The Investor July 2024
ShareFinder’s prediction for Wall Street for the next 3 months (top) and the JSE (bottom):
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Are they hiding the truth?
By Richard Cluver
“Small businesses are the backbone of our economy and the cornerstone of our communities.” – Barack Obama, former US President
Small business is arguably the best friend of all governments that seek full-employment and universal prosperity for their people because countless studies have shown that looking after the interests of commerce is the ultimate means of ensuring economic growth and the ensuing stability which in turn normally ensures that political parties get re-elected.
Yet, the sad truth is that across the Western World, business has found it increasingly difficult to make the profits required to guarantee its own long-term stability. A 2023 report by McKinsey senior partner Marc de Jong and researchers Tido Röder, Peter Stumpner, and Ilya Zaznov noted that “Over the past two decades, companies’ economic profits have, in the aggregate, been shrinking. Their capital has had to work harder just to keep up with historical results.”
“To gauge economic-profit dynamics, we examined the world’s 4,000 largest public companies, by revenue, in each year, starting in 2005. Because there are important differences between developments prior to the COVID-19 pandemic and those throughout the pandemic, we divided our analysis into a longer 15-year period, ending in 2019. Then we contrasted this time horizon with a two-year period, 2020–21.
This latter view is less definitive than longer time frames because of a shorter averaging period and the unique characteristics of the COVID-19 crisis. Yet those years, particularly when considered together with longer, prior periods, reveal that net economic-profit pools aren’t expanding in lock-step with companies’ revenues or accounting profits. Even considering that global economic profit halved from 2005 to 2019 and then rebounded in 2021, global net economic profit is experiencing a notable long-term crunch.
The following table details their findings:
And of course the decline did not start in the new millennium. Back in the 1980s a study by Martin Feldstein and Lawrence Summers of Harvard University showed that business profit margins had been declining steadily since World War 2. Examining US corporate activity from 1948 to 1976 they noted a decline in net profits from 13.64 percent to 9.2 percent and gross profit from 11.9 percent to 9.6 percent since the late 1060s as illustrated by their graph below:
US Department of Commerce’s Bureau of Economic Analysis figures indicate that the US corporate rate of profit is now some 30% below where it was after WW2 and 20% below the 1960s.
The following graph below shows the results, updated to 2015 for this measure, using either historic or current costs to value fixed assets.
What the graph makes clear is that the overall US rate of profit had four phases: the post-war golden age of high profitability peaking in 1965; then the profitability crisis of the 1970s, troughing in the slump of 1980-2; then the neoliberal period of recovery or at least stabilisation in profitability, peaking more or less in 1997; then the current period of volatility and slight decline.
And it was not just in the US that corporate profits have declined. The same has happened for the entire G20 group of nations as is made clear by my next graph on the right:
In recognition of this trend, governments everywhere have tried to compensate by on average halving corporate tax rates.
The following Reuters graph illustrates how OECD countries have steadily reduced corporate tax rates over the past half-century:
So, while governments throughout the West have steadily shifted the tax burden from corporates to private citizens, the trend has done little to assist business profitability and the cause of Western job-creation. Indeed, shifting the tax burden from business to private citizens has, as I have demonstrated in the previous chapter, stripped citizenry of their discretionary spending power which has in turn stripped business of its profits which has, in turn, been forced to reduce its workforce.
In a bid to maintain profitability, the West has over the past century migrated industrial production to the Far East in search of cheaper labour. But in the process it has created industrial ‘Rust Belts” where shuttered factories and unemployed workers has been the inevitable result. Ironically, however, the consequence has been an ever-growing army of unemployed citizens becoming reliant on “The Dole” which has, in turn created a vicious cycle of ever-increasing social wage demands upon governments which almost entirely accounts for the ever-increasing debt burden of governments.
Thus, for example, by 2024 more than 41 percent of the U.S. population had become “enrolled in at least one federal assistance program,” adding tens of billions of dollars to the national debt each year, according to new research by The Heritage Foundation’s Patrick Tyrrell and William W. Beach.
That means that a startling number of people in the United States draw income from money their family earns as well as money transferred to them from U.S. taxpayers via some form of federal assistance spending, according to the report from the Centre for Data Analysis at Heritage.
The rate of growth of those receiving federal assistance spending grew 62 percent from 1988 to 2011.
Thus, the well-intended efforts of Western governments to assist the cause of corporate profitability, it has done little to ease their unemployment problem.
But on its own the corporate tax breaks have not been enough to compensate corporate profitability from the effective loss of the ordinary citizen’s discretionary spending to the West’s taxation mills. As a result, Western industry has steadily given way to Far Eastern competition. The graph below neatly tells the tale in respect of the USA where, despite considerable cyclic volatility, total unemployment has risen steadily from below five percent to an average around 50 percent higher:
For a stark recent example of what has been happening, Fortune Magazine reported recently that the Geneva International Motor Show, which turned 100 years old in February 2024 its centennial event was also its last in the Swiss city.
For decades, GIMS was part of the auto industry’s big four events, alongside the shows in Detroit, Frankfurt, and Paris. But henceforth only its brand name will survive because its organizers have since set up shop in Qatar.
Further east, the Beijing Auto Show and Auto Shanghai have become the world’s largest car fairs. Caught between a post-COVID drop in car sales, a decline in European car manufacturing, and the rise of Asia, Geneva no longer had a unique appeal as a location.
The Tribune de Genève, a local newspaper, noted that car manufacturers presented only 13 new models during Geneva’s last show, compared to 117 at the Beijing motor show.
So far, Geneva’s other major mobility show, EBACE, which gathers the global private jet industry, had been holding on to its European home base. But even for the companies catering to the global jet set, Asia was becoming ever more relevant—and Europe less so.
For most of the companies, the Middle East had become either their number one or two market and Europe’s economy was losing ground, its population was aging, and its leading companies were still mostly banking on 20th-century innovations. In that sense, the demise of Europe’s business conferences was just the canary in the coal mine.
The problem does, however, not end there. To understand why things are destined to get far worse, I need to delve into economic theory to explain that the cycle of capital is understood to be reliant on labour-power in order to increase the value of commodities.
To illustrate the point, capital employed is not only required to buy labour. It is also required to buy and maintain both the machines and the raw materials used in the manufacturing process.
So consider the dynamics of Adam Smith’s pin-making factory. Let us suppose that when Smith started his observations a single person operating a pin workshop could alone produce 20 pins in a day or, if you like, eight pin makers in isolation could produce 160 pins a day. However, eight workers in a factory using far more expensive machines and tools, could produce 20,000 pins a day.
Thus we see that to produce the same number of pins required by lady seamstresses in Smith’s day, mechanisation dramatically reduced the number of workers that were required.
It follows that the result was a dramatic reduction in both the cost of pins and the number of workers needed to produce them which inevitably put out of business anyone who could no longer make a profit from the new cheaper pins. Furthermore, as technology improves, more and more capital is required to invest in the newest and best machines.
So we see an accelerating cycle of success breeding success. Those unable to afford the ever-increasing cost of new technology soon gets left behind. Production volumes increase but profit margins decrease. Successful manufacturers gain ground and generate ever-increasing sums of capital while the rest face shrinking profits, fall ever further behind in both innovation and production levels.
Inevitably the laggards get left behind, their companies are liquidated and their workers fall into unemployment.
As capitalism drags on and develops technologically, more and more machines and tools are needed to produce commodities. The centralization of factories has made them increasingly reliant on autonomous technology for example. Thus the capital spending required for constant capital goes up.
Thus, in a word, the West is getting left behind. The US graph below tells the whole story:
I might be forgiven for repeating here a verse from an intervarsity song of my student youth ‘Welcome to the Wild West Show’ which concerned the legendary Australian Oozulum bird which was said to possess only one wing which caused it to fly in ever tighter concentric circles, until it finally disappeared up its own fundamental orifice!
Might this fable hold the truth about Western economies?
A Sticky Last Mile
By John Mauldin
“Alice laughed. ‘There’s no use trying,’ she said. ‘One can’t believe impossible things.’”
“’I daresay you haven’t had much practice,’ said the Queen. ‘When I was your age, I always did it for half-an-hour a day. Why, sometimes I’ve believed as many as six impossible things before breakfast.’”
―Lewis Carroll
This week we find our own six impossible things in economics. Sigh.
Progress toward a goal usually isn’t linear. The first 50% isn’t too bad, the next 40% is harder, and the last 10% consumes most of the effort and resources. Business strategists call this the “last mile” problem… and it applies to inflation, too.
Inflation is Going, Not Gone. Two years ago, CPI was rising at a 9.1% annual rate and looked set to go even higher. It didn’t, and now is approaching 3%. That’s remarkable progress… but also not enough progress.
I’ve said this a few times and will keep saying it because I really want it to sink in. Learn to juggle these two thoughts in your mind because they’re both correct. Inflation is a) better than it was and b) still too high.
In my view, even the Fed’s 2% target is too high. Per Peter Boockvar, “Q2 GDP growth was 2.8%, above the estimate of 2%. Three tenths of this upside was due to a lower than expected price deflator of 2.3% vs. the estimate of 2.6%. Core PCE though of 2.9% was two tenths higher than expected.”
2.3% sounds almost like 2%. 2.9% doesn’t. Which way do you want to spin it?
I explained last week how this is mostly due to housing inflation, which might not fall as much as we would like (unless you are a housing real estate investor and then you want higher rents).
Today I want to go deeper on that point, and touch briefly on the timing of Fed cuts and interest rates. The last mile will be a long, tough slog.
Sticky Shelter
Jim Bianco of Bianco Research is one of my go-to sources on inflation and interest rates. He was talking about this “last mile” inflation problem long before anyone else I know. He was also early to point out how it’s all about housing. Here’s Jim from an interview back in February. What he said then is still pertinent today.
“… Any meaningful declines from here on out need to come from services ex-energy, and when you break down the main contributors to services inflation, the overwhelming majority boils down to shelter prices. That number is still up 5‒6% on a 12-month basis. A lot of people say housing inflation will come down considerably. But I think that’s wrong, which means inflation will remain elevated.
“You have to look at it cumulatively: Shelter—owners’ equivalent rent and rents of primary residence—are a third of headline CPI. Looking back, according to the CPI, housing inflation is up about 20% since 2021. But if you look at market measures such as the Zillow Rent index or the Case-Shiller Home Price index, they’re up like 30%. This suggests the shelter component in the CPI is understating the advance in home prices over the last three years. This doesn’t mean that the number can’t come down. But it won’t come down as fast as everybody thinks, because it still has more catch-up to do to close that gap to market measures. So housing inflation is going to stay sticky, and that’s going to keep services inflation up.”
Note that word “sticky.” Stickiness has this annoying way of spreading. Touch something sticky and it jumps to your fingers and then whatever you touch next. In this case, sticky inflation means sticky interest rates. Here’s Jim again.
“In a world where investors are wondering if the Fed will cut interest rates four, five, or six times this year, sticky inflation is going to kill that. It will just take all the talk about rate cuts off the table. The Fed can do whatever they want, as long as inflation goes back to 2%. They can cut rates to zero, they can do QE. But if inflation does not go back to 2%, it narrows their options. So inflation is truly the linchpin.”
The problem here, as Jim explains, is that the “neutral” federal funds rate will stay elevated along with inflation. The neutral rate is typically thought to be the inflation rate plus 50‒100 basis points. If inflation drops to 2%, the Fed has room to cut as much as 300 points from the current 5.5%.
If inflation stays in the 2.5‒3.5% range, as seems more likely, the neutral rate has a 4-handle. We could get a few cuts at some point in time, but how many is a few? Sigh. It’s data dependent. As of now, they have room to cut maybe 100 points, at most. This will remain the case until housing inflation breaks significantly lower. Which, as I explained last week, will probably take a long time. Barring a recession…
Diluting Inflation
Last week my friend Doug Kass flagged an article by David Stockman, who you may remember (if you’re old enough) as Reagan’s OMB Director. He left that job in frustration that neither Congress nor the public really wanted to get the debt under control. He seems to have become uber-hawkish on inflation and highly critical of the Fed, a bit like me.
Stockman shows several different inflation measures since 2017 which, considered together, show the most essential consumer prices rose about 4.0% annually over this 7½ year period. Much of that is since 2022, of course. But looking only at “trimmed mean” CPI (which omits the fastest- and slowest-growing categories), it has been 2% or higher for this entire period, averaging 3.7%.
He looks at this and, contrary to most everyone else, concludes the Fed needs to fight inflation harder and longer. Then he makes a really interesting point. Remember the talk (before COVID) about letting the economy “run hot” long enough to get inflation back up to the Fed’s 2% target? Stockman thinks we need to do that in the opposite direction: push inflation well below 2% in order to get the averages back down.
Here’s Stockman:
“To be sure, the 2.00% annual inflation ‘goal’ itself is nonsense. Yet when you overshoot even that arbitrary pro-inflation target by nearly 100%, why in the world is the Fed claiming that victory over inflation is at hand, and that the next round of rate-cutting and monetary stimulus is fixing to commence?
“If nothing else, you’d think that the paint-by-the-numbers monetary central planners at the Fed would at least deign to give America’s battered savers and wage earners an extended breather from inflation risk for several more quarters or even years. That is, by keeping its foot on the monetary brakes the Fed could preclude another burst of inflation—even as the most recent outbreak was being absorbed by savers, wage earners and entrepreneurs.
“Indeed, after six years of elevated inflation, the case for diluting the inflation trend with a period of low or no inflation is overwhelming. For instance, if the trimmed mean CPI were to run at exactly 2.00% per annum for the next three years, the index rise since March 2018 would still average +3.25% per annum; and even at 1.0% annually for another three years, the cumulative gain since March 2018 would be +2.81% per annum.”
I get his point. I don’t know how the Fed would do this, though. As I’ve noted, the inflation we have now is mostly in housing, and the Fed has no good way to push housing prices lower. I suppose they could raise rates enough to intentionally ignite a recession, but that would produce other problems.
We really are in a box. As Bianco explains, the Fed doesn’t have much room to cut rates. Nor, as Stockman demonstrates, can it raise rates high enough for long enough to bring long-term inflation averages to its own target over a longer period of time.
Reaching 2% inflation and sustaining 2% inflation are two different things. They might do the former. The latter is, sadly, probably off the table, barring some economic collapse scenario.
Or is it?
Sustainable Paths
The Federal Reserve isn’t the only institution whose decisions affect inflation. Fiscal policy matters, too. Congress’s tax and spending choices have macroeconomic consequences which, unfortunately, are often apparent only in hindsight.
Lacy Hunt has been preaching steadfastly for years that rising government debt suppresses economic growth and is thus deflationary. This happens because the “fiscal multiplier” effect gets smaller as more and more spending goes to service the debt.
You keep seeing numbers in much of the media that suggest the national debt is $1.7 trillion. But the national debt has risen by close to $2.5 trillion in the last four quarters. As Treasury rolls over its debt to new issues yielding 4% or higher, interest expenses rise. Right now, with the average rate slightly over 3%, Treasury’s interest is running over $1 trillion a year. This will rise over time, even with some rate cuts and yield curve normalization. Interest will be a bigger expense than national defense. Aaarrgggh.
I think Lacy is right this is ultimately deflationary. But at the same time, spending on a vast enough scale can still have at least a short-term inflationary effect. That is certainly what we’ve seen since 2020 with the various COVID programs and then the Biden administration’s infrastructure and social spending. Give enough cash to enough people and their spending will push price levels higher, particularly when productive capacity is constrained. It adds to the debt, but those effects come later.
Now, remember what I said about juggling competing thoughts. Here’s another one: Any given monetary or fiscal policy choice can be both inflationary and deflationary. The difference lies in when each effect happens. Policies intended as stimulative policies (lower taxes, higher spending) can be inflationary at first, then deflationary later.
My friend David Bahnsen tried to unpack this in a recent letter called The Inflation Conundrum, which I highly suggest you read in full (five minutes?). Here is his opening.
“You may have heard of several schools of thought about inflation. Differing opinions on what generally causes inflation, differing opinions on what caused the 2022 inflation, and differing opinions on what to expect from inflation going forward leave ample opportunities for a mixed bag of perspectives.
“One school of thought that I have [by necessity] tirelessly disputed for a long time is the belief that excessive government spending and easy monetary policy is, necessarily, inflationary. This is not because I support excessive government spending and distortive monetary policy but rather because I oppose excessive government spending and distortive monetary policy. The school of thought that has believed this has unintentionally proclaimed that the government can ‘heat up the economy’ with levers they firmly control and ‘cool it down’ by moving those same levers the other way. Sorry, but this is not true, and it has never been, and the testimony of history is abundantly clear (see: Japan, United States, EU, UK). My Japanification thesis runs counter to the view that all fiscal and monetary thesis is inflationary, though I certainly concur that policymakers wish it were!”
(I read David’s brief market analysis and some thoughtful and brief economic insights every day. A few minutes and I am caught up and am not glued to a screen. You can get it for free by subscribing here. A sign-up screen will show up shortly.)
Now, it is certainly true the economy is far too complex for the government to control with any precision. They don’t have such buttons to push. But fiscal and monetary policy decisions definitely have effects. They are never neutral. They override the choices of individual consumers and businesses in order to achieve goals different from what a free market would deliver. The goals may be good but achieving them always has a cost.
Right now, a complex mixture of policies is producing a complex set of effects. We have inflation, mostly concentrated in housing, and either disinflation or deflation in other goods and services. The net result, if your spending matches the CPI basket, is something around 3% annualized price inflation. Your income might or might not be inflating at the same rate. If it’s not, you are slowly but surely falling behind.
Jerome Powell and the FOMC members know this. They say they will cut rates when inflation (as they measure it) is on a “sustainable path” to their 2% target. Maybe that’s what they will decide next week, but I doubt it.
Further, Michael Lebowitz writes this week (in a report we sent in full to Over My Shoulder readers) that fiscal policy and not Fed policy will be the main driver of interest rates in the future, as the cost of the debt is drowning out the ability of the Fed to use normal monetary policy:
“As debt issued years ago with low interest rates matures and new debt with higher interest rates replaces it, the interest expense will keep rising. For context, if we assume the government’s average interest rate is 4.75%, likely close to their weighted average rate on recent debt issuance, the interest expense will rise to $1.65 trillion, not including new debt. $1.65 trillion is over $300 billion above the government’s next largest expenditure, Social Security. Furthermore, it is double defense spending for 2023. The annual federal deficit has only been above $1.65 trillion twice (2020 and 2021) since its founding in 1776.
“While the situation may sound gloomy, lower interest rates solve the problem. If interest rates return to the levels existing before 2022, the interest expense could easily fall below $700 billion, about half of the cost than if rates remain at current levels. Therefore, interest rates will have to be kept in check by the Fed.”
But wait! If the Fed accommodates the US government with lower-than-appropriate rates won’t that bring back inflation? Or worse, inflationary stagflation?
Yes, now you get it. Once again, you have to balance two opposite ideas at the same time.
The market expects a rate cut in September. But the market expected six rates cuts last December. The Fed has lots of impossible things to balance. The minutes from this week’s meeting should be interesting.
My friend Ed Easterling of Crestmont Research saw my letter last week and wrote to remind me of the coming yearly comparisons. Headline CPI actually declined last October-December—which is why Wall Street got so excited about rate cuts, then disappointed when inflation rose again in the first quarter. That period means this year’s Q4 CPI readings will be measured from a lower base. This “base effect” will mean a bias to higher annual rates.
The FOMC members surely know this. They understand it’s a short-term distortion. Nevertheless, they are conscious of how their decisions are perceived and the effect on market and consumer expectations.
Is the FOMC going to cut rates in September and/or November, knowing that inflation will probably pop higher soon afterward? Again, there will be a good explanation, but it will look like they cut too soon early next year. The resulting criticism may tie their hands later. That may sound like a stretch but trust me, they think of these things. At least, I hope they do.
A few months ago, Torsten Sløk made a stir by predicting no rate cuts this year. From what I see, he’s probably right. Housing inflation is unlikely to show substantial movement, and unless it does then it’s ridiculous to say the inflation target is coming into view.
For inflation, the last mile is the toughest. It may seem like “just” a mile considering where we were, but it is still a long way to go. So close and yet…
What Markets have told us about GNU
By BRIAN KANTOR
You might have expected more volatile markets, in this election year. The evidence however suggests otherwise. Investors on the JSE and the New York Stock Exchanges have coped comfortably well with the potential dangers.
Daily volatility on both share markets, the scale of daily ups and downs in average share prices, has been unusually subdued, and well below long term averages in the US. Electing a scoundrel or a cognitively challenged US President has not made much of a difference to stability in the US markets and the coalition outcome in SA proved welcome but not much of a surprise, again as judged by volatility trends.
The Volatility Index for the S&P 500 – the VIX- also known as the Fear Index- has averaged 13 this year well below a daily long-term average 2000-2024 of 19. The equivalent construct for the JSE, the SA Volatility Index (SAVI) – with a similar long-term average of 21, has also trended lower this year.
As may be easily observed the chances of an Index or any well traded share moving higher or lower on any day are about the same. The pattern is thus of a random walk, of ups being matched by downs of roughly the same average magnitude. Yet happily for shareholders these movements have come with a slight upward bias, above a daily average of zero, to provide shareholders with positive returns over the longer run. If they stayed invested in the share market the end result has been strongly positive annual returns over five or ten year periods rolled back each month.
(See below the daily moves of the S&P 500 and the JSE All Share Index in 2024. We also show the Daily SAVI in 2023-24 as well as actual volatility of the JSE – calculated as the rolling 30 day Standard Deviation about the Daily Average Share Pirce Move)
Daily % Share Index Movements on the JSE and the S&P 500 in 2024
Source; Bloomberg and Investec Wealth & Investment
Daily Moves in the SA Volatility Index (SAVI) and Volatility Measured as the Standard Deviation of the JSE (Annualised as a rolling 30-day average)
Source; Bloomberg and Investec Wealth & Investment
When daily volatility is more elevated, share prices will change consistently in the opposite direction. When the VIX or SAVI goes up share prices go down most days. They do so to improve the chances of higher risk adjusted returns- off a lower entry price- to compensate for more risk incurred. And vice versa. In 2024 it has been vice versa in the US and in SA- risks have fallen and values have improved. Extra risk comes with more returns and vice versa as nature intends. (see below)
The average move for the JSE in 2024 in the six months to June 2024 was an encouraging 0.27% per day. The S&P did only half as well- providing an average gain of 0.11% per day.
Daily % Changes in the VIX and the S&P 500 in 2024. Scatter Plot
Source; Bloomberg and Investec Wealth & Investment
Daily % Changes in the SAVI and the JSE in 2024. Scatter Plot
Source; Bloomberg and Investec Wealth & Investment
It is the quality of economic policy, more than the presumed certainty of such policies, good bad or somewhere in between, that will matter much more for financial markets in the long run. Any willingness of investors to accord a SA facing business an extended economic life will also add to present values. Provided the Return on Equity (ROE) exceeds the opportunity cost of capital, faster expected growth for a longer term, can explode the current present value of a share and market multiples. Price over Current Earnings or Cash flows and Market to Book ratios.
An accompaniment of lower ROE’s and a lower discount rate attached to future surpluses would also add much additional market value to SA companies. And to their willingness and ability to undertake and fund growth enhancing capex and employment. Faster growth if realised will add to an extra flow of cash to the government, bringing less risk to the fiscal outlook. And be reflected in lower interest and discount rates across the board and in higher share prices.
Extra wealth created in the bond and equity markets, is a game played by all with formal employment and retirement plans, and not only the richer few. The capital markets will provide an objective measure of the performance of the government of national unity (GNU) The score will be continuously kept and updated. While investors have not been frightened by the GNU, they have still to give approval. Over to the GNU.
• Kantor is head of the research institute at Investec Wealth & Investment. He writes in his personal capacity.
A Historic Shift to the Middle
By JP Landman
First, some things that did not happen during this election season are as important as those that did.
What did not happen?
• We did not see the violence and disruption that so many people predicted. It could still happen of course. We heard on Saturday that extra police units have been deployed to KwaZulu-Natal (KZN). So far, however, we have seen much less than the general expectation. This year, to date, 11 people have been killed in political assassinations in South Africa, mainly in KZN. It is 11 too many, and we’re only half-year, but still a marked decline from the 30 political murders in 2023 and the 41 in 2022.
• There was no disruption on Election Day, nor after the results were announced. There were threats and demands but nothing happened. Most people in the country, including the Zulu King, expressed the view that the elections were free and fair despite the acknowledged glitches. MK cried foul, but they did not produce any evidence. The Constitutional Court duly sent them away empty-handed when they tried to interdict the first sitting of the new Parliament.
• The ANC did not cling to power and refuse to accept the result. The importance of this fact cannot be overemphasised. It was a seminal moment. For 30 years people have said the real test for our democracy would be when the ANC lost power. Well, it did lose power and almost seamlessly moved to a new dispensation within 2 weeks.
• It was widely predicted that Cyril Ramaphosa would be kicked out as ANC leader if the party’s support plunged to 40%. That did not happen. He has been duly re-elected.
• Load-shedding did not resume the day after the election. It probably will return to some degree, but let’s give credit where it is due. We have had 80 days without load-shedding, and excessive amounts of diesel were not burnt. On the contrary.
• The polls were not wrong. No one got the final numbers absolutely correct, but the big moves and shifts were clearly predicted. Likewise, most of the post-election projections of the final results were very accurate. As citizens we can be proud that we have developed the capacity in the country to run world-class polls and post-election projections.
Make of these what you will, but for me, these non-happenings illustrate 2 things: there is more moderation in the country than extremism, and more capacity than we sometimes allow for.
Where we are now
More than a year ago, in May 2023, I wrote a note arguing for a ‘grand coalition’ between the ANC and the DA. I framed it as a coalition of parties of the democratic centre who can agree on basic values and an approach to government.
In August 2023, I wrote a follow-up note pointing out the developments in our body politic that seemed to be pushing us closer to a coalition. Well, we are there now. The election has brought us firmly to coalition territory.
Coalition territory
The ANC finessed this one, in my opinion, quite cleverly. The party achieved 2 things by introducing the idea of a government of national unity rather than a coalition. Firstly, they shifted the attention away from a binary choice.
Between the EFF/MK and the DA. Secondly, by emphasising common values – particularly the constitution and the rule of law – the process isolated the EFF and MK. This happened even in KZN, where the MK party got 45% of the votes.
The EFF and MK now stand on the outside, while there is a pretty tight coalition agreement between the ANC, DA, IFP and some smaller parties.
Thank the electoral system
Our founding fathers and mothers bequeathed us a proportional electoral system in 1994. For the first 30 years, the ANC got more than 50% of the votes in national elections. This is unusual in a proportional or party list system, and it is unlikely that we will soon see that again.
We surveyed countries around the world with proportional or party list systems. We identified 87 such countries. Two-thirds of them, 55 out of 87, have coalition governments. Only in a third of these countries could a single party garner a majority of 50% plus 1.
The reason is simple. In a proportional system, each vote counts exactly the same. Whether you vote in Mpumalanga or the Northern Cape, in a city or a deep rural area, your vote counts exactly the same. All those dispersed votes are added together, enabling a dispersed group of like-minded people to get a representative into parliament. It makes for a more representative parliament, one that cannot be easily dominated by a single big party.
This is very different from a constituency-based system, where members are elected by the majority in every constituency. That can easily lead to a situation where a minority of votes translate into a majority in parliament. In 1948, the National Party in South Africa got a minority of votes, but a majority of parliamentary seats. That paved the way for more apartheid legislation. This also happened in the UK in 2019, when the Tories got about 45% of the votes, but 55% of the members of parliament. The majority then pushed Brexit through.
South Africa in 2024 is firmly in coalition territory thanks to the voters and our proportional system. Be careful to tinker with it.
Can a national coalition be different from local government ones?
South Africa has had terrible experiences with coalitions at local government. How then will this national coalition be different?
What we’ve learned at the local government level is that one cannot have a successful coalition if the focus is on the who and not on the how. Who gets the job, who is the mayor, who is the speaker … rather than how are we going to do the job? Who rather than how did not work well for us in local government.
The who versus how paradigm was broken in KZN more than a year ago when the DA and IFP signed a coalition agreement on how they will run the 13 municipalities in KZN where they are in the majority. They stipulated their common values, set out what they wanted to achieve during their term of office, and outlined some practical steps on how they would do it.
That is precisely the approach in the 9-page agreement the ANC and DA signed on Friday, 14 June. The parties agreed on 10 foundational principles and a minimum work programme with 9 priorities (these are below this note as an addendum). The new cabinet will have a joint strategy session to develop a policy agenda based on these values and priorities. Provision is made for resolving differences and handling disputes. It is the president’s prerogative to appoint the cabinet, but he will consult with party leaders and consider the number of seats that parties have in parliament.
This systematic approach, focusing on how, is very different from the haphazard who approach that characterised coalitions at many local governments.
More agreement than disagreement
Many people in both political parties and the commentariat have talked about what they see as major ideological differences between the ANC and DA. In my view, they have more in common than they disagree about. The 10 foundational principles and 9 priorities they agreed on prove that abundantly. The differences are more in style.
And rhetoric than in substance, caused more by different backgrounds and living experiences than different world views.
In fact, the policy differences between the ANC, MK and EFF are bigger than those between the ANC and DA. MK wants to abolish the supremacy of the constitution and return to the old SA arrangement, where parliament is the supreme authority in the country. The ANC believes in the Constitution as the supreme authority (as does the DA). The DA and MK are miles apart.
The EFF believes that all land should belong to the state; the ANC favours a mixed-ownership model where individual citizens directly hold land in their own name. Both the MK and EFF want to nationalise whole industries and put them under state control. The ANC is bringing the private sector into key industries where the state traditionally had a monopoly (energy, railways, ports, water). On all these issues, the ANC are much closer to the DA than to MK or EFF.
What about the DA’s perceived opposition to transformation? The 10 foundational principles agreed on specifically refer to ‘social justice, redress and equity’, ‘the progressive realisation of socio-economic rights’, ‘the alleviation of poverty’ and other transformational principles. On those principles, the DA cannot stand against the ongoing transformation of society.
It is quite clear that the 2 main parties in the middle, the ANC and DA, are not that far apart, while both of them are very far from MK and EFF. Some call the EFF and MK ‘far left’. Truth be told, they are not so much left, but rather fascist parties of the far right, but be that categorisation as it may. The point is they are both far away from the middle.
Much is currently being made of a national dialogue to discuss appropriate responses to the nation’s critical challenges. That may enhance the areas of agreement, ringfence the areas of disagreement and strengthen the middle further. It is a space to watch over the next year.
Most South Africans have the same aspirations and needs. Hopefully, some of our political style and rhetoric will now adjust to this we-have-more-in-common reality.
What now …
… on appointments
The president was elected on Friday, 14 June. He was sworn in on Wednesday, 19 June at the Union Buildings in Tshwane. He will then appoint a cabinet of ministers from the parties to the coalition. There is no deadline, and he can take his time. Once appointed, ministers will take charge of their portfolios and execute agreed coalition policies. Should, for example, a DA member be appointed minister of labour, they would apply coalition policy on labour matters, not DA policy. A lot of negotiation and give-and-take will have to take place.
… on the economy
On economic policy the position is quite clear. Vulindlela, an initiative started by the presidency and National Treasury back when Tito Mboweni was still Minister of Finance, has scored some significant wins in the last few years. After a 10-year delay and numerous court challenges, spectrum release was done.
Electricity reform is another big example. Recently, some visa reforms were announced. Vulindlela played a key role in opening up railways and ports to private sector investment and operations. The president has already, in his regular letter after the election, committed the 7th administration to the continued implementation of the Vulindlela programme, which is supported by the DA. That will be the main platform of action for this coalition government. For that reason, I will focus my work for the rest of 2024 on progress with Vulindlela projects.
Here I want to draw your attention to a research note published the week after the election by the Bureau for Economic Research at Stellenbosch (BER), which was approvingly quoted by the president. The researchers addressed how South Africa can move from a 1.5% growth economy to a 3.5% economy. BER concluded that we don’t need new initiatives or new policies – just implementation of the Vulindlela projects. At 1.5%, the economy is growing slower than the population – ie we are getting poorer. At 3.5%, we will grow the economy at almost twice the speed of the population. That is what happened in the first 20 years of democracy.
… on the budget
It’s also clear that the 2 main parties agree on fiscal policy. Current prudent fiscal policy will continue. It is easy to measure that. In the last financial year, SA recorded a primary surplus for the first time in 15 years. This simply means that income was more than expenditure, excluding interest. The minister has pencilled in a primary surplus of more than R60 billion for the current year ending in March 2025. I doubt he will deviate from that target. A primary surplus is critical to bring debt under control. The DA has also committed itself to a debt-to-GDP ratio of 67%, lower than the current 74%.
… on disagreements
There are of course issues on which the 2 parties disagree, like the National Health Insurance Bill. This has now been signed into law, but there’s no money bill yet to fund it. That is where real negotiations will take place. The coalition agreement contains modalities for resolving differences.
Coalition doesn’t mean – and cannot mean – that people agree on everything. It also cannot mean that one party’s view will triumph over the others. Compromises will have to be worked out. It will be a learning curve for everybody.
… on local governments
Many of the most serious service and governance crises are at the local government level … potholes, water, electricity, and clinics. Local government elections are scheduled for 2026 – about 2 and a half years away. Parties will definitely not leave local government issues till then.
Already the disastrous mayor of Durban has been recalled by the ANC. The ANC mayor of Ekurhuleni also dismissed the EFF mayoral committee member for finance. More will follow in the coming days as we see a drastic reconfiguration of coalitions in local governments.
On Friday afternoon, Panyaza Lesufi, re-elected premier of Gauteng with DA support, confessed that ‘We were forced to accept the coalition arrangement’. (Lesufi would have preferred to go with the EFF.) Clearly, the whip of ‘democratic centralism’ was cracked, and he and his Gauteng colleagues had to fall into line. Expect more ‘democratic centralism’ over the coming weeks.
So what?
• The acceptance of the results and peaceful transfer of power, all in 2 weeks, is something to be proud of. We may take it for granted, but there are many places where it does not happen, like the US in 2020.
• On matters of economics, this coalition is very good news for the country. It reinforces a strong middle for rational economic policies.
• At the same time, transformation will be ongoing and will not be terminated by the coalition. Growth and more inclusion will go hand in hand.
• The election result and coalition are moving our politics towards the middle. The Radical Economic Transformation (RET) faction will find themselves to the left (or far right, depending on your lens), the libertarians will be on the right, and a sensible middle will raise the flag for what one can call social-democratic policies. It is the biggest political realignment since 1994.
• This move to the middle will also play out at local government coalitions.
Addendum
The ten foundational principles
8. All parties to the GNU commit to uphold the following fundamental principles:
8.1 Respect for the Constitution, the Bill of Rights in its entirety, a united South Africa and the rule of law.
8.2 Non-racialism and non-sexism.
8.3 Social justice, redress and equity, and the alleviation of poverty.
8.4 Human dignity and the progressive realisation of socioeconomic rights.
8.5 Nation-building, social cohesion and unity in diversity.
8.6 Peace, stability and safe communities, especially for women and children.
8.7 Accountability, transparency and community participation in government.
8.8 Evidence-based policy and decision-making.
8.9 A professional, merit-based, non-partisan, developmental public service that puts people first.
8.10 Integrity, good governance and accountable leadership.
The nine priorities
As Parties to this GNU, we agree that the 7th administration should focus on the following priorities:
11.1 Rapid, inclusive and sustainable economic growth, the promotion of fixed capital investment and industrialization, job creation, transformation, livelihood support, land reform, infrastructure development, structural reforms and transformational change, fiscal sustainability, and the sustainable use of our national resources and endowments. Macro-economic management must support national development goals in a sustainable manner.
11.2 Creating a more just society by tackling poverty, spatial inequalities, food security and the high cost of living, providing a social safety net, improving access to and the quality of basic services, and protecting workers’ rights.
11.3 Stabilising local government, effective cooperative governance, the assignment of appropriate responsibilities to different spheres of government and review of the role of traditional leadership in the governance framework.
11.4 Investing in people through education, skills development and affordable quality health care.
11.5 Building state capacity and creating a professional, merit based, corruption-free and developmental public service. Restructuring and improving state-owned entities to meet national development goals.
11.6 Strengthening law enforcement agencies to address crime, corruption and gender-based violence, as well as strengthening national security capabilities.
11.7 Strengthening the effectiveness of Parliament in respect of its legislative and oversight functions.
11.8 Strengthening social cohesion, nation-building and democratic participation, and undertaking common programmes against racism, sexism, tribalism and other forms of intolerance.
11.9 Foreign policy based on human rights, constitutionalism, the national interest, solidarity, peaceful resolution of conflicts, to achieve the African Agenda 2063, South-South, North-South and African cooperation, multilateralism and a just, peaceful and equitable world.
