Peter Montalto: No Zumxit yet – now DA’s turn to be tested

The big question on many investors’ lips is: when will President Jacob Zuma go? While many South Africans see his departure as a step towards improved living conditions and better economic prospects for the country, there’s big money to be made by investors in accurately timing a change in the country’s leadership. For insights into when Zuma will move on, many look to Peter Montalto, a London-based South African specialist with Japanese global investment bank Nomura. In addition to having well-placed connections in South Africa and making it his business to regularly visit the country to assess the mood and deepen his understanding of the country’s political nuances, Montalto is a remarkable number cruncher and analyst (see below). Big bets have been placed on Zuma leaving sooner rather than later, as a result driving up the rand’s value. But Montalto reckons traders shouldn’t bank on Zumxit any time soon. He also cautions against being overly enthusiastic about the rise of the DA following local elections. It’s going to be more challenging than meets the eye for it to outshine the ANC, is Montalto’s message. – Jackie Cameron.

Peter Attard Montalto on the staff rooftop chill area at Nomura's London HQ.
Peter Attard Montalto on the staff rooftop chill area at Nomura’s London HQ.

Alec Hogg is with Peter Attard Montalto, the go-to man when it comes to South African affairs in London. Peter, you’ve been very active in the last week with the municipal elections. We know that Ipsos called it accurately. You seemed to get it pretty close as well

It’s been a tough couple of days definitely, analysing what’s going on and I think broadly the themes were as expected. Yes the ANC did worse than we were forecasting but broadly it was about protesting a vote. I think we can say that the DA is doing well in highly selected areas, but not really nationally. The EFF, a similar sort of narrative as well, so yes I think the narratives are roughly as expected but some interesting details. Still a long way to go if we think about coalition discussions, the complexity around that in maybe more places than we initially expected in Ekurhuleni and Johannesburg as well, so it remains a fascinating two weeks to come I think.

Do you think we’ve reached an inflection point in South African politics?

It depends on what time horizon you define that over, so if we think about ten years, 15 years I think that’s definitely true. I think maybe we’ll look back and see the Nenegate constitutional court case etcetera as the start of that inflection point, but I was thinking right now, sort of out for a year or two I think that’s less certain if we can generate enough change and we need to, like the concluding two factors of this, inflection points if you like, which is the elective at the end of next year and then the election in 2019, so to complete that inflection point. I think it’s a long narrative if you like. These are important events but I think people who went into these markets maybe were slightly getting ahead of themselves in terms of actually what’s going to happen right now, what are the changes we’re going to see in the next year or so.

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What about Zumxit as you call it?

Zumxit I think is still on the table or it has been. There are people actively trying as they have been since the end of last year, since Nenegate to remove Zuma from within the NEC, but it’s a question of power play and balance of forces within the NEC and that’s where I think things haven’t changed. Where I think Zuma probably does, his faction I should say does have a majority of 60 percent within the NEC. Even if he himself is weaker, I think his faction, the way it operates; patronage etcetera is still largely unchanged probably. Although clearly things can still change in the next two weeks or so but I think as a result Zumxit is still there as a mechanism of transitioning into a 2019 election where they have to win, they really need a new face, not just to the ANC but of the government of the election campaign 2019 and therefore in January 2018 I think it still looks possible that you can have a smooth exit, a new person being elected.

Seeing it right now though I think it’s difficult. His side needs him in place to win the election, the elected conference at the end of next year to be in the right place, to manage levers of power. So they’re removing him and having someone else in place whether it’s Cyril or anyone else, Dr Mkhize which I think would be difficult, if you like in strategically thinking about how they win that elected conference at the end of next year. It just seems too early politically and strategically for Zumxit to happen right now, but I think it is there as a narrative but will play out in the longer term.

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To see the EFF gain such a big share of the vote and to have the balance of power in some of these important metros, surely has to have weakened his position given also that he’s lost, was it 106 councillors in those three Gauteng metros alone?

I think he’s weakened to a degree but it depends how much of the strategy he can win from a weakened position. He’s ultimately a party man. He knows how to work the ANC. I think we shouldn’t forget that and that’s why he’s survived several attempts on his position already. Yes, maybe he’s weakened internally but still as president he has a lot of power both to do things and to not do things and I think that’s particularly on the economic policy front where we have to remember the lack of leadership, the lack of action is as important as doing stuff and is holding back whether it’s reform of parastatals or of wider policy, great policy, labour changes, all the rest of it. The lack of doing things, the lack of leadership which he still has and that position is equally as important as moving to the left or anything like that.

We’ve seen the Rand strengthen in the run up to the election and thereafter. Is this an overreaction?

The Rand is playing a global game round the fed, around a global bond bubble, is probably the correct term to use where bonds have really become a commodity. Particularly European government bonds, they have to be bought by insurance companies regardless of yield. They have to hunt for yield. As a result we see more money from these European pension funds, American insurance money coming into emerging markets and that’s really the driving factor around the Rand, more than buying South Africa in and of itself because of a strong post-election story, but markets do wrap stories around the sort of positions that they have and I think that’s what we’ve seen after the local elections.

People have wanted to buy carry and have then sort of retroactively fitted the story around an opposition taking over, around overestimating the Zumxit, things like that afterwards. So I think we shouldn’t overplay the Rand strength too much as a sign of necessarily investor faith in South African policy, in South African growth, things like that in the short run at least. It is very much linked to those global factors.

We have just over a week to go for the period that the opposition parties or indeed the ruling party can make coalitions. How do you see this all turning out in the most important of those 27 municipalities that are now in a hung state?

The interesting thing is going to be if the ANC can actually get together a national strategy to deal with other parties across all those 27 metros. That’s what the DA is doing. They’re seeking to put in place national level agreements where maybe they’re going to help out, not necessarily in coalition but in terms of vote support, EFF in some provinces in the North, if they can come to policy agreements and things like that. They’re probably applicable across various different metros whereas I think the ANC risks maybe being a little bit more factional between provinces in particular which maybe makes our protest a little bit harder.

Of course the requests from the other side, from EFF especially are so much higher when it comes to ANC because they’re in national power because they have Zuma there as president, so that’s where you see things coming in like removing Zuma, like prosecuting the Gupta’s, things like that. It is possible to get ANC/EFF coalitions but the hurdle just seems very, very high at the moment, so my bass-line is still that you see some national level agreement between the DA and EFF, pulling in smaller parties into grand coalitions like UDM and VF Plus as well.

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That could see an ejection of the ANC mayor and officials in Tshwane, Johannesburg, Ekurhuleni, and perhaps other smaller councils as well.

Exactly. That’s going to be a big shift inside the ANC where people will have to think what are they going to do without jobs, the lack of higher income they get from those managerial posts and that potentially in the medium run is a difficult fact for Zuma and his faction to handle but I think investors overplay how much that can swing power away from his faction towards the other side. There’s a lack of strength within the ANC around the broader anti-Zuma faction. It’s more peace-making if you want to put it that way, between different factions, different provinces around the country. Whilst all the people say, “All these people are going to be out of jobs” maybe forces Zuma out, I think it’s still difficult to piece those two together quite so succinctly but the DA in power in those areas is going to be very interesting. They’re going to be very stretched.

We’ve always complained in the past about the ANC having capacity constraints but the DA is going to have the same problems in terms of a certain number of senior people that can be deployed around the place. You could have Helen Zille trekking off to be a problem buster or whatever around these different municipalities but actually having people in place in each individual council, having the quality of councillor and to take on that role is something that we need to watch out for.

We must not give the DA too much of a free pass on these things and need to be quite balanced around judging ANC versus local government. That’s particularly applicable to Johannesburg where Parks Tau was doing a lot of very good things and was seen as pretty investor-friendly so yes, I think there are some nuances to dig down into on that when judging the DA and how they’re doing in government.

They have a couple of years before the big election for the DA to build on the strength that they showed in this last municipal election. Where will they find those resources to actually do a Cape Town on some of these other metros?

Exactly, the real problem there I think is in Cape Town you had a lot of network effects potentially of already a higher standard of income for the region as a whole. You saw generally high levels of education etcetera coming into this sort of DA period in power around 2006. It was easier to draw on more resources faster around there than maybe it is now, so you’re going to have to bring a lot of business leaders loyal consultants probably to help them move at the speed they need to. They don’t really have two years if you think the 2019 election campaign will probably get going in December 2018. So it’s going to be quite a slog I think to show removing corruption, which will hopefully be a first stage.

Things like township business formalisation might be another one that can be at least be put on the road quite quickly, maybe health as well, some things they can do around that but yes, it’s going to be a big challenge for them to use their good governance sort of flag, which they waved at this election really to go on a vote in a meaningful way at the next election, but also I think we need to be very careful around this election where the DA did well but actually the swing to them wasn’t massive.

The bigger swing was ANC voters staying away, 3-million odd voters that didn’t come out for the ANC, that their low turnout problem that they had and those voters don’t necessarily go to the DA in 2019, they could go back to the ANC under a new face, under a new leader for them, they could go to EFF even. So there’s going to be a lot of competition for those voters still and to stay away. They can stay away again in 2019. It’s far too early to say the ANC will drop below 50 percent by 2019.

You’ve been talking to a lot of portfolio managers and the narrative that most people are using is that the era of competitive politics has now arrived in South Africa. Is this part of the reason why there would be apparent increased interest in investing in the country by the big money?

That’s definitely part of the story that people are constructing around why they’re happy to hold South African assets, why they’re happy to be neutrally weighted in the sort of carry environment but I think it’s important not to overestimate these implications of competitive politics into growth. I don’t think we’re suddenly going to see a leap higher in GDP because we now have the DA running all these metros around the country potentially. I think the link between competitive politics into credit quality, into tight new spreads and things like that, it’s quite pleasing and probably only for the very long-term, but no it’s definitely part of the argument that people are constructing.

When you have a look at these potential alliances between the EFF and the DA and the impact that might have on the future, surely it also brings up other kinds of risks, i.e. the DA trying to implement a policy that the EFF disagrees with and then breaks the coalition.

Exactly, it’s going to be tricky but ultimately both sides need to show you that they are in power, that they’re doing things around the country, the EFF and the DA want to show that into 2019, so I think that keeps them together probably to a degree but it’s going to be a lot of monitoring by the DA of what the EFF are up to and the other way around as well probably. We’re going to have to watch very carefully how coalition agreements are constructed that allows parties to measure each other and what they’re up to and how they’re sticking to agreements, but acting on the policy, I don’t get hugely bearish around what maybe the EFF might be up to or their requests with the DA.

There’s a lot they can do together on urban land reform for instance, which is a very, very different kettle of fish to national land reform where there’s lots, for instance like the Free Market Foundation has been advocating and giving land rights from municipal land back to individuals in informal settlements and townships. That supports it, both EFF and the DA can agree on and there’s an area where the EFF can say “Look we are doing land reform. Yes, it’s not their hashtag give back the land in quite the same way, but they can show you some success around that.

I think it is workable and people shouldn’t be too bearish about the ability to form those sorts of alliances. The real issue is how the EFF will behave on procuring issues, on things where there’s still some residual concerns around, is the EFF actually an anti-corruption party given all the history of some of its leaders etcetera, so no we’re still getting some question marks around that which I think the DA will clearly be watching out for.

What is the investment grade status of South African bonds?

We’ve seen the agency’s reaction in a very different way after these elections. I think pitch has been the most consistently bearish saying “There’s not really going to be much change and spending pressure emerging as a result of policy shifts”. S&P has been a bit mixed; it depends who was doing interview. When Bloomberg interviewed the rating chair Ravi Bhatia here in London. He was sounding optimistic and then they interviewed the local rating analyst who’s also on the rating committee who is much more bearish and I think that shows the difficulty in analysing this and the different time horizons you can look over, whereas Moody’s actually came out much more positively on this which didn’t make much sense to me talking about the sort of ultra-long-run positives because you can still damage the credit quality in the interim with what goes on in terms of national government policy etcetera. Even with these long run positives from more contested elections going on. So I think we’re still on the downgrade path certainly. I think that Fitch and S&P will probably still downgrade at the end of the year.

Moody’s may now be giving a little bit of benefit of the doubt and we’ll wait to see maybe what actually comes along into next year before another downgrade but I think we will see at least one of S&P or Fitch go by the end of the year and ultimately it will depend on what way policy swings. I think if you’re implementing minimal wage at a high level which seems likely after this is your accelerating land reform potentially at national level there’s still factors that will swing S&P and Fitch towards cuts.

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The next move by Jacob Zuma, some are predicting that he is going to grab power and implement a draconian approach, get rid of Pravin Gordhan, change the treasury, use this final opportunity that he has to loot the public purse. Others are saying that he has now been weakened and in fact, Pravin Gordhan’s position has been strengthened as a result to the election. You watch this closely, how do you read it?

I think we need to differentiate very clearly between Jacob Zuma’s power per se, his factions of power and the power that Pravin Gordhan has and I think that we risk falling into that sort of bucket of views that came up after Nenegate, which was Pravin Gordhan’s magic wand, all-powerful, he can wave it and any part of the economic policy or government policy as a whole can be changed, which definitely wasn’t true and that was the lesson since December, so I don’t think this really plays into Pravin Gordhan having a wider policy scope around the whole of government or anything like that. I think that’s still the wrong view to have.

There is still the chance of a reshuffle to move SACP members. That still seems like an unattainable position for people like Blade Nzimande in the government and I think there may even be some backing for that from wider parts or more neutral parts of the NEC as well and so I think a reshuffle is possible. Whether that touches national treasury, I think is very, very difficult to call and is possible certainly but I think it’s one of those un-forecastable events if you like. As you say Zuma on his agenda still needs contracts signed off, things like that which national treasury are blocking but equally state enterprises are sort of tootling on their own quite nicely along his agenda and the other reshuffle of course is what happens with Gauteng ANC, which is going to be crucial for the 2017 elective conference.

If there is a clear out there of the leadership, some form of change it can make it a lot easier I think to have Gauteng neutralised or even on the side for Zuma’s faction in 2017. Remember the provinces are quite powerful around selecting people who go to elective conference, the filtering that happens from branch level and members that they send along and things like that. That reshuffling is quite important as well to see his internal power within the party and that will be the focus, I think, even more than government policy and what happened to the cabinet reshuffle will be those sorts of internal political machinations

That’s the next thing to watch out for, the elective conference.

The run up to it and how it all works in these reshuffles exactly and that internal power play within the ANC because I think that’s the key for investors in the long run, is how long does the status quo basically last and if you get a status quo candidate like Jacob Gedleyihlekisa Zuma coming out to the end of next year then the status quo likely stays on for longer as opposed to say Cyril getting elected at the end of next year or some other investor-friendly candidate.

What are you telling the portfolio managers and you’ve been talking with many of them, dozens of them over the last week?

The real problem we’ve had is investors have a very short timeframe now in this global risk on environment and you’ve seen that with Turkey as well after the coup where markets have traded very well. It could be of one of the carry, so we’ve actually been saying to people that we still are quite positive on the Rand in the short-term even though we’ve been very bearish in the long run in terms of trades idea strategy and the same for bonds as well. We’re not telling people to sell everything here or to throw all the toys out with the bathwater.

The issue is to watch out for this realisation that will come eventually that it hasn’t been structured or formed that we are still on the downgrade path and to be ready to flip from the current sort of neutrally weighted positions, long bonds, long currency start hedging out those positons and that may well come through the second half of this year as we approach the anniversary of Nenegate. So yes, it’s not necessarily fight the global current environment at the moment, but be aware of the risks and ready to flip when those signs start to emerge.

Is volatility likely to continue?

Exactly.

Then just a final point, 27 councils are up for grabs. Do you think that the opposition are going to end up taking most of those?

I haven’t done a full breakdown of every single one. I’ve mainly looked at the metros but I think if you can form these national level agreements between the likes of the DA and EFF then a lot of them can fall into opposition control. That will be possible but there will be localised things as well where the ANC maybe is able to maintain control with individual parties’ independence and things like that, so talking about a council is quite difficult but for the metros, certainly I think we can certainly see a large number of them fall into opposition control.

  • Peter Attard Montalto is Head of Emerging Europe, Middle East and Africa Economics at Nomura.