The Investor October 2024
ShareFinder’s prediction for Wall Street for the next 3 months (top) and the JSE (bottom):
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We need a better way
By Richard Cluver
Have you ever paused to take a good look at the politicians who represent you, the people your vote gave awesome power over every facet of your life – the same people whom innumerable public opinion polls have shown to rank with used car salesmen as the least trusted people in society?
How deserving are such people of the power we have given them? And how did we ever come to such a system where the very people we demonstrably despise have been given such unquestioning power?
I know that within the ranks of those we have appointed to rule over us there are a few of undoubted quality and integrity. Nevertheless, most folk rightly subscribe to the old adage that if one has failed at everything else, then a job in Parliament offers one a comfortable place to sleep away one’s days with the benefit of a hundred percent pension at the end of it.
Given the evidence of the polls it is probably fair to say that the majority of citizens regard politicians as mostly untrustworthy and incompetent. So how can it be that we are apparently content to live within a system which strips each one of us of close to two thirds of everything we earn and then hands it over to these same deadbeats to administer?
Writing in The Financial Mail of October 3 2024, Justice Malala who is one of South Africa’s most respected political analysts succinctly summed up public opinion when he argued that, “Most of our politicians have demonstrated over the past eight years that they are carpetbaggers, bereft of altruistic instincts and uncaring of the needs of our people. They know the price of a Gucci bag but they do not know the value of honesty, integrity or principle.
“Nothing illustrates this more than the absolute shambles that has been our local government administrations since 2016.”
I could not have said it better. Even at the most superficial level it is clearly a system designed to fail. Yet for centuries mankind has proclaimed the sovereignty of Parliament and hailed our Westminster system as the best form of governance we have yet designed.
Plainly we could do a whole lot better if we were to give some serious thought to this ultimate compromise over how we choose to live together. Matter of fact, might this fundamentally flawed system of government not have a lot to do with how fractured human relations have become this 21st Century?
To make things worse, though democracy rules in most countries today, individual citizens have little or no power over the choice of who gets to represent us in the halls of power. All our votes allow us is the right to collectively choose a political party which is, in turn, free to foist upon us anyone chosen by its apex committee of just a handful of people.
Doesn’t that make a complete mockery of the profound principle of democracy that government is “…by the people for the people.”
And what a sorry list of people our politicians often are, numbering among them accused fraudsters, people of questionable morality and often people known to hold extremist political views!
And then we wonder why service delivery is so poor, why corruption is rampant, why crime is out of control, unemployment is soaring, why our highways are crumbling, why our waterways are choked with sewage, why we are subject to frequent power outages and why the frequently-interrupted supply of water to our homes is of suspect quality?
Given all of the above, isn’t it extraordinary that we believe we have the world’s best constitution and, worse, that despite all our hard work, few of us have sufficient money, after the politicians have collected their multitude of taxes, to provide our families with the amenities we all aspire to.
If you doubt this latter fact, let’s start by noting that the average person labours 233 days a year for an average of 47 years before he retires. That’s an average of 11 000 working days in a lifetime.
In South Africa, where the average salary is R1 597 a day, close to two thirds of that amount is daily stripped away from the average worker by a cleverly-designed series of direct, indirect and hidden taxes which I have comprehensively detailed in my latest book ‘Robbed’ which I will shortly be sending FREE to everyone I know because I am hoping to start a conversation!.
Believe it or not, an average of around R248 000 a year is being sacrificed by the average salaried-earner and handed over to politicians who are in turn free to squander it all, demonstrably if you regularly scan the newspaper headlines on an endless series of wasteful projects that seldom achieve the desired objective…and even those that succeed are often not in the broadest interests of the majority of taxpayers.
Could that money be better used? Well, let us assume for a moment that ALL taxation were to be temporarily abandoned and the average man was free to invest that surplus at the prevailing prime rate of 11.5 percent. You might be agreeably surprised that over 47 years it would grow to a little short of R400-million: enough to put a Ferrari in every pensioner’s garage, not to mention all the other good things that would flow from such a cornucopia.
Meanwhile, Bankserv Africa statistics suggest that a typical South African pensioner actually enjoys a monthly income of just R5 531: light years less than he could have enjoyed if his taxes had been invested for his personal benefit. Furthermore, given that the net worth of South Africa’s wealthiest Top One Percent is a hundred times less than that at just R4.2-million, it is abundantly clear how poorly all those taxes have been invested in the South African economy.
Actually, the average tax take of ALL working people in South Africa is less than half the average salaried figure at only R101 000 a year. Nevertheless, it is a huge sum for ordinary folk: enough to guarantee a first-class education for their children and accordingly go a long way towards making this country a winning nation!
Of course it is impossible to imagine a functional world without taxes but what if Government’s responsibility was confined, as, the father of modern economics Adam Smith suggested it properly should be, to just making laws and keeping citizens safe in their homes?
Annually South Africa spends R114-billion on the police force and R51-billion on defence. So if Government were to only provide these two important services and invested the balance at the prime rate of 11.5 percent for ten years it would grow to an astounding R29,070,077,069,430……that’s 29.07-trillion: or enough to make ours one of the wealthiest nations on earth!
Better still, from year two, as the income grew, the income from such a fund would allow the Government to start reinstating all the services it currently provides until, in year six, it could entirely give up collecting tax and still provide more than it is currently providing.
Even better, were government to provide just defence and policing in the first year and use the balance to invest in a selection of Johannesburg Stock Exchange listed Blue Chip shares which, based on their compound annual average growth rate of 17.4 percent each year since the ANC came to power in 1994, it would be able to end all taxation after just one year and still provide all its current services.
So just imagine what else might be achieved if we could install just a few imaginative leaders in Parliament
Hard or soft?
By John Mauldin
A lot happened in the last four weeks: an FOMC meeting with major policy changes, a surprising jobs report, important shifts in the bond market and yield curve, hurricanes, China, some geopolitical events, and a political race, just to start. I haven’t mentioned them because I was on other, also important topics. Now it’s catch-up time.
One popular narrative right now says the economy is slowly returning to normal following COVID disruptions and then a severe inflation wave. That’s not entirely a fantasy; many long-term trends do appear to be resuming their pre-2020 paths. But it depends heavily on how you define “normal.” Some things change, others don’t. Normality is always a moving target.
Many analysts expect a recession by next year. Then again, those who have been forecasting the US economy to continue on its growth path have been right for some time. With the stock market making all-time highs this week, it does look more than merely Muddle Through.
The real distinction is between the economy we have today vs. the hypothetical, unknowable economy we would have if that virus had stayed where it came from and Russia hadn’t invaded Ukraine. Today’s economy would probably look different. But that’s pure guesswork.
Can we still rely on rules forged in a world that no longer exists? Maybe. I’m more in the camp that we cannot—at least not without extraordinary caution. I believe with the government deficit and debt growing massively and the Fed’s aggressive policies, we have crossed a Rubicon, an “event horizon” where basing predictions on past data relationships is far more difficult. But since past data is all we have, forecasters still use it.
We do know one thing, however. The effects of 2020–2023—the pandemic, the Fed, the inflation, everything else—grow more distant with each passing day. The runway metaphor is overused but it fits: Planes can’t stay in the air forever. This one will land. The question is whether we passengers will feel a hard or soft landing.
The Federal Reserve started raising rates (way behind the curve) in March 2022 and stopped in July 2023. Then began the giant guessing game of when they would reduce rates. The answer turned out to be September 2024. We can debate whether the Fed waited too long or not long enough, but here we are.
While every cycle is different, this one seems particularly so. We are not following the “standard” sequence, which goes like this:
- An overheated economy makes demand outstrip supply, causing price inflation.
- Central banks tighten policy, discouraging credit-financed activity.
- Employers reduce payrolls, leaving workers with less spending power.
- Producers have to cut prices to maintain sales, ending the inflation.
- Another growth phase begins and the cycle repeats.
In this case, the price inflation that began in 2021 wasn’t growth-induced. It was more about supply disruptions, though fiscal and monetary policy did spark some unwise speculation. Then a war caused Europe to reduce its dependence on Russian energy supplies, with global spillover effects.
Central bankers have few ways to solve those kinds of problems, but they had to “do something” about inflation. Higher rates didn’t slow consumer demand or raise unemployment, at least not initially and not much even now. GDP kept rising, rolling merrily along and surprisingly higher. The inflation rate came down in most categories, housing being the prime exception. Wages rose, even adjusting for inflation.
That sounds a lot like the “soft landing” most of us thought unlikely… but it’s not over yet. Much depends on how the economy responds to the new direction in interest rates. Here, we must talk about which rates are going in which directions.
Here’s the question: Who is going to be helped by modestly lower short-term rates? What activity are they going to stimulate that isn’t already happening? And who will be hurt?
The Fed’s power is mostly over short-term rates, primarily the overnight federal funds rate. The last year or so has been wonderful for savers, i.e., retirees or anyone holding a lot of cash. They’ve enjoyed nice, (almost) risk-free returns on money market funds, Treasury bills, etc.
Meanwhile, millions of homeowners who locked in low, fixed mortgage rates during the pandemic also have more spending power. This probably helped consumer confidence.
I suspect the Fed thinks its rate cuts at the short end would be accompanied by similar but slower declines at the long end, eventually restoring the yield curve to its normal shape. This would also bring down mortgage rates and reduce housing costs. If that was the theory, it’s not happening yet. Long-term Treasury and mortgage rates are actually up since the Fed began cutting.
Consider this chart from the invaluable Wolf Richter.
Source: Wolf Richter
The blue line is the yield curve on the day before the Fed’s cut. Notice how it compares to the red line 3+ weeks later. Rates at the short end fell, as expected. But debt maturities of a year and longer actually rose. Rates on the 10-year bond actually have risen 43 basis points. The difference is even greater since July (the gold line).
Mortgage rates (not shown here) generally take their cue from the 10-year Treasury yield, and indeed they rose, too. My friend Barry Habib of MBS Highway noted this isn’t unusual (even if it seems to be a surprise to some business media). Here’s Barry:
“This is not an unusual phenomenon—We have seen this happen in almost every rate cutting cycle except for 2019, and a lot of the reason why is investor psychology. Investors believe we have a greater chance of avoiding recession once the Fed starts cutting, which causes them to invest in the stock market at the expense of bonds. And the Fed cutting causes some to fear inflation rising once again, which causes bonds to temporarily sell off.
“But the Fed is cutting for a reason, and it’s because they are seeing the economy slow. And that helps the bond market and inflation come down. In each of the last instances where yields initially rose, they eventually fell much lower and we don’t believe this time will be any different.”
We will have to wait and see if Barry is right. I’m sure Jerome Powell hopes so; the Fed’s job will be a lot harder if long-term rates stay at these levels or rise further. It won’t be great for the federal debt problem, either.
Speaking of the yield curve, we need to keep another historical pattern in mind. An inverted yield curve has long been one of the best recession indicators. In this case, the inversion happened in the summer of 2022. Why no recession yet? The indicator has been reliable but usually early. But two-plus years?
Back in May I shared one of Dave Rosenberg’s SIC charts and talked about this. Quoting myself:
“… Notice how the yield curve inverts (i.e., drops below the zero line) months before recession, then rises and is back above zero before the recession arrives. Currently we are in the first part of that process: The yield curve, while still inverted, is headed back to its normal condition. If the pattern holds, it will cross back above zero and then another one of those gray recession bars will appear soon after.
“For this to happen, we need some combination of lower short-term rates and higher long-term rates. (That’s the definition of inversion; the 2-year Treasury yield is above the 10-year yield.) When that happens, you’ll probably see a bunch of analysts sound the all-clear. But in fact, we will be entering the danger zone.
“When could it happen? This week’s FOMC statement showed (if there was still any doubt) lower short-term rates are unlikely for several more months, at least.”
Again, that was from May 2024. Note the part I bolded where I said the line would cross above zero with recession likely soon after. That crossover just happened.
Source: GuruFocus
It’s hard to see, but that blue line just crossed back above zero, indicating the 10-year Treasury yield is slightly higher than the 2-year Treasury yield. The gap is small and has wavered a bit from day to day. But the inversion seems to be ending, which historically means recession should be brewing.
Is recession brewing? This is still unclear. Some data says yes, some no. Some analysts I deeply respect say no. The Fed seems most concerned about the unemployment rate, which has indeed risen quite a bit from its low last year. But that low was unusually low. The current level isn’t especially alarming; the concern is that it seems to be trending higher. But the strong September jobs report called that trend into question.
Other indicators—industrial activity, default rates, consumer spending, etc.—are inconclusive, too. And GDP shows nothing like recession; the latest data shows real GDP rose 3.0% in Q2 after a 1.6% Q1 reading.
The stock market isn’t acting like recession is near, either. No one is worried about earnings growth. Maybe they should be, but they’re not. The September inflation number was okay, but not as good as expected. Employment claims rose but the hurricanes could explain some of it.
And yet… if recession isn’t imminent, how do we explain the yield curve? I’m beginning to wonder what the years of extreme intervention since 2008 did to our indicators. Does the data still mean what we think it does? Maybe not. And that’s on top of questions on whether the data is even being measured correctly.
Everything I’ve learned and experienced in 50+ years of watching the economy tells me not to expect a soft landing. But maybe that’s because I’ve never actually seen one.
If we are headed to recession, something will trigger it. What might that be? Before this week, I had been thinking China was a strong candidate, but the Chinese economy is in a rough stretch. Sheer size gives China global importance. The government is launching new stimulus programs so maybe all will be well. Or maybe not.
Closer to home, the devastation of hurricanes Helene and Milton is economically significant as well as heartbreaking. And no, it is not going to “stimulate the economy.” Frédéric Bastiat put that misnomer to rest back in 1850, but people continue to repeat it. Yes, a lot of money will be spent—and many jobs created—to repair and rebuild. Bastiat explained how this is only half the equation. You have to consider how all those resources would have been spent otherwise. Rebuilding houses that the hurricane destroyed isn’t growth. The economy gains nothing; it just recovers a lost asset, at significant cost.
Think also about the many thousands of victims, along with those who rushed to help them, who haven’t been doing their usual jobs. Some will be “unproductive” for months, in the normal sense of productive. Whatever output they would have generated isn’t going to happen now.
Yes, of course there will be some new activity. We’ll see increased demand for building materials, construction workers, and all the other things people lost and will want to replace. This will be inflationary, at least in those sectors. And it comes at a time when many kinds of skilled labor are already scarce and expensive.
Could these storms trigger recession—or rekindle inflation? If you read my Late Summer Sandpile letter, you know this is the wrong question. Sandpiles collapse on their own. The specific trigger is usually impossible to identify until it happens. The economy has seen tremendous growth since the short (but deep) 2020 recession. We have built a very large sandpile in these years. The growth may continue but not forever. Let’s hope the collapse, whenever it comes, is a soft one.
So far so Good
By JP Landman
The middle ground is getting stronger.
Two and a half months into the Government of National Unity (GNU) and contrary to the expectations of many, it is holding firm. A major red line for some coalition parties – the BELA bill – was crossed when the president signed it. Despite the noise, no one left the GNU. From his side, the president didn’t force through the two most contentious parts of the bill, giving three months to find a compromise. And if that fails? The Constitutional Court will sort it out.
Earlier on, the president signed important legislation on electricity reform. too, he did not enact the most controversial clauses (affecting municipalities’ role in electricity distribution) to allow time for finding a compromise. On NHI, he has already signalled a similar approach – talk to all parties and find a compromise that works.
This is politics in motion, not a wrecking ball.
Cutting the deadweight loose.
In the same week, the Democratic Alliance (DA) showed it was serious about unity. John Steenhuisen axed his chief of staff and kicked a problematic MP out of the party. Their weird views were toxic to the GNU’s goal of cooperation. If you want to be part of the centre, you’ve got to ditch the extremes.
Earlier, less than a month into GNU, ANC MP Sisi Kodwa resigned because corruption charges were hanging over him.
The land issue – let’s get real.
The new minister of Land Affairs, PAC leader Mzwanele Nyhontso, a party for whom the restoration of land is a “red line”, took a pragmatic turn. In an early speech, he referred to “low-hanging fruit” on the thorny land issue – issuing title deeds and finishing land restitution claims, a project mandated by the Constitution. Being inside the GNU tent changes you – it pushes you towards solutions, not slogans.
Pushing in the scrum.
The GNU isn’t just a political experiment; it’s a chance for parties to get things done. Being in the mix brings purpose, visibility for their parties and personal perks. None of these participants will walk away easily from all that. And who doesn’t want to be seen pushing hard in the political scrum?
Gauteng is the outlier.
Encouraging as the above picture is, it does not apply to Gauteng. Sadly, there is a stubborn refusal to form unity governments in the province and the metros. We will see how that affects the position of the various parties in the run-up to the 2026 local government elections, now about 26 months away.
Danger from within.
The progress of the national government should not blind us to the reality that party members not in the executive can easily turn on their colleagues who are. The blame game is inevitable: ‘Why didn’t you stop this?’ or ‘How could you agree to that?’ That is what happened in the first government of national unity after 1994, which contributed to its break-up. Managing internal dissent might become more challenging than dealing with other parties. The role of internal party managers like Fikile Mbalula and Helen Zille is critical. Their actions should reinforce the GNU, not weaken it.
Is it too expensive?
Critics say the GNU is too costly, with 10 more executive members than before. But look at what it brings: 21 newcomers contributing diversity, fresh energy, and voices from across the spectrum – DA, IFP, PAC, GOOD, and more. It’s not just more people; it’s a broader, more inclusive government. Is that too high a price for a country desperate for social cohesion?
The real test is fixing the economy.
Ultimately, the GNU’s success hinges on real change – jobs, poverty, inequality. The roadmap is there: implement the Vulindlela reforms (energy, transport, water, visas), and we could see 3,5% economic growth, according to the Bureau for Economic Research. Since their report was published after the election, the 3,5% growth possibility has been confirmed by the governor of the South African Reserve Bank and the deputy minister of finance (himself a leader of the SACP – one of those unique South African paradoxes).
At 3,5%, economic growth will be more than twice the population growth of 1,6% (or 1,5% if we accept the criticism that there are one million fewer people in SA than the Stats SA census showed).
A manufacturing survey by the BER released this week found that the political constraint has declined to the lowest level since 2012! This is a remarkable survey result. Unsurprisingly, the BER finds that fixed investment in manufacturing has already increased substantially. Manufacturers are buying into what is happening.
The manufacturing survey shows that in the GNU government SA has the very real chance to break the decade of economic growth lower than population growth. It will turn the tide on unemployment and poverty, even if 3,5% does not eradicate them.
So what?
The GNU has survived its first red line, is stable and is getting stronger.
The president’s balanced approach on controversial issues, like the BELA bill, electricity bill and NHI has reinforced the GNU, relying on the old South African ability to find solutions through negotiation.
From all parties we are seeing a commitment to the GNU with pragmatism trumping ideology. This does not apply to the province of Gauteng.
The increased confidence amongst and investment by manufacturers prove that the GNU is South Africa’s best shot to break free from a decade of economic stagnation
The Kitchen Sink Approach
By BRIAN KANTOR
JSE-listed companies have been beating themselves down lately. There have been in the region of R250 billion in write-offs and write-downs of assets recently, according to Kabelo Khumalo, writing in Business Day.
This will perhaps mean that the book values recorded on their balance sheets will accord more closely with the market value of the company. However, the cash flows of the business will be unaffected by the action and there are unlikely to be any taxes saved on the losses because they will not be recognised as a business expense. The bottom-line effect will be even less meaningful.
The prior damage done to cash flows and market value by poor investments or acquisitions will long have been recognised and deducted from the value of the company by investment analysts and the investors they advise. They will have made their own diminished sum-of-the-parts calculations of the present value of the divisions of any company. And they may still have a different view of what the underlying assets might bring shareholders in the future.
Aligning book and market value
There is something important to note about these adjustments to the books that are designed to align book and market value, notably that is there is unlikely to be an equivalent urgency to upvalue the assets on the balance sheets that have proved to be market value adding. The great new mine that has proven to be so valuable to shareholders is likely to remain on the books at something close to its historic costs and not written up to enhance earnings and equity capital employed, and the strength of the balance sheet. And when an excellent acquisition has been made, paying above the book value of the company acquired, this goodwill is very likely to be amortised against earnings, thus reducing the book value and the capital employed by the business – rather than logically seen as adding to the amount of valuable capital employed by the business.
The benefits of writing off capital employed in a business will show up in an important measure, and that is as return on equity capital employed (ROE). The less capital recognised, the better the return on equity – all other operating details remaining the same. And the managers of the business are likely to be rewarded directly based on ROE. Shareholders will benefit when the company to which they entrust their savings can deliver a return on the capital they employ that exceeds the opportunity cost of capital employed. In other words, the returns shareholders might expect from investing in an alternative company with similar operating risks.
Making poor investment decisions reduces ROE. Recognising past failures will not change past performance. It might however indicate that milk has been spilled, that costs have been sunk, that bygones are bygones and, most importantly, that more good money is less likely to be thrown away on lost causes. And if the managers are surprisingly contrite, it might help add market value by improving expected performance.
The kitchen sink approach
But what could be more helpful to an incoming CEO, also to be measured on future ROEs, than to begin a reign with less capital? True kitchen sinking, recognising the mistakes made by predecessors, could be wealth enhancing for managers, if future rewards are to be based on higher ROEs, as they should be.
If the actual capital entrusted to the incoming CEO and the team of operating managers is accurately measured, it is only then that improvements in ROE can be properly recognised and encouraged. They will also be rewarded appropriately in all the operating divisions whose managers can be held responsible for the capital they are given to manage, again provided it is accurately estimated.
South African directors of companies now burdened with justifying not only what they pay their senior managers, but also justifying the absolute difference between the rewards at the top and bottom of the pay scales, which may point to the example of Starbucks. The change in CEO recently immediately added over US$20 billion to its market value. Paying the right CEO enough – not too much, nor too little, with rewards based predominantly on realised improvements in ROE, properly calibrated and communicated – should be the primary task of any board of directors. And when this is put into good practice with successful and competitively paid CEOs, it will deserve the approval of shareholders.
