Jeremy Siegel, Ph.D. The Future for Investors

In June I spoke at the Wharton Global Alumni meetings in Cape Town, South Africa.  It was my first trip to Africa, and I was eager to see firsthand how this country was faring after its remarkable transformation from a stronghold of apartheid to a multi-racial democracy in the early 1990s.

The trip did not get off to a good start.  After driving with my family to New York’s JFK airport for the non-stop flight to Johannesburg, I was told by South African Airways that I could not board my flight because I didn’t have two blank “visa” pages in my passport, which they claimed were required by the South African government.  I actually had three blank pages in my passport, but if you look at an American passport, the last two pages, in small type, are marked “Amendments and Endorsements” and not “visa pages.”

This snag meant paying $360 for 24-hour emergency passport service and substantially rearranging the itinerary of our trip. The biggest irony is that after the trip was over I noted that all the South African passport markings were placed on only one page, even though I exited and re-entered South Africa twice to take a side trip to Victoria Falls! Warning to prospective travelers: Have enough visa pages or send your passport to have extra pages added, by the US passport agency, at no extra cost.  

Strong Growth

Nevertheless, once we arrived in South Africa, the trip was a pure joy.  The country has experienced strong economic growth, which has averaged about 4.5% over the past five years. And South African stocks have been on fire, chalking up an average of 30% per year returns over that period, although this year, they are off 15%.

Everywhere one senses much excitement about the upcoming 2010 World Cup, which has prompted a major renovation of its international airport in Johannesburg and the construction of huge soccer stadiums in Johannesburg and Cape Town.  The South Africa Rand, now at 7.6 to the dollar, makes the country a cheap destination for Americans and a bargain-basement one for Europeans.  Tourism has been extremely strong in recent years and has replaced gold as the country’s largest source of foreign exchange.

Political and Developmental Problems

But despite these many attractions, the country is beset by problems.  Nelson Mandela is revered by both the whites and the blacks, and is viewed, along with the former president F.W. de Klerk, as the fathers of the “New South Africa,” as South Africans now call their country.  The current president, Thabo Mbeki, has little charisma and a mediocre record. But there is genuine fear about the newly-elected head of the Africa National Congress, Jacob Zuma, the natural successor to Mbeki.  Zuma has been indicted on charges of corruption and was recently acquitted of rape charges after acknowledging having unprotected sex with a known HIV-positive woman, an embarrassing situation since he was head of the National AIDS Council.

Furthermore, South Africa’s economy has slowed and inflation is running at double-digit rates.  Recently, parts of the economy, particularly the important mining industry, have been disrupted by numerous power outages.  The reason for these outages is inadequate investment and upkeep of the electrical grid that some critics claim is due, in part, to the rigid affirmative action laws that have placed unqualified people in charge of key parts of the industry. 

During my stay I had the pleasure of speaking with Cas Coovadia, the managing director of the Banking Association of South Africa.  Mr Coovadia is an extraordinary man who had fought apartheid for many years (and spent time in prison because of his support for black rights), but now expresses concern for South Africa’s future.

Mr. Coovadia claimed that there are four issues that the government must act on:  Crime, health, job training, and education.  Although blacks are of course no longer legally excluded from any job, the educational deprivation and discrimination suffered during the apartheid era left a large number of Africans without the skills required to navigate the new economy.  

In the health area, Mbeki, as well as other African leaders, have reluctantly and belatedly acknowledged the AIDS crisis. A recent South African National HIV Survey estimated that 10.8% of all South Africans over age two were living with HIV in 2005, resulting in a daily death toll of almost 1,000, or more than one million lives in the last three years.

Crime

But it is crime – and the fear of crime – that is seen by foreigners as the number one problem of South Africa. Several people told me that investment banks, even those bullish on South Africa, find it hard to recruit individuals to work in the country, especially in Johannesburg.

The signs of that fear are everywhere.  Downtown Johannesburg has been largely abandoned, as many businesses, hotels, and restaurants, including the Johannesburg Stock Exchange have moved to satellite areas, such as Sandton.  Many fine houses are surrounded by high walls and electrified fences and many corporate areas are gated and staffed around the clock by security guards. A Bulgarian taxi driver told me that he will stay in that country only until the World Cup, when he expects business to be very good, and then move back to Sofia, where he can safely raise his family.

But it is not just taxi drivers who express fear. The day before my presentation in Cape Town, F. W. de Klerk, the last president of apartheid South Africa who negotiated the historic accords with Nelson Mandela, addressed the Cape Town Press Club and expressed grave concern about the future of South Africa.  He felt that much of the good work that was achieved during the negotiations leading to the new constitution were, to use his words, “under severe pressure.” He criticized the government for meddling in the private healthcare sector, intruding on the independence of the judiciary, and sponsoring legislation that expands expropriation of farm lands. All these actions threaten the confidence that foreign investors have in the South African economy.

Investment Value

With such problems it’s easy to shun South African stocks.  Yet I believe these uncertainties are already priced into the South African stock market.  The Johannesburg All Share Index is priced at only 9.1 times this year’s earnings and only 8 times estimated 2009 earnings, which ranks the South African stock market as among the cheapest in the world. Furthermore, the South African rand is cheap relative to other world currencies, particularly the euro.

Given these circumstances, I believe South African stocks should be part of every investor’s international portfolio. Barclays has issued a South African exchange-traded fund (ticker: EZA) and WisdomTree Investments* has issued diversified, dividend-oriented emerging markets ETFs -- (DEM) and (DGS), in which South African stocks have the second highest weight.  You can also hedge the currency risk of the South African rand with a new currency ETF (SZR) by WisdomTree.

Conclusion

South Africa has made some great progress since the 1994 accords that ended apartheid.  It faces many problems, but these are mostly priced into its stock market. I therefore recommend that investors hold South African stocks as part of a broadly-diversified international portfolio.

* Full disclosure: I am an advisor to WisdomTree Investments