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Young Analyst Programme
Women of CIB
Real yields put real pressure on expected returns
Walter De Wet, Reezwana Sumad
Posted 03/10/2023 2 mins
Nominal bonds remain our preferred asset class in South Africa (SA). That said, where we ranked the expected return of cash already ahead of most asset classes for the last quarter, cash’s expected return is now also closing gap with bonds. This comes as higher domestic real yields weigh not only on growth, but also on asset valuations. In short, higher real yields imply higher real risk, which results in investors wanting to pay less than before for the same earnings. Our analysis suggests that nominal bonds, on a 12-month horizon, remain likely to generate low double-digit returns, followed by cash, inflation-linked bonds (ILBs), listed property and equities.
Growth, monetary and fiscal policy
Growth is set to remain weak. The Monetary Policy Committee (MPC) paused its rate hiking cycle, although the latest surge in oil prices, combined with a weaker rand exchange rate, prevented the SARB from becoming dovish. The post-Covid period of strong tax revenue overshoots has proven to be fleeting and SA’s fiscus is expected to deteriorate.
Fixed income and the currency
We prefer nominal bonds over cash and ILBs. Although we believe nominal bonds remain attractive, we avoid maturities beyond the R2035. For ILBs, we expect further bear steepness in the ILB curve. For the currency, the US rates market may still cause emerging market (EM) currency weakness into the next Federal Open Market Committee (FOMC) meeting on 1 November. However, we also believe it is too late to turn too bearish on the rand. Plenty is priced in already.
The sector currently trades on an earnings yield of 11,0% and a forward dividend yield of 8,8%. This has decreased from 11,9% and 9,9% in 3Q23, respectively. We believe there is downside risk to earnings as higher funding costs filter through.
SA retail and industrials
We are becoming more constructive on the SA retail and industrials sectors, with a small overweight on SA apparel, Neutral on SA food and Overweight on SA industrials.
SA food producers
The SA food producer sector has come under pressure over the past five years due to factors that are both cyclical and structural. While most of the factors have played out, we believe we are now reaching the trough of lower earnings across the sector.
The gold sector faces several operational challenges, which could weigh on its operational performance and margins, and we continue to rate the sector Neutral. In the PGM sector, we do not expect a material re-rating in equities and do not see the index trending back to the long-term range anytime soon.
For the most part, our commodity price forecasts have remained unchanged from 2024E to 2027E. We maintain our Overweight stock recommendation for ARM and South32.
SA telecommunications and media
While load shedding remains a constant headwind for SA mobile network operators (MNOs), the shift of capex to power resilience is bearing fruit, with improving top-line growth for these MNOs.
Healthcare – corporate activity-driven price rallies
The fundamentals that drive the sector remain intact, with a few stocks offering decent entry positions at current levels. We are Neutral the healthcare sector.