A Precarious State For The South Africa ETF

The iShares MSCI South Africa ETF EZA, the largest exchange traded fund dedicated to stocks in Africa's largest economy, is up about 6 percent this year.

On the surface, that sounds pretty good, but upon further examination, EZA looks weak and vulnerable to some downside.

What Happened

To be precise, EZA is up 6.05 percent year to date, but the South Africa ETF is trailing the MSCI Emerging Markets Index, of which South Africa is 5.95 percent, by more than 300 basis points. That statistic underscores the disappointing nature of South African stocks in 2019, but there's more.

South Africa is the world's largest producer of platinum and the second-largest palladium-producing country. EZA is slightly outperforming the largest U.S.-listed platinum-backed ETF, but the Aberdeen Standard Physical Palladium Shares PALL is up 20.27 percent year-to-date, making the fund one of this year's best-performing commodities ETFs.

Why It's Important

“The February 2018 installation of a new president, Cyril Ramaphosa, has rekindled hopes of an economic renaissance, but the country still faces serious challenges,” said FacSet in a recent note. “After seeing two consecutive quarters of economic contraction in the first half of 2018, significant economic uncertainty remains.”

While the regime change was initially cheered by investors, South Africa's economy still faces significant hurdles. Those hurdles can be seen as roadblocks for investors considering EZA because has to handily outperform the MSCI Emerging Markets Index by wide margins to turn its risk-reward proposition favorable.

Over the past 36 months, the MSCI Emerging Markets Index outperformed EZA by 2,100 basis points while being 1,300 basis points less volatile than the South Africa ETF.

What's Next

Last month, “finance minister Tito Mboweni painted a bleak picture as he outlined the state of South Africa’s finances for 2019,” according to FactSet. “While the National Treasury predicts accelerating real GDP growth rate over the next three years (1.5% in 2019, 1.7% in 2020, and 2.1% in 2021), both the current account deficit and gross debt are expected to swell. Gross government debt, which has been rising steadily since 2009, surpassed 55% of GDP at the end of 2018. The latest government forecasts have debt topping 60% of GDP by 2024.”

If the U.S. dollar regains momentum, EZA would likely be sapped due to the commodities-intensive nature of South Africa's economy.

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