Investment Guru finds value in South Africa

9 February 2007

I realized about halfway through my recent trip that it had been some time since I was in an emerging-market country. I have been to over 50 countries over the past 20 years, but recently most of my travels have been to Europe and Canada, with the occasional vacation trip to Mexico.

As I observed South Africa, it was forcefully brought home to me that there is more to the emerging-market story than China, India and Brazil. There are any number of countries that are seeing robust growth and contributing to the world economy. It was reported at Davos this year that for the first time the developing world has a larger share of world GDP than the developed world.

Here we focus on an emerging-market country that does not make as much news as it should.

The mood among those I talked with in South Africa in the early 1990s, when I was traveling often to South Africa, was quite pessimistic. The economy was not good, due to international economic sanctions stemming from worldwide protests over the policy of apartheid. Changes and elections were coming, and it was not clear what would happen.

The contrast today is amazing.

World-class cities; cranes everywhere
There are construction cranes everywhere in the four cities I visited: Johannesburg, Pretoria, Durban and Cape Town. Twelve years ago the 30 miles from Johannesburg to Pretoria was mostly agricultural land. Today it is one big city, with offices, malls and homes lining the freeway.

Johannesburg is a world-class city, on a par with New York or London or any major city in terms of facilities, shops, infrastructure ... and traffic. There are new shopping malls all over, and the stores are busy. The restaurants are excellent. The hotels I stayed in and spoke at were excellent and modern. The Sandton area is particularly pleasant.

Durban is a tropical jewel on the Indian Ocean. Again, there was construction everywhere - a green, verdant city of a million people, with modern roads and great weather.

I have been to Sydney, Vancouver and San Francisco. I love all of them. But for my money, Cape Town is the most beautiful city I have been to. Amazing mountains, blue water harbors, white sand beaches, with wineries nestled in among the mountains and valleys. The Waterfront area, where I stayed, is fun and vibrant.

Again, an amazing amount of construction everywhere, especially in the Waterfront area, as investors from Dubai are pouring huge sums of money into creating a massive residential/business/ retail/restaurant development. There are several similar, quite large developments going up in different parts of Cape Town.

Value for money
I ate dinner one Friday night at a restaurant called Baia at the Waterfront. I find I really love the better South African chardonnays. My friends know I am something of a chardonnay snob. I like the better California wineries.

I was pleasantly surprised to find more than a few South African chards the equal of their US counterparts, but at a third to half the price for the same level of quality. (I should note that a decent chardonnay in London or Europe is twice the US price.)

Two of us had the best chardonnay in the restaurant and one of the better meals I have had in a long time, and the bill was less than $100. The next day my partner, Prieur du Plessis, informed me that Baia was one of the most expensive restaurants in town.

By way of comparison, you can easily spend two to three times that at a comparable restaurant in Dallas, and four to five times that in New York. Forget London.

I began to ask about the bills for food, drinks and such for the rest of the trip. The country was uniformly about half what I would pay in Texas for the same quality.

I stayed in a very nice five-star hotel (The Commodore) for six nights for less than $1 000, including several meals, laundry and my bar tab. Their walk-up price was much higher, but clearly you can get deals, and it was tourist season at that. The service was terrific and uniformly delivered with smiles.

The exceptionally nice private game reserve (Itaga) we stayed at when I first arrived, trying to get over jet lag, was only a few hundred a night, including meals, wine and game runs. In short, after having been to London and Europe for my last few overseas trips, South Africa seemed like a bargain.

Optimism fuelled by growth
And it was not just the people I spoke to that were optimistic. Grant Thornton (a large international accounting firm) did a survey in the 30 countries in which they do business. The four countries with the most optimism and confidence were India, Ireland, South Africa and mainland China.

Why such confidence? I think there are several reasons. The economy has been growing at a reported almost 5% a year for the past several years, which is quite strong. They have had 32 consecutive quarters of positive growth.

But the official figures may understate the reality by a significant amount. If you look at the VAT (value-added tax) receipts, as well as other tax figures, some economists estimate the economy may be growing by 7% or more. Why the difference?

There is a large "informal" economy in South Africa. While much of the income may not be reported, when something is bought and sold in the retail sectors, taxes are collected.

The stock market has grown by over 25%, 47% and 41% for the last three years. Such a bull run is always a boost to confidence. But there are also some real fundamentals underlying the emerging-market bull markets.

South Africa has a strong commodity sector, with numerous commodities and not just gold. JP Morgan thinks that earnings growth for South African companies, even adjusting for some anomalies, will be 20% this year, which should mean another good year for their local markets.

This link between commodities and stock market prices is reflected not just in their stock market, but in emerging markets worldwide. Look at the close correlation for the last 10 years between the prices of commodities and the emerging-market equity index. I think this rather clearly shows the link between the recent rise in commodity prices and emerging markets. It is more than just a China story.

Football as an economic driver
The attention paid to football (or soccer in the United States) is rising to fever pitch in South Africa. And for good reason: they will host the World Cup in 2010. They expect some 3 000 000 fans to show up.

The government is using the occasion to spend some R400-billion (a little over US$50-billion) on all sorts of infrastructure projects. They are doubling the size of the major airports, which had already been significantly improved. Walking past the construction at the Johannesburg airport, you have to be impressed with the size of it.

New roads and other forms of infrastructure are being added to prepare for the influx, but it will have the added effect of making the country more competitive, just as infrastructure in China has been a boost to that country, and a lack of infrastructure has limited India.

The World Cup will also be a boost to tourism, already one of the most important sectors of the economy. Cape Town is becoming an international destination for vacations and conferences. The growth in tourism has been strong, showing 20% growth last year from 2005. 2006 was a record year.

A deal-doing financial centre
Interestingly, 75% of the traffic reported in the tourism growth is from Africa and the Middle East. While a lot of the people are vacationers, I think a goodly portion are businessmen and women from all over sub-Saharan Africa who look to South Africa as a deal-doing financial centre.

South Africa has a quite strong, very competent and growing financial services sector that is a magnet for entrepreneurs from all over Africa seeking to find capital. South Africa also has a strong entrepreneurial class which is the base for much of the new business and development, not just in South Africa but in all of Africa.

The rest of the world rightly sees South Africa as the place to launch into the rest of Africa.

Problems common to emerging markets
Are there problems in South Africa? Of course, and some of them are quite serious. But that is the case in nearly all (I cannot think of an exception) emerging-market economies.

While the overall crime rate is dropping, it is still far too high. Some rather high-profile crimes of late have resulted in a strong outcry for serious change.

Corruption is an issue, but that is the case in almost every emerging-market country. The high levels of poverty are evident. Although employment is growing and more and more of the poor are being brought into the economy, there is still a lot of room for progress.

The telecommunications infrastructure is hampered by a lack of serious competition. Access to the internet is limited in many areas, and it is really slow where it does exist. This will improve in the coming years, but it is a serious handicap to business. There are power shortages and the need for more power-generation plants to keep up with the growth.

But all these areas are (mostly) going to improve.

Potential in African farmland
I see a lot of opportunity in South Africa in particular and Africa in general. Let's look at one area where there may be more than a little potential in the future.

I think there is deep long-term value in African (not just South African) farmland. Right now, given the nature of US and European subsidies to agriculture, it is hard for developing-world farmers to compete. But that will change in the next decade.

As I have written before, "Old Europe" and the US are going to come under intense government budgetary pressure due to the high levels of pension and medical costs they have promised their retiring boomers. Europe is particularly vulnerable.

Quite simply, Europe cannot afford to keep the pension promises they have made and pay for any other normal government expenses without raising taxes. Except that they already have economy-stifling high taxes.

Budgets are going to have to be cut in other areas. At some point, sooner rather than later, agricultural subsidies are going to come under pressure, as politicians must decide where to find the money to pay for the promised pensions and health care. There are more voters who are older and on pensions than there are farmers.

I can count votes, and it is not hard to predict the result. It will be with a lot of fighting, but in the medium run the agricultural subsidies in Europe are going to have to go.

When the writing is clearly on the wall, Europe will start to negotiate on those subsidies, trying to get something for what they will have no choice but to give. Part of that will be to reduce US subsidies as well.

Africa will become a breadbasket for much of Asia. With China pressed for water and much of its agricultural land being used for development, China will need to import more food. And as the rest of the world becomes more developed, there will be an increased demand for meat, which means an even bigger demand for feed grains for livestock. The growing use of ethanol is increasing demand for corn, absorbing more of the world's land use for energy corn rather than for food.

The simple fact is that as the world grows more prosperous we are going to need more grain and other foods. Where is the land we are going to need to feed the world? There is an abundance in Africa, along with the needed water and labor.

And as African countries upgrade their infrastructure, it will improve the ability of farmers to get their grains to market at profitable levels.

There is much to like about emerging markets. That is where a great deal of the real potential growth in the coming decades will be. And South Africa will be one of the better stories. If you are not doing business there already, you should ask yourself, why not?

This is an edited version of an article published in the 9 February 2007 issue of John Mauldin's free weekly investment e-letter, Thoughts from the Frontline.

Mauldin is president of Millennium Wave Investments. A recognized expert on investment issues, he is a frequent contributor to financial publications such as the Financial Times, and a frequent guest on CNBC and Bloomberg TV. His book "Bull's Eye Investing" made it onto the New York times best seller list. In his latest book, Just One Thing, "twelve of the world's best investors reveal the one strategy you can't overlook".

Property in Observatory, Cape Town, South Africa on http://www.hotpropertyincapetown.com

South Africa creates more jobs, better jobs

South Africa's economy is creating more jobs, and jobs of higher quality, than ever before, according to Statistics SA's latest labour force survey.

The survey, released on Thursday, shows both a modest decline in unemployment between September 2005 and September 2006 as well as - as Business Report puts it - "a number of encouraging longer-term trends".

South Africa's official unemployment rate decreased to 25.5% in September 2006, down from 26.7% a year previously, with 500 000 new jobs being created.

And according to Stats SA's deputy director-general for population and social statistics, Kefiloe Masiteng, South Africa's formal sector (excluding agriculture) was the main driver, accounting for 1.4-million of the 1.6-million new jobs created in the five years to last September.

There was also a drop in the number of unemployed South Africans in the year to September, from 4.4-million to 4.3-million, as well as a decline of almost 100 000 in the number of discouraged work-seekers.

This saw the percentage of working-age South Africans with jobs improve from 41.1% to 42.7% - despite the increase in the number of people in the market for jobs.

South Africa's labour force grew from 16.7-million to 17.1-million in September 2006 as the working age population (15- to 65-year-olds) rose from 29.6-million to 30-million.

In all, the number of South Africans with jobs rose from 12.3-million to 12.8-million. Of this number, 8.4-million were in the formal sector (excluding agriculture), 2.4-million in the informal sector, about 1-million in agriculture and about 886 000 in domestic work.

T-Sec economist Mike Schussler told Business Report that the jobs total was the highest in the country's history.

"The strongest growth was in the formal sector, which is encouraging because formally employed workers are more likely to have a constant salary and a pension or provident fund," Schussler added.

Lagging economic growth
Nonetheless, Business Report states, the growth in jobs still laggs behind the country's economic growth rate.

South Africa's gross domestic product (GDP) increased by a higher than expected 5.6% in the fourth quarter of 2006 as the economy notched up its 33rd quarter of uninterrupted growth since 1998 - the longest upswing in the country's history.

Real annual gross domestic product increased by 5% in 2006, following growth of 5.1% in 2005.

The government is busy fine-tuning and implementing a strategy - known as the Accelerated and Shared Growth Initiative for South Africa (Asgi-SA) - to accelerate the country's growth rate and make sure that this growth is accompanied by job creation.

According to Masiteng, the country's trade industry (including the wholesale and retail sectors) accounted for 23.9% of the total increase in employment, the single largest contribution by any industry. The industry currently employs more than 3-million people.

The community and social services industry, which employs 2.3-million people, was the second largest contributor to total employment at 18.1%. Manufacturing, which employs 1.7-million workers, accounted for the third largest share at 13.6%.

Stats SA's labour force survey is based on the responses of approximately 67 000 working age adults in over 30 000 households across the country.

SouthAfrica.info reporter – 30 March 2007

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Spain, Ireland and threats to the property boom

There are two phases in an asset price bubble that repeat themselves with clockwork regularity. The first is the phase of the bogus economic theory. I am sure you heard the one about the paradigm shift due to the more widespread sharing of credit risk; or the one about the profits/wages ratio rising indefinitely.
The second phase is a prolonged state of denial.
In the US subprime mortgage bubble, we are now in phase two. It is difficult to explain rationally why anyone would want to give out large mortgages to people with no credit rating, or why a bank would want to give out interest-only mortgages at more than 100 per cent of a property’s value to anybody. Most of those products are based on irrational expectations by lenders and borrowers.
The European Union is a little behind the US when it comes to such crazy financial innovation, but only a little. There is a subprime mortgage industry in some markets, such as the UK and Spain. You can also find interest-only mortgages.
Unsurprisingly, these are also the markets that have seen the strongest increases in property prices over the past 10 years. The Europeans are still in phase one of the bubble. The bogus economic theory from Spain is that large immigration can maintain a construction boom indefinitely.
Let us just look at some statistics. In Spain, the construction and housing sector accounts for 18.5 per cent of gross domestic product, about twice as high as the eurozone average, according to the latest data from the EU’s Ameco database. The comparable figure for Germany is 8.7 per cent. The justification given for this increase are: a net inflow of immigrants, many from Latin America, who find it easier to purchase, rather than rent Spanish property; changes in the Spanish way of life, as young people leave homes earlier than they used to; and Spain’s continued popularity amongst sun-loving northern Europeans. In other words, the Spain-is-special-crowd argues this is a structural boom, not a bubble. They claim that Spain’s property market can grow at faster rates for longer than most other European markets.
I do not want to dismiss all of these points. The trouble is that these merely tell us why the bubble happened in the first place, not why the path should be sustainable. In Spain, the average price of a square meter of residential property went up from about under €700 in 1997 to just under €2,000 at the end of last year – up threefold. House price growth has moderated more recently – from year-on-year growth of more than 15 per cent two years ago to more than 10 per cent now. It is true that Spain still has an extremely low level of mortgage defaults compared with the US. It is also true that Spanish mortgage banks are relatively flexible in terms of their willingness to refinance loans. Then again, Spain is in a different phase in the housing boom-bust cycle. Spain is today where the US was approximately a year ago.
In Spain, most mortgages are variable-rate, so the rise in short-term market interest rates to more than 4 per cent is beginning to have an effect on the Spanish housing sector. Monetary statistics tell us that the boom in European mortgage lending is slowly receding but this process still has some way to go. If, as a likely consequence of the subprime mortgage crises in the US, there is a global reappraisal of the price of risk, Spain would be hit by a double whammy – higher rates and higher spreads.
Now since 18.5 per cent of the Spanish economy is housing-related, a gradual convergence towards the eurozone average would seriously weigh on economic performance for a long period. Post-unification Germany experienced flat house prices for 15 years and a depression in the construction industry.
Spain has one of the lowest rates of productivity growth in the EU. The rest of the economy may not be strong enough to fill the gap left open by construction. It does not take much imagination to see that a perfect storm is building up. The idea that Latin American immigrants will continue to jump on the property ladder under these circumstances and rescue the housing market is a little optimistic. While it is true that there has been a structural shift from a conservative to a more liberal society, such shifts end at some point. And Germany and British homebuyers may eventually find alternative and better priced homes in other parts of the Mediterranean. The explanations of the past cannot be extrapolated.
Another example is Ireland. In Ireland, the GDP share of construction and housing is even higher, at 20.7 per cent. While the performance of the Irish economy during the past few decades was remarkable, there are some deep underlying structural problems that are now surfacing. In particular, Ireland has been fast losing competitiveness within the eurozone – not a subject that has been talked about much outside Ireland recently. With interest rates rising and a slow return to sanity in the financial sector Ireland is going down the same route as Spain, perhaps only faster.
The US housing recession is not over yet. In the past the correlation between US and European property price movements has been extremely high. If the transatlantic tsunami comes, it is perhaps best to avoid some of Europe’s western coastline states for a while.

Written by Wolfgang Munchau for the Financial Times, published on Monday March 19, 2007.

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