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Behind the Recent Rise in the South Africa ETF

Zacks Equity Research

While a cut in credit ratings normally makes the going tough for a country ETF, exactly the opposite had happened for the South Africa fund lately. This emerging nation is plagued by a prolonged mining strike, ever slowing growth, huge current account deficit and structural bottlenecks, but it has seemingly managed to persevere nonetheless.

Notably, South Africa is the world's largest platinum and second-largest palladium producer, accounting for 80% and 33% of global supply, respectively. S&P believes that the strike could take the nation to a recessionary phase, though there are now hopes that the strike may be behind us for now (read: Two Precious Metal ETFs Set to Soar).

Thanks to these aforementioned worries, Fitch Ratings slashed South Africa‘s credit rating outlook from Stable to Negative on June 13 while S&P trimmed the foreign-currency rating from BBB- from BBB and the local-currency rating was lowered to BBB+ from A- on the same day. However, the S&P raised the outlook on the ratings from negative to Stable (read: Russia ETFs in Focus on Credit Downgrade, Rate Hike).

As per Bloomberg, the nation was slapped with a GDP contraction (0.6% sequentially) in Q1 for the first time since 2009 hurt by reduced production from the platinum mines. The World Bank trimmed its 2014 South African growth forecast from 2.7% to 2.0%. S&P cut the growth forecast to 1.9% while the central bank of South Africa lowered its 2014 growth forecast to 2.1% from 2.6%.

Thanks to these cuts in their rating, the South African currency, rand, fell a bit in the recent trading sessions. The rand lost about 2.1% so far this year and 16.7% last year. Amid such a situation, Morgan Stanley believes South African equities will win over the bonds as equities offer some hedge against the struggling rand.

The logic behind this belief was the formation of the Johannesburg Stock Exchange (:JSE) Index.  More than half of the JSE Index’s earnings are generated from foreign locales, which will be beneficial when profits are converted into a weaker rand. Also, 22% of the index hails from the resources sector, which gets help from a weaker rand.

ETF Impact

Given these positive fundamentals, the South Africa ETF – iShares MSCI South Africa ETF (EZA) – added about 1.05% past week (as of June 20, 2014). The ETF gained 1.77% in the last two weeks and 8.78% in the year-to-date frame.  

The fund was massively beaten down last year thanks to the QE taper talks and prospective rise in rates.  This made the fund fairly valued to enter 2014 and gifted it with such gains.

Though emerging market investments will be edgy this year, the recent dovish comments made by the Fed on a relatively benign interest rate outlook and reduction in the U.S. growth outlook can reward emerging market ETFs with a look in the short term.
Investors should note that we currently have a Zacks ETF Rank of 5 or Strong Sell long-term rating on EZA. Still, for investors who believe that the recent rise in EZA will likely continue for quite some time, we have highlighted in detail the ETF below (read: Will Election Hopes Boost The Fragile Five Emerging ETFs?).

EZA in Focus

This ETF looks to track the MSCI South Africa Index. It has a major focus on large and mid cap equities (read: Top Ranked Foreign Large Cap ETF in Focus: FNDF). The ETF invests about $593.6 million assets in 51 holdings.

EZA carries high company-specific concentration risk with Naspers Limited N Ltd (15.2%), MTN Group Ltd (11.7%) and Sasol Ltd (10.7%) taking the top three spots of the basket. From a sector point of view, the fund is tilted towards financials (26.9%) and consumer discretionary (23.9%). The fund charges 61 bps for an expense ratio.

For a technical look, the short-term moving averages (9-day SMA) for EZA is well above the long-term averages (both 50-Day SMA and 200-Day SMA) signaling some upward move. Further, the Relative Strength Index (RSI.TO) is around 59.04, suggesting that the ETF is yet to enter overbought territory.

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