the SA economy – the lessons in vanity, sanity and reality

Undoubtedly, the Covid-19 pandemic and resultant lockdowns crippled the South African economy. For months, various sectors battled to stay alive due to various restrictions. Even now, the tourism and alcohol industry – to name a few – are still trying to bounce back from last year. But, as Mike Schussler writes below, the South African economy was in a spot of bother even prior to the Covid-19 pandemic. While he says that the country should see some bounce back, the economy is in deep trouble. – Jarryd Neves

By Elize Kruger and Mike Schussler for Brenthurst Wealth

GDP is either produced or consumed, and that is how it is measured too. Production cannot happen if consumption does not occur, and consumption needs products and services to happen.

Production is the foundation of the economy and produces the goods and services needed in an economy. Mostly referred to as the non-financial private sector in an official language when recorded from GDP production statistics.

Many call the non-financial private sector the real economy or even the core economy. Without the non-financial private sector, banks have no one to lend to, while governments will not have a tax base. Consumption will not take place as people will not earn a living.

In South Africa, the actual economy has been hit hard over the last few years. But even before Covid 19, the economy’s private sectors’ core was declining. For eight of the previous twelve quarters, the South African private sector economy recorded declines.

Even worse, in only 3 of the last 27 quarters (almost 7 years!), the economy’s core grew faster than population growth. Furthermore, the three quarters where the economy’s private sectors core did grow faster than population growth, it was due to a rebound in Agriculture after the 2015 drought.

In the 4th quarter of 2020, the number of people employed in the non-financial private sector was at the lowest level since 2015. At the end of 2020, job numbers in the real economy grew by just 10,3% since 2007. 

The core private-sector economy made up 69% of total GDP in 2000, while two decades later, it is but 63%! This shows that the burden that the non-financial sector carries has increased as it now funds more government from a small share of the economy. This places a heavy burden on the private sector.

It is easy to blame the pandemic, and SA should see some bounce back, but even before the pandemic, the real economy grew at an average 1,2% annual rate for the ten years to 2019! 

The engine of the South African economy is in deep trouble. We try to answer that question below.

Vanity, sanity and reality in the South African economy

There is a simple saying for all enterprises: turnover is vanity; profit is sanity, and cash flow is the reality. The above simplicity hides a few exceptions, but this is the actual situation for almost all private-sector producers.

Revenue is vanity but necessary

One needs turnover in a business to make it happen. The total sales of a company are the first and most crucial step for enterprises. Without revenue, there will be no firm and that revenue growth is the lifeblood of stock market expectations.

Of course, one needs to adjust turnover for inflation. That is precisely what the graph below reflects of the entire South African non-financial private sector. 

Turnover growth for South Africa incorporated has been in decline since August 2018 after adjusting for inflation. When actual turnover declines in the private sector, the engine for expansion of the economy disappears.

Even banks have fewer customers to lend to while the government has less room to tax. Employment creation disappears, and people hang on for dear life in their current jobs, hoping the firm survives.

Turnover is in decline after inflation. That means executives are fighting more about market share than growing the market. That means that cost savings remain the order of the day while expansions remain plans and are not often implemented.

Graph 1: Real turnover in the non-financial private sector

Vanity is necessary but Sanity must prevail for success

Many businesspeople are quick to say what their sales or turnover is. They point to it like it is the end-all and be all that outsiders should take note of. But one could have a turnover of say R10 million, but that cost you R20 million to produce.

So turnover is named vanity, but profits or return on assets is called sanity.

Profit measures are not one size fits all, as service companies would look at the margin between revenue and total costs. The above is not an accounting lesson, so here we refer to the difference between revenues and total costs as a % of the total assets employed by the South African non-financial private sector.

Here the core of the South African economy has not had a great time either. The return on assets has been less than what the private enterprises could earn in interest in the bank for most of the last five years.

In graph 2 below, one can see that the massive drop in interest rates in response to Covid and the lockdowns saved the day by the end of 2020. Returns on assets, while low, were higher than the money market rate for the first time since q1 in 2015.

Graph 2: Return on assets vs money market rate

Return on assets – after interest –  are not academic and influence South African equity market prices even if the JSE top 40 earned more revenue outside SA. The returns show a high correlation with the SA MSCI for large, medium and small caps with small and medium caps particularly well-correlated. 

Like the age-old investment advice that assets need to offer a risk-based return, the evidence is clear at least for South Africa. 

In the graph below, we compare the MSCI price return for small and medium caps, representing ‘many of the larger firms in the non-financial private sector. The non-financial sector’s return on assets minus the money a shareholder can earn in the bank is compared with the price return of the SA MSCI small and medium cap index. 

When the money market interest earned is higher than the return on assets in the South African economy, the SA MSCI shows a shallow level of price change. The private sector return on assets is often a leading indicator of actual returns in the SA equity market.

Graph 3: Real price changes of the mid and small-cap MSCI versus real return on the SA private sector assets

One hopes that the graph makes things more straightforward for investors in South Africa that returns matter for the JSE beyond the Naspers, BATs, etc.

So sanity or return on assets compared to other possible investment choices matter. It, however, does not only matter for the JSE. It counts for employment too.

The following chart makes the point that as profits faltered, unemployment grew.  

Moreover, there is a correlation between return on assets as well as changes in private sector fixed investment. Profits are sanity, and they are the crux of any economy. 

Profits grow employment, share prices, fixed investment and they also lower political risks. The madness of a government at war with its private sector has to stop. The evidence that the data provides makes a strong point for less government interference and more support, for less red tape and better economic infrastructure.

Graph 4: Unemployment grows when profits decline

Reality is the here and now and can be measured by cash flow

A well-known businessman once told me that most businesses he knows survive day to day and month to month because they can defer the depreciation of assets. Not forever, he said, but until times get better.

That is what has been taking place in South Africa as even during the worst of time, cash flow never decreased below the average inflation rate of the country.

Therefore, the reality is the everyday costs such as interest, employees, stock but without accounting for depreciation and buying and selling off non-core business assets.

It makes sense for most business owners as they see their salaries as part of the “economic gain” they earn. Remember the typical SA business have only about nine employees, and he may have other reasons not to close shop and put his money in the bank. The owner does not want to lose his salary and sees that as part of his share. 

He may not be able to profit from the company, but he can live, save, and keep people employed. Because businesses that have say less than 50 employees, the owner will know most of them and see them as family.

One could also say that positive cash flow is a good survival indicator but not a growth indicator.

The graph below shows the after inflation free cash flow of the non-financial private sector. Only during the 2008 great financial crisis did real cash flow get near to zero. 

Graph 5: The survival indicator – cash-flow is reality

In summary, cash flow is the essential day to day indicator of survival, while sanity is the best indicator of economic growth. Turnover is an indicator of growth and market share but is the basis of the rest of the indicators.

So, what does this tell us about the future investment performance of SA?

These trends and numbers are useful for analysing the SA stock market and certain sectoral behaviour in the future.

We know that profits are increasing, but the biggest driver of positive return was declining interest rates in an ultra-low-rate environment.  As long as SA and international rates remain low, investing in a money market account will not deliver compared to the other two primary asset classes bonds and equity.

Equities are risky, but at present, they have lifted somewhat and are likely to grow faster when easy money is available all over the world.

The most significant risk factor will be short-term interest rates as set by the world’s Central banks.

In South Africa, we will see rates rise but moderately, so we believe most of the equity price rises in SA are now likely to be behind us. Still, there is not much of an alternative to equities in the short-term money market. But there is still some headway left and that may be good enough for a year or so.

Longer-term, if the government does not change its strategy of a high company tax environment and lots of profit sapping laws like BEE and other compliance factors, returns will be limited. The SA equity market will be limited in its ability to make a decent return, and prices will reflect that.

The other primary investment alternative is the bond market which offers about 9% for a ten-year government bond. The risks are less here, but if inflation in the world (or SA?) does take off, say, beyond 3% to 5% a year, the bond market will offer a low return.

(Remember bond prices are inverse to yields so when inflation rises, so too will yields. This is not so much a problem if you are keeping the bonds to term, but for changing investment strategy or if inflation goes to say 10%, then bonds will give you negative returns.)

Graph 6: SA short-term interest rates. Low for long?

I believe that playing safe with money in the bank is a fatal strategy in this environment and may even need to increase my risk tolerance. This is a dilemma for many people over 50.

I think returns in the bank are not safe from inflation, and most equities are a better bet at present.

Some equities such as in the construction sector are highly cyclical, and if the interest rate adjusts profits return to negative, then construction and infrastructure type stocks can collapse. But at present, that may not be the case, but it is a high-risk strategy in SA.

The other signal I get is that some Rand hedge stocks will not have a great time when the Rand remains strong. Strangely during times of low SA interest rates, the Rand is more stable, and that is probably since low rates encourage equity investments which see more flows than money market funds do. (more on this another day.)

Overall, SA equities are better than money markets for the foreseeable future. If more risk-averse, then SA government bonds are perhaps a better bet.

Foreign equities will have lower money market rate hurdles than SA Rand hedges and may make more sense than Rand hedges.

So, equities are the main drivers, and a part will have to be in foreign equities, is what the data tells me now. That is, if rates stay low for longer.

When you do not know, follow the dollar billionaires

Self-made billionaires are probably vain but are sane and certainly have a good hold on reality. You have probably heard of “following the money” well, here is some money to follow.

Did you know nine or ten SA born dollar billionaires live outside the country? Inside South Africa, we have six-dollar billionaires living here. So in total, SA has at least 15 dollar billionaires.

The younger billionaires live outside SA, and they are Elon Musk, Roelof Botha jnr, Patrick Soon-Shiong, David Sacks and Lyndon Rive (perhaps his brother Peter too?). Older ones such as Douw Steyn, Mannfred Gorey, Richard Enthoven and Ivan Glasberg still have an interest here in SA, but most of their fortunes are overseas.

Of the six billionaires still living in SA, three have companies that primarily earn their revenue outside SA. Nicky Oppenheimer, Johan Rupert and Koos Bekker make more outside SA by far than inside.

Table of SA-linked billionaires

South African born Dollar billionaires living elsewhere
Name Living where Company
Ivan Glasenberg  Swiss /Australia Glencore
Elon Musk USA Tesla Space X
Nathan Kirsh UK / USA Jetro
Manfred Gorvy  UK / USA Hanover Acceptances
Douw Steyn UK / SA BGL group UK
Patrick Soon-Shiong USA NantWorks
Roelof Botha (Jnr) USA Sequoia Capital Pay Pal
Richard Enthoven  Australia Hollard Insurance, Nandos
David Sacks  USA Pay Pal, Yammer, Uber
Lyndon Rive USA  Solar City / Tesla
Michiel Le Roux SA Capitec
Koos Bekker SA  Naspers
Patrice Motsepe SA ARM
Johann Rupert SA Rembrandt
Nicky Oppenheimer SA /UK Anglo American
Stephan Saad SA Aspen

Honourable mention Peter Rive brother of Lyndon and Kimbal Musk brother of Elon also have Tesla shares Kimbal also owns a $400m chain of restaurants

All three have moved more of their assets offshore over the last three decades.

So only 3 South African of the 6? Billionaires residing here in SA earn most of their income in South Africa. That in itself tells me that returns may have struggled in SA for longer than we have data of. Or at least the risk-reward of South African profits are not good enough to keep some SA residence billionaires here.

So let us say six of our fifteen-dollar billionaires earn most or some of their wealth from SA, while eight have very little to do with SA. Of the six with earnings in SA, at least three make most of their revenue offshore.

So, ten of the dollar billionaires earn their revenue outside SA, although they are connected to SA by birth and education. Only five-dollar billionaires make much of their income here. Patrice Motsepe, Michiel Le Roux, Stephen Saad, and Richard Enthoven (who now lives in Australia). Douw Steyn too still has large holdings in SA.

So 10 earn the most revenue offshore while 5 earn more in South Africa (although Douw Steyn could be mainly offshore now). Therefore at least two-thirds of our dollar billionaires make most of their revenue offshore.

That more than any figure above should give you a good idea as to where to invest. To lose one billionaire is unfortunate to lose two dam unluck; Losing four is a disaster. SA lost at least eight and even some here grow their business elsewhere. For a developing country that is at least a lost generation.

Once we were rich

One final picture to conclude… a comparison of the wealth per person suggests that the typical person in the world is now more prosperous than the typical South African. The graph also says how much the world citizen is overtaking South African in absolute and relative terms. 

Graph 7. Typical wealth compared

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