Time To Get Out Of South Africa

| About: iShares MSCI (EZA)
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South Africa faces severe challenges.

The general population is severely financially squeezed.

It is time for investors to liquidate South African financial holdings.

There is an expression that one should not believe everything one hears on the news and this is something that I have attempted to follow faithfully in my research.

Nevertheless, when the issue is South Africa and President Jacob Zuma then it becomes a far more nuanced topic because consistently across the board, it is being asserted that he is bad for South Africa.

With the recent news that he should be charged on over 800 charges, the conclusion ought to be that he should step down for the sake of the country.

Despite this, I do not agree with the view that President Zuma is solely responsible for the current ills affecting South Africa, which are likely to get worse after the exit of the UK from the EU.

An understated but important dimension of Brexit is its effect on emerging economies particularly from Africa. While many campaigners to leave the EU have emphasized deepening and restoring commonwealth trade relationships with African nations, it is unlikely to get very far because these nations simply do not trust the Western nations, they prefer to work with China with whom they believe trade relations are fairer.

I do not see significant consequences for South Africa as a result of Brexit because as the 10th largest investor into South Africa, I expect to see further inflows of investments into the nation.

South Africa has not really had difficulties attracting FDI especially since the year 2000 as this graph shows, but the problem is increasingly a bifurcation of South Africa into two parts, a rich and affluent South Africa and a poor South Africa where the ability to engage in society is still extremely limited, a generation after the end of apartheid.

The main issue with this is that we may see a continuation of this mass disenfranchisement we see into further generations. Artificial programs of inclusion like the land redistribution and Black empowerment programs can only be useful if skills gaps are bridged to help the great majority of the population utilize the opportunities to better themselves, the nation and future generations.

The social challenges the nation is facing may seem like harmless riots which do not have any lasting impacts on the economy and on the surface. It seems like this because despite what we all see from various sources or first-hand experiences of South Africa, we only see the occasional flight of 'hot money' normally before the US Fed speaks about interest rates.

This is because the truth is that the current global climate makes it very attractive to borrow in the US, Japan and Europe to invest in South Africa and as a result, the government of South Africa being short-sighted politicians are content to maintain the status quo and only giving lip service to the concept of deep social and structural reforms.

Yet, those areas of the economy that will pay the largest dividends like education, healthcare and skills development are left far behind.

The truth is South Africa is really on an interest rate precipice, they are very exposed to external shocks, there is a dark side to their FDI bonanza. Firstly, a lot of this is short-term money as the spike in FDI in January of this year showed.

The graph below shows a significant correlation between falling US interest rates and historic highs in the Johannesburg Stock Exchange.

The next graph below shows the comparison with US interest rates and the South African 10 years' bond.

We have not yet seen the full unintended and indirect effect of Brexit, but where it to precipitate a global economic crisis that increases interest rates and depresses yields then South Africa will find itself horribly exposed.

The next chart compares its currency to the EUR/USD and it is clearly seen that it has also gained in value significantly more than its international trade partners which is hampering its full export potential.

On the other hand, inflation is also a major concern for a country with such high unemployment with youth unemployment at a massive 50%.

This is an even bigger concern when one considers the chart below, which shows that mining fell to a maximum of 18% this year.

Looking at the South African economy, a casual observer would not really notice anything dramatically amiss, in fact inflation is gradually falling but beneath the surface, the social discontent in the rainbow nation is really palpable because there is widespread

Food inflation remains high and will get higher as the global price of crude oil picks up because as the chart below shows, the correlation between crude oil and South Africa's gasoline prices are highly positively correlated.

Household debt to income remains high at 78%, bank lending rate is 10.5%, personal savings, retail sales and consumer confidence continue to fall at a time of high and rising unemployment.

This state of affairs is really an explosion waiting to happen and the worst part about it is that the central bank of South Africa cannot do much about it, because if they were to decrease interest rates especially with rising oil prices, inflation will be a big problem and many people will go hungry or default and possibly trigger a banking crisis.

On the other hand, high interest rates also significantly affect the quality of life of the citizens and give the impression that the government is only looking after the interest of the international bond investors and banks.

What we are witnessing in South Africa is a very challenging situation, an edifice whose centre has been hollowed out. It looks attractive on the outside but on the inside is full of dead wood that only the slightest of weight placed upon it will see the whole structure crumbling down, especially when coupled with the current political crisis facing the nation.

The inevitable crisis coming will be the opportunity that they need to rebuild the economy again from the ground up.

In the meantime, I will urge investors in South African bonds and equity markets to begin to liquidate holdings because the market has peaked; US interest rates are unlikely to fall anymore, with the economy weaker and the political crisis engulfing the nation, there is nothing propelling the market higher and the only way is down.

It is my belief that JSE will fall to the band between 35000 and 40000 within 12 months while the rates on the 10 years' bond will rise to at least 12% during the same time because the central bank will prefer this to higher inflation.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.