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International

Democrats – targeting the boogieman

As the Americans go to the poll today to vote for a new house of representatives and a few senate seats, they have the chance to change the path of current politics. The Republicans have a slim majority in both houses. If the Democrats win either of them, their win would have been because of a rise in the “anti-Trump” vote, rather than a vote for the Democrats. These days Democrats are united because of a common boogieman, Donald Trump, rather than a common ideology.

 

Gone are the days of true liberal leaders who could unite the followers behind a shared vision on how a better future would look like. Leaders who don’t try and win votes by discrediting each other but by convincing you with their argument on how to build a society that you can be proud of. And with such a lack of clarity of what they stand for, it will be very hard to beat a showmaster like Trump. It would be even more difficult to come up with new policies that would convince the electorate to vote for them at the next elections.

 

We in South Africa have a similar scenario. With Zuma removed, the EFF and the DA are struggling to define themselves. Their political visions are confused, and their purpose faded. Who should the voters vote for if they don’t get a coherent message? Not one about removing an chauvinistic, polarizing and corrupt fool, but a idea about what you as a party would do different, to make the lives of your fellow citizens better. It seems like the only leaders in politics these days are populists who win on a message of fear and hate. What a sad state of affairs.

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South Africa

Investing in turbulent times

October has thus far been one of the worst months for equity investors in the past few years. Lots of people have asked me how to invest in these times, here are my thoughts.

The market is on a rollercoaster. The tech-heavy NASDAQ is heading towards another week of declines, the S&P 500 has had more down-days than up-days this month. The effect of the negative sentiment is even greater on the South African markets. The JSE All Share Index is down from a high of 61 684 points to a current low of 50 877 points. That is very close to bear market territory. Yet the base case seems to be that this is still a correction in a bull run, rather than the start of a bear market. Everybody points to the strength of the US economy, a feature that president Trump takes full credit for. I don’t agree. I would be very cautious. In the fund I manage, I have been selling equity in June and early September. I have never had this much cash.

There are a few reasons for my pessimistic view on the future short-term prospects of the share market. Many originate in the USA .

We have had almost a ten-year bull run since the end of the great recession of 2008. The recovery from the second most severe downturn in the last 100 years has been shallow, but because of that, it lasted very long. Companies now record record profits, mostly aided by un-natural low interest rates. Since Trump was elected president of America, the economic growth accelerated even more, topping 4% on an annualized basis. The unemployment rate is at a very  low level,. The share price valuations reflected such optimism. Not since the dot.com bubble, when valuation of a business plan written on a napkin was worth U$100 million, has the Shiller’s P/E ratio reach such lofty levels.

The problem though is that the last spurt of growth was caused mainly by the Tax cuts imposed by Trump. I am not against the Tax cuts, but using it now leaves the president with one less tool should the economy slow down. You would want to have some powder dry, because open economies do have natural cycles.

Then come the tariffs. The first salvo was aimed at almost all aluminum and steel producers outside of the US, friend or foe. The problems are twofold. The first is that if the biggest consumer imposes tariffs, other big consumers of the metals need to follow suit or fear of getting the surplus glut dumped onto their market. The marginal cost of finished steel and aluminum are the transport and storage costs. The second issue with tariffs on steel and aluminum is that they are also mostly input costs for other goods such as cars or buildings. The knock-on effect on prices is far greater than tariffs on finished products. US producers would have also increased their prices to reach import parity and as such, almost everything – from cars to houses to beer cans get more expensive, and somebody will have to pay for it. Initially the producers would absorb some of the costs, lowering their profit margins. But eventually the consumer will need to pay more for their goods.

In an effort to “make the USA great again”, president Trump started a trade war with China. His reasons are debatable, but the economic impact is underestimated. Gone are the days where the Chinese only imports were cheap cloths and plastic goods. These days, much of the imports are sophisticated electric and mechanical machinery, often used in the production of other goods. Thus this supply chain is very difficult to replace overnight, let alone get American companies to take over the slack. Therefore, all that would happen is that in the short-term consumer prices will increase. And as anybody who has done economics 101, if prices increase, quantity demanded decreases. One can see it already in for example the new home sales or vehicles sales, both of which are significantly off their highs.

Because of the reasons mentioned above, demand for goods will decrease as prices rise. Therefore companies will not reap in as much profit as they have before. Profit growth will certainly slow. The share prices in September did not reflect that.

They are more reasonable now, but I do think that we have more to go before we reach a bottom. There are two main reasons for it. Firstly, markets always over and under shoot. Secondly, we have recently seen a few times markets that closed lower a couple days in a row, followed by a massive up day. The rallies tended to fade, and the next day Asia opened weaker again. That shows clearly that there is no more the glut of money waiting on the side just waiting to enter the market.

So why does that affect us? Simply put: If America sneezes, the rest of the world catches a cold. Since they are by far the biggest market, they will have an influence over the direction of the JSE. The tricky part is how to position yourself as an equity investor, because if history is a lesson, the Rand US Dollar exchange rate will weaken.

I took a dim view on South Africa, because we have structural problems that need to be addressed before we grow at 4%+. Thus I am underweight SA focused companies. Most of the selling I did recently were such companies that mainly serve SA. That portion is now held in cash. As before, I am overweight defensive Rand hedges such as BAT. Yes in general their shares would also go down in a bear market, but since I expect the exchange rate to weaken, it would absorb some of the losses and protect the value of the investment.

(please note that this is from a South African standpoint, it differs depending on where you live. Always consult with your own investment professional before you make any investment decisions)

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Namibia South Africa

Good for headlines or good for growth

Two stories were released at the weekend that should boost investments in two neighboring countries, one is little more than window dressing while the other will have actual and fairly quick impact.

 

South African president, Cyril Ramaphosa took to the streets on Saturday to celebrate a commitment of companies to invest R290bn over the next ten years. This was largely achieved by his star-studded investment envoys who have been traveling the globe, trying to lure more investments to SA. While they were rightfully celebrating the milestone in the streets in Soweto, Tom Alweendo, the Namibian mining minister announced that they will scrap a rule that requires mining companies to have at least 20% of their shares in the hands of previously disadvantaged Namibians.

 

While Ramaphosa’s achievement sounds good, Alweendo’s amendment to the ownership requirements will have a much bigger impact. To see why, one needs to analyze the numbers. The investment pledge is spread over 10 years. It is not clear if they are new investments, or if capex already planned anyways is included. Industries such as mining, real estate development, manufacturing, energy and communications will have a steady stream of capital expenditure that is needed just to stay competitive. Is this counted as new investment? And even though R290bl sounds big, if one compares it to the R200bl that was invested into the renewable energy sector between 2011 and 2016, Ramaphosa’s announcement sounds modest. Bloomberg, a financial data provider, estimates that there was another R550bl investment planned into the renewables energy sector of South Africa between 2016 and 2020. Hopefully the joyful celebrations in the streets of Soweto don’t cause the government to their eyes off the ball, because there is lots more to do to turn around the ailing economy.

 

Contrast that with the Namibian announcement. That’s will have an immediate impact, because the mining companies’ rate of return will increase by owning 100% instead of 80%. That’s will make new investments a lot more attractive. It also shows that the government is serious about becoming more business friendly, a seldom feat in Africa. I do think that the impact of minister Alweendo’s decision is far greater than that of Ramaphosa, and should be a bigger reason to celebrate.

Categories
International

The merits of Capital Gains Tax

Taxing a gain that wasn’t there

The idea behind the capital gains tax is simple: tax any gains on the increased value of capital, as the increase of capital was due to a better performing economy. Whether the capital is in the form of shares or property value, it has benefited from a growing economy, and therefor the value of the capital has risen. The taxes would fall disproportionately onto the rich because they have the excess capital to invest. That sounds like a just idea, but is it?

 

Like so many other countries, South Africa fell over their feet to implement capital gains tax. After all, it would raise more money, which the government could use to fund their social upliftment programs and infrastructure spending. They have raised over R100bl since it was introduced in 2001. During the boom years, there was not much pushback, as it only seemed fair that the capital, that was invested in the South African economy, benefited from the strong growth. As governments invest more into public goods, such as roads, schools and hospitals, private capital benefits by being in the vicinity of it.

 

But now in leaner years, one should question the merits of Capital Gains Tax. The problem is that it is calculated on the nominal value of the increase (the nominal value includes inflation). In countries like the USA or Europe, this is not much of a problem, because their inflation rate is about 1-2%. Our inflation rate is three times higher at about 6%, but our economic growth is much lower than that in the West. The increase is capital value is almost all due to inflation. Why should the investor pay a tax on a gain that has not really been a gain at a ll. In-fact, when there is a recession but high inflation, the capital value might go up, but in real terms the value of the investment has decreased. Yet, you would have to pay tax on that. Is that a fair system?

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South Africa

The land debate is clear …. or is it?

After a two-day policy huddle, the ANC announced that they have decided to proceed with changing the constitution to be able to expropriate land without compensation.

When Ramaphosa took over as president of the ANC, and a few months later as president of South Africa, he was dealt a weak hand. The party is divided between populists and traditionalist. Some care to continue the legacy of Nelson Mandela, to build an all-inclusive South Africa where everybody gets the same opportunity to work and create wealth. Others only care about enriching themselves, while some just care about winning the next election. After all, a politician is one of the best paid jobs in South Africa. Ramaphosa’ s first task would be to unite everybody within the ANC ahead of the next elections. That requires compromises, but surely none as great as giving in to populist policies that are sure to backfire. Sadly, that is exactly what he has done.

A commission was established to investigate the possibility of amending the constitution to allow expropriation of land without compensation. They are currently busy holding public hearings, where citizens can express their views. But before they are able to compile their report, or even finish the public hearing, the ANC, under the leadership of Ramaphosa, decided to amend the constitution, which makes the commission pointless. But that will be the least of their worries.

As a typical trait of modern times, the campaign has been fed by misleading information. According to the economist Johann Bornman, more than half of all farm land in the three most fertile provinces is currently already owned by black farmers. The Ingonyama Trust, whose sole trustee is the Zulu king, owns 3 million hectares, about the size of Belgium, making him the biggest landowner. Much of the rest is owned by companies such as Sappi and Ilovo.  The three provinces with the lowest share of black ownership are the Western Cape, Northern Cape and Freestate, probably because most of the land is semi-desert making farming extremely difficult.

Through the ongoing re-distribution program, the government has already acquired vast amounts of land, on a willing seller willing buyer basis. Many emerging farmers could have been given land (which is just sitting idle now) were it not for the governments incompetence.

What many attendees of the public hearing seem to be focusing on though is urban land, rather than farm land. That makes sense. As South Africans became richer over the last 20 years, more have been drawn from the rural areas to the cities. This is a worldwide phenomenon.

No country has ever become richer by getting more people to take up farming.

A side effect is that there is an enormous pressure on urban land. Government is making progress though. According to the Race Relation Institute, a think tank, there are 10 new low-cost houses built for every informal shack erected. That is the inverse of what happened 15 years ago. But the pressure on housing is relentless, as evident by companies like Calergo M3, a low-cost housing developer. They just reported that they have had delays in delivery of units because of illegal occupants tried to “hijack” the units before they were finished.

The real problems are less obvious though. A move to take away land without compensation puts the whole banking system at risk. Banks lend out money and take the asset as security. The size of the loans are determined by the banks ability to recover the money in a fire sale, should the borrower default. If the bank can’t be sure that the applicant will always be the owner of the land, they will simply not lend any money at all. And if some of the banks current assets held as security are repossessed by the government, they will need to shore up their capital ratios to cater for the increase in non-performing loans. Simply put: banks will stop lending out money, and the money that do get lent out will be done at a higher interest rate. This would not only affect farmers, but everybody.

Secondly, white farmers would surely not be in a rush to invest in their farm if they can’t be sure that they will always own the land. This is already happening, as the debate continues. This not only affects our food security but puts thousands of seasonal workers at risk.

Thirdly, this change in constitution does nothing to shore up the confidence of international investors. They would rather invest their money in an environment where they can be sure that the rules they signed up to will stay throughout their investment. Have we not learned the effects of the constant changing of the mining charter? Foreign investment into our mining industry has almost dried up, declining sharply since 2003, through the biggest commodity boom the world has ever seen. Is the ANC willing to do the same to farming, just to counter the populists?

Lastly, it is a very highly charged moral issue. White settlers arrived in 1652, 50 years after the first Europeans settled in the USA. That is 150 years before the great Zulu king, Shaka Zulu took the reign, and expanded his territory dramatically. To which point in history would the government like to turn the clock back to? Besides that, most land has been bought by the present owners, no matter if they are black or white. Should they suffer from consequences from actions taken centuries ago? It can’t be denied that under the apartheid system there have been all sorts of dubious deal done (like the “rent” of the land on which the Wild Coast Sun casino is built), but that should be addressed through the ongoing land reform, where claimants can either get the government to buy back the land and give it to the rightful claimants or pay them a compensation.

The stakes are very high. The economy will not be limping along as it is now, but another recession will be much more likely.

Categories
South Africa

Eskom is drowning South Africa – what to do

Eskom, the electricity producing giant is South Africa’s biggest state-owned enterprise (SOE). It has a monopoly, but is drowning in debt, corruption and inefficiencies. If nothing is done, it is in danger of dragging the Government, who guaranteed most of the debt, down to junk status.

Out of a need to be self sufficient during the apartheid years, Eskom continued to build power stations far beyond their actual needs. 7 out of the 15 coal fired power stations were commissioned in the 1980’s. Eventually they produced so much electricity that South African businesses enjoyed some of the lowest tariffs in the world, and excess was exported to the neighbouring countries. The new government rather focused on expanding the grid to electrify most of the population. That was done successfully, but the increased demand was not matched with increased supply. The resource boom years were not anticipated and in 2007 Eskom began to run out of electricity. This forced Eskom to build new capacity. Among the expansion plans are two big coal fired power plants, called Medupi and Kusile. Both cost a lot more than planned and are lagging far behind their completion date.

Besides the operational difficulties, Eskom was plundered by scrupulous contractors, aided by corrupt Eskom management. Eskom also has a bloated staff contingency, who enjoyed underserved massive bonuses and pay hikes. All that lead to the issuing of more and more debt. But that party has now ended, and like after the end of any good party, the hang over is starting to rear its ugly head. We now know that there are a lot of things they should have done differently, but that doesn’t help explain what should be done going forward. For that, the very capable Minister of public enterprises, Pravin Gordan has enlisted the help of some of the top CEO’s to come up with a strategy to get Eskom back on its feet.

Here is my take on what should be done: Eskom should be broken up into two units, power generation and grid. The grid should be kept by the state, because it provides the infrastructure to get everybody connected, no matter if rich or poor. A private company would prioritise the profitable lines, and neglect the ones just costing them money. In a fair society, this would be an unfair practice.

The power generation section should be partly privatised. This can be done by selling off power generators, mainly the coal fired power stations to the highest bidder. In return they would get a 10,15 or 20 year electricity take-off agreement, similar to those of the renewable power generators. With that in hand, the winning bidder will be able to raise funding in the private sector to finance the purchase of the power plants. Thus, it is ideal for previously disadvantaged, and will help the governments goal to foster black industrialists. It would be up them run the units as efficiently as possible. The government will use the money raised by the sales to settle the outstanding debt.

 

It might sound a little bit simplistic, because I have not taken into account a failure of power generation from any of those newly established private companies, but when that happens, you can be assured that competitors are quick to jump at the opportunity. As we have seen with the renewables, give the private sector the right playing field and a reliable set of rules, and they will fill any opportunities that might present themselves.

Categories
South Africa

South Africa’s universal healthcare plan

The South African health minister, mr Motsoaledi has unveiled his long awaited universal healthcare plan, called the National Health Insurance (NHI). It has a noble cause – to make the same healthcare available to the rich and the poor. His solution shows that he has not understood the problem though.

According to the website news24.com, Mr Motsoaledi plan envisages one big fund that will act as the single purchaser of health services, and thereby it will “pool funds to provide access to quality health care services for all South Africans, based on their health needs and irrespective to their socio-economic status. He went on to say that “currently the private sector spends 4.5% of GDP on health but only provides care to 16% of the population while the public sector spends 4.2% but provides 84% of the population.”

The public hospitals and health care institutions are in such shambles that something needs to be done about them. A recent example of public healthcare blunders is the life Esidimeni tragedy, that cost the life of 143 helpless patients., which was purely down to bad management decisions. No one has been arrested and held responsible for it.

Mr Motsoaledi insists that, currently, the poor are subsidising the rich, and that needs to be turned around. 16% of the population that currently spend 4.5% of GDP on private healthcare are also the main income tax generators. Thus, they pay taxes, but do not make use of the healthcare provided by the government

Whoever has the means, takes out private health care insurance. It is an indirect tax, because healthcare is something that the government should, but does not provide.  Insurance companies offer different packages, because not everybody wants or is able to pay for a full comprehensive package. Health insurances are zero-sum businesses. Essentially, the co-payment required on the cheaper packages can be viewed as the statistical shortfall in previous contributions.

But mr Motsoaledi also wants to eliminate co-payments, forcing everybody who want to be privately insured to take out the comprehensive insurance plan.

. What should be done? The private sector is only able to provide the service because the public sector is not providing it. Maybe the most noble thing to do would be to admit to the current mis-management and commit to make sure that the public institutions are run efficiently and effectively. That would eliminate the urge to go to a private hospital at almost any cost. It would also ignite competition and therefore bring down prices of private hospitals. Lastly, let those who can, take out private healthcare insurance. At least they will not be putting pressure on the public healthcare system. The rich and poor would not compete for the same public health service, rather the rich would subsidise the poor.

Categories
Current

US migration – crying babies

The USA has adopted a zero tolerance to illegal migration, resulting in thousands of refugees being arrested at the border. The minors are being separated from the adults, causing massive uproar.

 

In a world where we are being inundated with ever more gruesome visuals, it was a audio recording that really shook the world. One could hear the heartsore cry of a child being separated from its parent which caused a chill down the spine of most parents. Although it is deeply un-ethical, the attorney general, Jeff Sessions vowed to continue with the ruthless clampdown on illegal immigration. Donald Trump continued to be remorseless, but that would be expected from a man who was mainly absent when it came to raising his own children. He wants a merit based immigration system, probably similar to those in Australia. The logic goes that well educated immigrants contribute more to the economy, and thus help America grow. But that only makes sense for immigrants, and not for refugees.

However, at the point where the “illegal immigrants” cross the border, the border patrol would not know if they are refugees or illegal immigrants. That doesn’t seem to matter, because they immediately separate the family units and lock them up in what looks like “holding cages”, where they would officially stay up to 5 days, but how long they really stay nobody knows. This is like assuming that somebody is guilty before proving that they are innocent.

There is a much bigger fundamental problem though. The USA, more than any other country in the world, is built on immigrants. They mainly came from Germany, Ireland and Italy, but later also from Asian countries. They came not to flee the great wars, but they came because of poor economic prospects at home. The Irish flooded in during the well-known potato famine during the 1840’s, the Germans came during the 1820 to 1860’s when the effect of the industrial revolution caused wide spread unemployment and despair, the Asians came later from 1880 to 1914.

The dominance of American citizens with a migrant background is nowhere more obvious than in their own political elite. Currently there is no native American serving senator, there have only ever been 5. There are only two in their lower house, the House of Representatives. There have only ever been 16 though. A country, where the migrant is so engrained in their DNA, isn’t it ironic that their politicians are crying foul over the current immigration?

Categories
Current

US tariffs – own goal

US imposes tariffs on Aluminium and Steel from almost all major producers, and they will suffer the most – why?

President Trump has once again blundered his economic policies, and imposed tariffs on most aluminium and steel products from all major producers. He has done so in the name of “national security”. Assuming that the US would ever go to war against one of its Allies (which is a peculiar thought in the first place), America would not have enough own production capacity to produce aluminium and steel for the production of their own weapons. Not only does show that Trumps policies are stuck in the cold war era, but Trump has also struck a spectacular own goal.

 

Aluminium and steel are input products in a vast array of products, ranging from motor vehicles to Pepsi cans. It is so versatile, that there is hardly any manufacturing industry that could get by without it. Therefore, it is vital for the US to get a steady and competitively priced supply of the materials.

 

It is not certain that imposing tariffs will cause the permanent production of US steel and aluminium to go up, because not many companies will commit the capital to build new production facilities. It is more likely that old inefficient ones, which have been laying idle will start up again (and can again be shut down quickly, should the tariffs be revoked). It is certain however, that the price of steel and aluminium in America will go up. That will hurt all the manufacturers who use steel and aluminium in their products. The higher input prices will have to be passed on to the consumer, and therefore all US produced products will get more expensive.

 

There are predictions that cars produced in the US will be between U$4 000 and U$8 000 more expensive, which would surely cost them market share. In return all those nations that had tariffs forced onto them are retaliating by imposing targeted tariffs on everything from Bourbon to Oranges, Pork and Harley Davidsons. They shouldn’t bother. Many of those products are going to be uncompetitively priced anyways.

So, what should Donald Tump have done to increase their homegrown production of steel and aluminium?  He could have lowered taxes on US aluminium smelters and steel mills or given them special tax breaks. But he has already given a broad tax reduction to corporate America, while the economy is booming. It is never wise to play your trump cards at the beginning, Mr Trump.

Categories
Current

Namibian Fishing quotas –catch the foreigners

The Namibian Government wants to bar foreign and listed companies from bidding for fishing quotas. This is a mistake.

 

One of the greatest natural resource of Namibia are the abundant fishing grounds off the Namibian coast line. It is a treasure, and the government is right in saying that it should benefit Namibians, but they are wrong by insisting that all quotas must be allocated to Namibian citizens, and not foreigners or listed companies. This is a misguided decision on three accounts; firstly the scale and complexities needed to operate in the fishing industry, secondly the scarcity of capital and thirdly the message this policy sends to foreign investors.

 

Start with the complexities. To operate commercially viable fishing companies requires a fleet of ships that can stay at sea for weeks. They must be able to at least partially process the fish, pack them and get them ready to be delivered to the final destination within hours of getting to shore. The logistics are complex and often involve trucks and planes, because if the produce is not fresh, the customer would simply buy fish from another destination that can deliver fresh fish. In addition, these companies have got massively fluctuating overheads, predominantly fuel to run the vessels. Therefore, to be able to bring the product to the market profitably, these companies need volume (ie big quotas) and very deep pockets. Do we have enough local fishing companies that are able to operate in this volatile environment? Or would the recipients of the quotas just sell them on to a company that is able to handle the complexities?

 

Now to the second problem, the scarcity of capital. Put simply, capital is the total available money for investments. By definition, each country only has a specific pool of capital at any time. You can’t print more, because that causes inflation (ask Germany in the 1920’s or more recently Zimbabwe). It grows as investments grow, but that takes time. Thus, the available capital within Namibia can decide to invest a bit more into the fishing industry, but that would also mean that it has less to invest in other sectors, like agriculture. The best way to grow your economy, and thereby creating more jobs and more opportunities for all the citizens, is to attract foreign capital. In that way you can expand the fishing industry as well as agriculture. That is one of the distinguishing characteristics of wealthy countries. All of them were able to grow much faster than they would have otherwise, no matter where they started from. Think of Germany and Japan after the second world war, South Korea and now China, Vietnam and Eastern Europe, just to mention a few.

 

That leads me to my third point: the message the Namibian Government is sending. At a time of low growth and high unemployment, the message being sent to international investors is “we are closed for business”. They could help the economy, but instead, the door is being shut. India did something similar when they became independent. They insisted that they could do everything themselves and would no longer need any foreign help. It caused years of almost no growth, and rising corruption – because everybody was fighting for a piece of the pie, that doesn’t grow. Let’s not repeat the mistakes of others.

 

The rich fishing grounds should benefit all Namibians, and not just a few well connected who are able to get their hands on quotas. The fishing industry should be dominated by Namibians, as investors and employees, but don’t exclude the foreigners.  Foreign investors, who deploy their capital in Namibia  create jobs and opportunities for the locals.