Headlines like “clothing workers to reject new wage offer” truly highlight the harsh reality of the current and future South African economic landscape. On the one hand one cannot help but to feel truly sorry for these factory workers. Surviving on a R1000 cannot be easy.
Every industry in South Africa have striked over the past 6 months, or are planning to do so soon. And I can understand why people would want to strike, and demand better pay. But what is surprising is the timing of the strikes and the extent of the demands: Double digit wage increases when the CPI is only 8%, and the rest of the world gets significant pay cuts, or worse, laid off. One would expect a sensible partner of the economic ecosystem to support businesses to keep their doors open, and ultimately save jobs. But instead trade unions come around at the most difficult phase of the business cycle, demanding even more from business, that is already on its knees from the recession.
This clearly demonstrates the complete disconnect between labour and business in South Africa, and how the one views the other as an enemy, rather than seeing themselves as different sides of the solution. Labour’s ideas and actions are still steeped in Marxist ideology, where free enterprise is the villan always out to abuse poor factory workers (and this often is the case). South African trade unions also sell the fable that a welfare state is the answer to South Africa’s poor.
Many citizens and trade unions hold the believe that government should provide housing, healthcare, infrastructure, and even jobs. The big problem is that the positive effects of government expenditure are always followed, and often overtaken, by formidable negative consequences. I’m not even referring to the huge problems of corruption, favoritism, and inefficiency that is often associated with government. Why do I make such an upsetting assertion against our much beloved government?
The big problem with government is that it requires external funding for anything it wants to do. Ultimately it is dependent on individuals and companies for its funding. The more capital government has, the less someone else has. The reason for this is that government produces little of value, and almost never makes a profit, if it is producing and selling something. So where does government get the funding it requires to fund its bureaucratic agenda.
The most obvious way to obtain the necessary funding is through taxes.
The net effect of this is that instead of spending or saving more money on the things that are most important to the company or individual, more money is diverted to the government. This means that everyone else earns less, and if a business earns less it employs less people and is less likely to save and is more vulnerable to a slowdown in the economy.
Another option available to government, to finance its budget, is through the issue of treasury bonds. There are a number of problems with issuing bonds. First of all it competes for the same savings, as other types of securities. This means that when investors acquire government bonds, there are less funds available to entrepreneurs, and funds available cost more. This makes it more challenging to business to obtain start-up or growth funding.
The last option is to inject more money into the economy by creating and spending it or making more of it available through banks. The net effect is the same, the supply of money is increased, which in turn causes inflation. Inflation favors consumption, because if you save money it becomes worth less the longer it is saved. It is also better to borrow money, because the repayments are worth less the further in the future they occur. This creates a very unsustainable business cycle, where capital is poorly allocated until it ends with the bursting of an economic bubble. An economy biased towards consumption or saving is unsustainable. For an economy to become and remain healthy, a good balance between consumption and saving must exist.
For a business to succeed it requires a sustainable, and relatively predictable environment.
One of the key problems South Africa faces is the apolitical nature of trade unions. Trade unions support a specific political party, and encourage their members to vote for this party. This provides trade unions with a powerful political voice, and the ability to influence affairs beyond economic and labour spheres. On the other hand politicians willing to dance to the tune of the trade unions, obtain a single support base that can put them in power. Jacob Zuma used this fact to his advantage with great success, and the detriment of Tabo Mbeki.
This begs the question: Why is South African trade unions so involved with politics? To answer this question we need to revisit the liberation struggle. The trade unions formed a very important part of the liberation struggle against the racist apartheid regime. During the later years of the struggle, the ANC was collaborating closely with the trade unions as one of its revolutionary partners. For instance in 1981, “the ANC for its part was trying to support workers’ strikes by taking armed action against certain companies.” The ANC petitioned “the creation of combat units at factories,” at a meeting to form a national trade union federation. At that time the ANC assisted as the integration force of the trade unions with other opposition organizations (Vladimir Shubin, ANC a View From Moscow, 2008).
Pre 1994 the ANC and trade unions as a joint political movement, with a common enemy, made complete sense, to mobilise black workers against the apartheid government. But when the ANC came into power it became responsible for more than the social welfare of the country and the people’s liberation. In this new phase of the ANC’s life, it is responsible for two opposing forces. Why are they opposing? Because the South African trade unions favor a communist arrangement of the economy and society, instead of seeing business as their partner providing jobs to their members.
The Entrepreneur’s Ship Is A Canoe
After going over the things that got the country to where it is today, the next thing to ask is, what is the solution to these problems? There is only one individual that can truly move South Africa forward, and deliver the improved quality of life that was promised during the liberation struggle. This is the individual, or individuals, that can think critically about problems or opportunities and invent solutions demanded by the market. Government might be able to run some enterprises moderately successful. But let’s be honest here. Government has never achieved a reputation to efficiently identify new needs and bring innovative solutions to the market, that leads to an improved quality of life for employees and consumers. Government also lacks the ability to extend this beyond its own national borders. The entrepreneur can extend his successes across the globe.
Government and the labour movement has an important role to align their strategy to stimulate, support and sustain entrepreneurial enterprises. They should give consumers the freedom to choose what is most important to them, and allow entrepreneurs to provide a range of options. Not force them to buy, say electricity, from only one supplier, Eskom.
This does not mean that the Department of Trade And Industry’s budget should be doubled, so they can hand out more loans to entrepreneurs, or that another government programme be launched to lecture people on the virtues of entrepreneurship. What I am referring to is that government must understand the total impact they have on the economy and how it affects entrepreneurs. Rather than spending millions on keeping South African Airways running, sell it and reduce the amount of taxes and bonds issued. This will allow consumers to direct more of their money at what’s really important to them, which in turn will give entrepreneurs a bigger incentive to start or increase their business based on what is really important.
A cornerstone of Dow Theory is confirmation. Dow Jones used industrial and railroad indexes as indicators of the state of the economy and business. Confirmation is the process of comparing two averages, to assert the direction of the primary trend. What this means is that if the one index reaches a new high, yet the other index doesn’t, it means the primary trend is running out of steam. If one index reaches a new high, then the other index should also, around the same time. They don’t need to reach new highs or lows at exactly the same time – a few weeks is acceptable. The primary and secondary indexes should perform together. If not, a divergence suggests a reversal is likely.
The secondary index should complement the primary index. The secondary index should also consist of securities that are completely different from those in the primary index. For instance in Dow’s time he used the industrial and rail indexes. Today the modern version of the rails index is the transportation index. The American transport index is the Dow Jones Transportation Average. On the Johannesburg Stock Exchange (JSE), the equivalent index is the Industrial Transportation Index (INDT – Black Line Chart).
If we compare the JSE’s Top 40 Index (TOPI – Blue Line Chart) with INDT, we can clearly see that the Top 40 reached a new high on 20 June 2007, yet INDT failed to reflect this peak. On 6 March 2008 another divergence occurred, when the Top 40 reached another new high, and INDT continued its downward trend. On 22 May 2008 the Top 40 reached its all time high, and the INDT yet again told us otherwise.
What can we say about the past 5 months? Well it looks as if the Top 40 is trending sideways, and INDT is continuing its downward trend. This is yet another divergence. Not as strong as the ones produced during 2007, and 2008, but still suggesting that the Top 40 might fall even further than its lowest point on 20 November 2008. It looks like the Top 40’s current support is around the 16000 to 16800 range. On the 3rd of March 2009 INDT reached an all time low, but TOPI has not yet reached an all time new low. I believe there is a strong likelihood that the TOPI will continue trending downwards during the next 6 weeks, and reach a new low. It will be interesting to see if this is indeed the case.
What’s so powerful about Dow’s confirmation is that it provides a strong early warning signal that the big trend is changing. In the recent past we were warned almost a year before the JSE finally came crashing down.
Many people have asked why the South African Rand is so weak currently, when the financial crises is primarily a western problem. I think there are several factors that is causing the Rand weakness (and please let me know if you think there are any that I’ve left out, or that you think is incorrect):
- Investors are in dire need of cash. The credit crunch is forcing them to sell whatever assets they have in order to salvage their cash flow. This is maybe another reason gold has struggled to surge over a $1000 per ounce. All the leverage that the previous housing bubble provided is being removed from the markets.
- Investors are pouring their money into the traditional de facto safe haven asset that is US government bonds (treasury bills and notes).
- Hedge funds need to sell assets as clients take their money out of these risky funds, that often stops short of almost gambling with their money.
- A long list of stop losses are unwinding, which triggers a new wave of selling.
Looking at point 2 it should be clear not to underestimate the importance of bonds, and especially government bonds, during a bear market. During a strong bull run, like we’ve had over the past 5 years on the Johannesburg Stock Exchange (JSE), nobody tends to take notice of them. But when the bears arrive, bonds become an ever important asset that should definitely take up a larger part of one’s portfolio.
In South Africa investors have a few options to trade bonds and bond based securities:
- Trade in the spot market on the Bond Exchange of South Africa (BESA) or the JSE’s Yield-X.
- Trade in the futures market on Yield-X.
- Trade in the options-contract market on Yield-X or Justrade.
- Trade in Investec’s Zshares GOVI Exchange Traded Fund (ETF) on the JSE itself.
It is Investec’s Zshares GOVI ETF that I’d like to introduce here today, as it will enable small investors to gain exposure to the bond market. The GOVI ETF saves you the time and effort of opening another trading account at a bond broker since it’s traded on the JSE, and from R10 per “share” you gain access to the bond market. Zshares GOVI will list on the JSE on the 21st of October 2008. As the name suggests it tracks the total return of BESA’s GOVI index of government bonds.
Zshares GOVI has the following characteristics:
- No cash distributions are made, since all coupons and bond maturities received on the underlying government bonds are automatically reinvested by acquiring additional bonds in the same proportions as the index constituents.
- Total Zshares GOVI Return = Price Performance of underlying bonds + Reinvested coupons and bond maturities + Fees earned on any bond sale and repurchases (ie: repo’s).
- It’s an ETF and units trade live on the JSE.
- All underlying government bonds are bought and sold on BESA or Yield-X.
- Transparent index methodology.
- Portfolio rebalanced in line with GOVI index rebalancing.
- Transparent portfolio composition. The fund’s composition is available on Investec’s Zshares web site.
- Trade settlement guarenteed by the JSE, making it a very safe investment.
- Very importantly it has a very low cost: The annual management fee is 0.2% to 0.25%.
This is a wonderful tool, that will give small investors an easy way to make bonds a part of their portfolio.
Investec Bank (INLP)
As a moderately eager income investor, I like keeping a few preference shares in my portfolio. One share I have been watching over the past 5 months is Investec Bank’s preference share (INLP) on the JSE. Currently it’s the 8th highest dividend payer on the JSE, based on historical dividend payments. It was recently priced at R78, with a P/E of 1.38 and a Dividend Yield (DY) of 13.12. Its chart is indicating an oversold position, without any indication of a turnaround, so it will most likely become even cheaper. R78 is also its current support level, and I expect it to trade sideways for a while.
I believe South African banks are very solid, and should weather the financial storm relatively well. Regardless, they’ve become part of the global fire sale of stocks. INLP is a non-redeemable, non-cumulative, non-participating preference share. Personally I prefer to invest in cumulative preference shares, so that the dividend payments are guaranteed (unless of course in the situation that the company goes bankrupt). So that’s the only disadvantage I can see with this share. But with a P/E of 1.38, and technical indicators predicting that number to shrink even further (although I’m no expert in technical analysis), you can’t go wrong to put in your bid for it when the trend changes into a bullish one (which could be a long time from now).
What a hectic fortnight! With the left-wing in the ANC finally taking control of the organization with Mbeki’s resignation as South Africa’s president, under pressure from Zuma’s left-wing buddies, I believe the Rand and JSE will remain under pressure over the next 18 months. The good news this week was that the PPI increased by a modest 0.2% in August 2008. The bad news is that it’s standing at a whopping 19.1%. Ouch! But with the comrades’ red flag waving high in government, I don’t believe we are in for any interest rate increases by Tito Mboweni for at least 6 months, even if inflation jumps with another full percent.
Everybody was shocked at how fast Mbeki was kicked out of government, and at the timing of it – amid a global financial crises. This was followed by the resignation of several ministers loyal to him. Some who’s political careers are nearing the end anyways, like Alec Erwin. I guess it’s better to go out with some fireworks, and controversy, than facing the embarrassment of not getting a post in the new government after next year’s elections. Some we weren’t going to miss at all, such as the aforementioned, which brought us legendary hits like “Darkcity”, or better known as “Mzansi Without Power”. Some, like Trevor Maneul and Tito Mboweni (yes, I know I’m most likely standing in my own little corner adding him to the my-favorites list – but I have my reasons), we feared that should they leave, large parts of government will collapse into a state of total anarchy, and any hope of a seamless continuation of policy lost forever.
At least the fact that we would’ve had 3 new presidents in 6 months, should reassure the international community that South Africa won’t have a dictator anytime soon. It should also silence the skeptics that South Africa is the next Zimbabwe. Yeah right! The competition in the ANC for the post of president is way too intense for a Mugabe-like figure to rule for a second longer than his allotted 8 years. Hey, come to think of it, South Africa has not had one president that completed his second 4 year term. Now that’s what I call democracy! The only aspect that smells of a Zimbabwe land-grab stink, is the notorious Expropriation Bill. This ugly anti-capitalist piece of legislation has been shelved for the time being, while the ANC is gearing up for the 2009 elections. But it’s still lurking as the precious ring of Mordor in the dark basements of government, that will bestow it with the ultimate power to confiscate and hand out any property, without having to answer to a court of law. What any corrupt politician won’t give to wield such a wonderful tool to hand out property at free will to his confidants.
Kgalema Motlanthe was appointed interim president. Although he is a left leaning comrade, coming from the trade union side, he looks like a humble (well, probably as humble as a big shot politician can be), and diplomatic person. Exactly the kind of leader we need to massage the current government pain points, until Zuma takes over. Or might he attempt to win the hearts and minds of his party and people by next year’s election? I’ve already read in The Sunday Times that in some quarters he is more popular than Zuma. It will be interesting to see how this suspense drama plays out: I can already see a new wave of infighting as Motlanthe maneuvers to compete with Zuma for president.
With the local and international scene churning out one new catastrophe after the other, I definitely urge those of you who haven’t invested in gold to do so urgently. And I’m definitely more in favor of actual gold, rather than gold stocks. I’m not saying sell all your stocks and buy only gold coins to hide under the mattress, but I definitely recommend allocating about 10% of your portfolio in the ultra cool, ultra liquid, New Gold ETF, listed on the JSE. The wonderfully Rand denominated gold ETF, will insure you against negative movements in the dollar, and Rand. Wow! Two for the price of one. What a bargain.
As I’ve mentioned, South African stocks will remain under pressure amid all the uncertainty, especially as far as capital growth is concerned. I believe it’s definitely the time of more defensive, good dividend paying stocks.
Hey, talking of good dividends; definitely take a look at preference shares. Most stocks bought an sold are “ordinary shares”. These stocks have have no maturity (expiry) date. Meaning they exist in perpetuity, or well, at least until the company goes bankrupt. Ordinary shareholders have a proportional claim to the income and assets of the company after the company’s met all its obligations to creditors and preference shareholders. So you’re last in line should a company go bankrupt, and its assets sold off to pay its outstanding debt. New ordinary shares can’t be issued, unless you’re offered the first “right” to take up more shares in the same proportion as your current ownership. You also have the right to vote on various resolutions at company annual general meetings. Although for small investors, such as myself, this really doesn’t matter since we usually own so few shares that it’s not going to make any difference whether we vote or not.
This brings us to preference shares, or preferred stocks. This type of share is a combination of equity and debt, issued with a “guaranteed” percentage dividend. You buy and sell these stocks just like normal shares, but you don’t get any voting rights. However you are first in the shareholder line when it comes to dividends, and claims. This means that should a company declare a dividend, preferred shareholders must get a dividend, before ordinary shareholders get their share of the dividend.
They also have other benefits, such as that the dividends are tax free, unlike dividends on ordinary shares, and the dividend amount is based on a ratio of the prime interest rate. The net effect of this is that they actually pay larger dividends as the prime interest rate increases, yet the actual share price comes down, just like normal shares do in a higher interest rate environment. But watch out, you do not nearly get the same price appreciation with preferred stocks, that you get with ordinary shares. Preferred stocks are also less liquid than ordinary shares.
The different types of preferred stock
Cumulative preference shares:
In the event of a company being unable to pay preference share dividends in a particular financial year, the amount of these “unpaid” dividends will be paid in subsequent years when results allow. These types of preference shares are my favorites. On the JSE it’s mostly the non-banks’ preference shares that are cumulative. Although there are exceptions, such as ABIL’s preference share which is in fact cumulative.
Non-cumulative preference shares:
In the event of a company being unable to pay preference share dividends in a particular year, the holder of a non-cumulative preference share forfeits the right to this dividend. The majority of the banks on the JSE have this kind of preference share.
Redeemable preference shares:
A redeemable preference share is issued with the provision that the company will be able to redeem this share at some future date. This means the company will be able to “buy” these shares back and remove them from circulation.
Convertible preference shares:
These shares can be converted to ordinary shares, at a specified or unspecified time in the future. The Sasol Inzalo shares will be converted to ordinary Sasol shares, after 10 years.
Participating preference shares:
These shares get both the preferred dividend, and the ordinary dividend.
In future posts I’ll cover the characteristics of individual preferred stocks on the JSE. But that’s it for now. Have a wonderful week!