S&P announced it was lowering the long-term foreign currency credit rating from BBB- to BB+, while the long-term local currency rating was cut to BBB- from BBB. Importantly, the outlook remains negative. In addition, Moody’s also issued a statement yesterday that its sovereign credit rating of Baa2, two notches above junk, was under review.
The decisions by the rating agencies shouldn’t have caught anyone by surprise. Zuma’s latest shenanigans have placed a major question mark behind our country’s political stability, and therefore also the growth prospects of our economy – crucial considerations for the rating agencies.
What are the implications for financial markets, and our clients and investors?
First, our fragile currency has naturally come under severe pressure, as a result of capital withdrawals from South Africa. The rand remains the barometer of foreign investors’ view on the health of our economy, and since the Cabinet reshuffle, it has depreciated by 11%, a material decline.
Second, the downgrade in the credit rating would implicitly dictate to foreign investors to demand a higher premium to buy an asset that has just been tagged as higher risk. Over the past week, bond yields kicked higher and the capital value of government bonds has dropped by 4.8% – a massive value destruction.
Third, we have witnessed dramatic changes in the share prices of companies listed on the local stock exchange. However, the overall market has moved sideways and essentially retained its levels. On the positive side rand hedge shares have held up well and some have in fact strengthened on the back of a weaker currency. Unfortunately, the share prices of companies that rely predominantly on South African-based revenue have come under severe pressure. The two sectors most sensitive to rand weakness – banking and retail – have borne the brunt, with the SA Bank Index losing 14% of its capital value.
Of course we can’t ignore the psychological impact and stigma of our country having its debt associated with ‘junk’ – a term that doesn’t sit well with any self-respecting nation. We will now also be associated with countries that have a track record of economic mismanagement and the reputation of being a high-risk investment destination.
A NOTE ON CLIENT PORTFOLIOS
The performance of our clients’ portfolios amid all the uncertainty has been resilient. Although we do have some exposure towards more South African-focused companies such as banks and retailers, our house view equity portfolio is still weighted towards companies that earn the bulk of their income outside South Africa. We therefore expect our portfolio to hold up better than the JSE All Share index should the rand deteriorate meaningfully in the coming weeks.
Our balanced portfolios currently have virtually the maximum offshore exposure allowed in terms of Regulation 28 of the Pension Funds Act – 25% – and we have no intention to amend this ratio in the short term.
Amid all the political uncertainty, our approach to actively managing portfolios has not changed. Our transactions in the portfolios will remain dictated by price. In fact, if irrational investor sentiment succeeds in driving the prices of quality shares down, we will make use of the opportunities created and consider adding them to our portfolios, despite the fact that the rand may lean on some of these prices for some time to come.
WHERE TO NOW?
So, where to now for South Africa? The political drama of the past week and the decision by S&P have the potential of derailing the sterling efforts over the past months by business to support the efforts of Treasury and our former Finance Minister Gordhan. This has now changed, and the role of business, and all reasonable South Africans, has to be to protect our key institutions and the broader economy. Sanlam is actively participating in various forums involved in this – including organised business and the CEO initiative.
We will watch developments closely over the next couple of weeks and will continue to provide support to the economy, our clients, and actions aimed at protecting our young democracy.
