Don't Expect Much From The South Africa ETF

The iShares MSCI South Africa ETF (NYSE:EZA) is up 3.28 percent over the past week, reducing its year-to-date loss to just over 22 percent. That's more than double the 2018 loss of the MSCI Emerging Markets Index and enough to make EZA one of the worst-performing single-country exchange-traded funds this year.

Even with those ominous factoids, investors may want to temper their expectations regarding EZA's potential to deliver significant near-term upside.

What Happened

South Africa, Africa's largest economy, isn't in the tenuous positions of other emerging markets, such as Argentina and Turkey, but analysts and market observers remain reserved about the near-term rebound prospects for South Africa's economy.

“South Africa's latest economic plan is unlikely to deliver a significant boost to economic growth,” Fitch Ratings says. “Several of the measures relate to existing proposals and others will take time to finalise and to have an impact. The announcement does not affect our recently updated growth forecasts.”

Why It's Important

South Africa is a major precious metals producer, exposing its economy to weak commodities prices and the strong dollar. EZA devotes 13.35 percent of its weight to materials stocks, the fund's third-largest sector weight and enough to be a drag on the ETF while gold prices stumble.

“The recent rand depreciation has complicated the policy reaction to low GDP growth,” said Fitch. “We think the depreciation primarily reflects the rand's role as a proxy for emerging market currencies during times of broader emerging market risk aversion. But domestic factors including the recession and discussions about land reform have also contributed to outflows.”

South Africa's benchmark interest rate is 6 percent, below those of other scuffling developing economies. The South African Reserve Bank kept rates at 6 percent earlier this month, but the vote was close, indicating a rate hike could be forthcoming.

What's Next

South Africa's economy contracted in the first two quarters of this year, indicating a recession has either already arrived or is highly possible.

“In our latest Global Economic Outlook, published on 21 September, we reduced our GDP growth forecasts for 2018 and 2019 to 0.7% and 2.1%, respectively, from 1.7% and 2.4%,” said Fitch. “The economy shrank in the first and second quarters of this year and the recovery, driven by a moderate strengthening of investment growth, will be modest.”

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