Piet Viljoen: The case for investing in SA keeps growing, Iran War included

Key topics:South African assets undervalued due to offshore capital flightMultipolar geopolitics and inflation favour emerging markets like SA resource economiesIran war causes short-term EM pressure but long-term upside.Sign up for your early morning brew of the BizNews Insider to keep you up to speed with the content that matters. The newsletter will land in your inbox every morning on weekdays. Register here.Support South Africa's bastion of independent journalism, offering balanced insights on investments, business, and the political economy, by joining BizNews Premium. Register here.If you prefer WhatsApp for updates, sign up to the BizNews channel here..By Piet Viljoen*.A lot of what passes for research in the investment industry is simply emotions and desires expressed in numbers. To avoid falling into this trap, it's useful to review one’s investment strategy now and then as objectively as possible. For quite a while now, I have been saying that many listed businesses in South Africa are undervalued due to South Africans' strong desire to invest offshore and a lack of foreign appetite for South African assets. As such, these businesses offer high prospective returns on investment.Why South Africans have this strong preference for offshore investing is a puzzle wrapped in an enigma. South Africa is filled with smart entrepreneurs, building great businesses. But the first thing these entrepreneurs say when they are the recipients of a liquidity event is: "Take my money offshore, this country is uninvestable". Can you spot the irony?.Read more:.Ramaphosa woos investors as Iran war clouds SA outlook.I guess the answer to this puzzle lies in a combination ofHighly incentivised, fearmongering "helpers" who are only too happy to help their clients move their money into offshore “investments” - most of which end up performing poorly;A "grass is always greener" effect; andAn understandable reaction to our inept government's absolute inability to build trust with the business community..This offshore flow occurs despite South African assets performing much better than investors believe. But it is this persistent outflow of a "wall of money" that has created the investment opportunity.Over the past few years, my "base case" investment thesis implied that these undervalued South African assets would do even better than they have done historically. However, considering developments in Iran this year, it's worth re-examining this base case scenario to see how the war has affected it:Geopolitical tensions and Western financial vulnerability are fracturing the world into a multipolar system, away from the previously unipolar world in which the USA ruled the roost.This is placing increasing barriers in the way of the free movement of goods, capital, and people globally.In this environment, countries will have to become more independent and reconstitute their supply chains locally ("reshoring").This is good for demand for commodities and will put upward pressure on their prices, which will, in turn, cause inflation rates to be higher than otherwise.Due to high debt levels in Western developed markets (DMs), upward pressure on interest rates from higher inflation will be resisted by fiscal authorities through repressive measures such as exchange controls, prescribed assets, and other regulatory interventions.This is a good mix for emerging markets (EMs): low real interest rates, high nominal growth, and high commodity prices.Within emerging markets, South Africa would be a key beneficiary due to its high resource endowment and (relatively) strong fiscal and monetary situation..With this backdrop, I would want:Exposure to undervalued EM currencies and specifically undervalued Asian currencies.Little or no exposure to developed-market bonds, preferring shorter-duration, high-yielding EM bonds.In equities, I prefer EM equities over DM equities, and within that, I prefer high-quality durable businesses - valuations permitting. The South African small and mid-cap situation is a subset of this category. Hence, my bullishness on this particular asset class.A significant exposure to inflation-resistant hard assets..This is exactly how my cockroach portfolio is positioned.The war in Iran has changed some things, though:Food and energy prices will face upward pressure, with emerging markets bearing the brunt. As a result, EMs could destabilise - recall that the 2007/08 food price spike helped trigger the Arab Spring. Early warning signs are already visible (e.g., protests in the Philippines over rising food costs). Locally, diesel prices are hurting.EMs face a double whammy: higher expected inflation and a larger risk premium. This means higher bond yields, as we have recently experienced in South Africa, with the 10-year yield moving from a low of 7.8% just before the war to its current level of 8.9%. To the extent that asset prices are the present value of future cash flows discounted at an appropriate interest rate, higher interest rates (i.e., bond yields) reduce asset prices.The closure of the Strait of Hormuz will drive a surge in global capex to reduce future dependence on this chokepoint. It will take years to build the necessary infrastructure to reduce Hormuz's importance to the global economy, but it will happen. Pipelines and LNG terminals will be built, and alternative oil and gas resources will be exploited (such as the ones off Namibia and South Africa's South Coast?) - this will, eventually, further strengthen the demand for resources.Globally, there are massive reserves of carbon-based energy (oil, gas, and coal). Eventually, energy prices will revert to much lower levels, at which energy companies' profits are more reasonable while energy remains cheap for consumers..On the face of it, markets have taken these developments in their stride. Since the war started, the MSCI World is down only 3%. Counterintuitively, EM continues to outperform, up 2.4%. But the biggest contributor to EM equity strength over the past month has not been strong growth and commodity demand, but AI-related hardware and technology manufacturing, particularly in Taiwan and South Korea.In the short term, higher energy prices and higher bond yields are negative for South Africa, and particularly for SA small and mid-caps – even the high-quality ones. But if one looks at current events, the process of Balkanisation of the global economy will accelerate, supporting the South African investment thesis.The war in Iran creates a paradox. .Read more:.Treasury announces extension of short-term fuel relief measures.The short term is uncertain and could be painful. The medium- to long-term (i.e., the next 2–5 years) is much more predictable and, I would hazard to say, prosperous for us here in the Southern tip.Overall, though, the war has merely interrupted my investment thesis - it has not superseded it..*Piet Viljoen is the founder of Re:CM. This article is drawn from the latest edition of his weekly newsletter, which you can subscribe to by clicking here.

Piet Viljoen: The case for investing in SA keeps growing, Iran War included

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