But take heart, for things are al­ways dark­est be­fore the dawn

Financial Mail - Investors Monthly - - Contents -

Chi­nese GDP growth was fore­cast at 6% for the year but has now been re­vised down to 4.8% be­cause of the pan­demic’s im­pact on trade and man­u­fac­tur­ing

The SA in­vest­ment com­mu­nity has been on the edge of its seat for some time in an­tic­i­pa­tion of a sov­er­eign credit rat­ing down­grade from Moody’s rat­ings agency.

As is well known by now, Moody’s is the last of three rat­ings agen­cies that still con­sid­ers SA sov­er­eign debt as in­vest­ment grade.

Much has been writ­ten about the con­se­quences of a down­grade to subin­vest­ment grade by Moody’s and by now most read­ers will know that if Moody’s down­grades our na­tion, SA govern­ment bonds will have to be ex­cluded from a va­ri­ety of global bond in­dices, so large in­ter­na­tional in­vest­ment funds will be forced to di­vest from SA as­sets.

There has been much chat­ter about how dire the con­se­quences would be if this hap­pens.

Re­cently, though, things may have changed.

The like­li­hood of be­ing down­graded is now higher than ever. Moody’s has cut its 2020 growth fore­cast for SA to 0.4% from 0.7% be­cause it con­sid­ers SA as one of sev­eral coun­tries that will have lower growth prospects in the wake of the Covid-19 pan­demic.

It says: “The global spread of the coro­n­avirus is re­sult­ing in si­mul­ta­ne­ous sup­ply and demand shocks”, cit­ing this as the rea­son for low­er­ing the growth fore­cast. About the im­pact of Covid19, it adds: “We ex­pect these shocks to ma­te­ri­ally slow eco­nomic ac­tiv­ity, par­tic­u­larly in the first half of this year. We have there­fore re­vised our 2020 base­line growth fore­casts for all G20 economies.”

Fur­ther­more, con­sid­er­ing the im­pact the Covid-19 out­break has had on China, SA’s big­gest trade part­ner, and its ex­pected GDP growth, the knock-on ef­fect on the SA econ­omy can­not be ig­nored.

Chi­nese GDP growth was fore­cast at 6% for the year but has now been re­vised down to 4.8% be­cause of the pan­demic’s im­pact on trade and man­u­fac­tur­ing.

PwC says in a re­cent re­port that for ev­ery 1% China loses in GDP growth, SA could lose 0.2 per­cent­age points to its own growth prospects be­cause of the deep de­pen­dence SA has on China as a trad­ing part­ner. And this is just tak­ing into ac­count the im­pact of im­ports and ex­ports. Con­sid­er­ing the im­pact that the Covid-19 out­break in SA could have on our econ­omy, an even grim­mer pic­ture emerges.

Be­fore com­pen­sat­ing for the im­pact of the pan­demic on our lo­cal econ­omy, mar­kets were mostly ex­pect­ing that SA’s sov­er­eign in­vest­ment rat­ing would be down­graded any­way.

Load-shed­ding still plagues our coun­try. The eco­nomic growth es­ti­mate as set out in the bud­get speech for 2019 has re­duced to a mea­gre 0.3% from 0.5% pre­vi­ously. The fore­cast for 2020 is noth­ing to get ex­cited about ei­ther at 0.9%, but even be­fore all the re­cent tur­moil Moody’s fore­cast was set at 0.7%, then re­duced to 0.4%. For 2021, the bud­get speech sought growth of 1.3% and then 1.6% in 2022.

Nto­beko Stampu, se­nior fixed as­set port­fo­lio man­ager at Vu­nani Fund Man­agers, high­lights a num­ber of in­ter­est­ing in­di­ca­tors.

First is that SA govern­ment bonds are al­ready trad­ing at yields higher than other coun­tries that are rated as subin­vest­ment grade.

To il­lus­trate this we can look at Brazil­ian 10-year bonds, which are trad­ing at a yield of about 8%, ver­sus SA 10-year bonds, which are trad­ing at about 10%.

This means that the mar­ket con­sid­ers SA govern­ment bonds more risky than Brazil­ian govern­ment bonds.

This is in­ter­est­ing con­sid­er­ing that Brazil is cur­rently rated as subin­vest­ment grade by all three ma­jor rat­ings agen­cies and SA is not.

The take­away here is that from an “at­trac­tive­ness of govern­ment debt” per­spec­tive, SA has al­ready been priced as subin­vest­ment grade.

An­other in­di­ca­tor comes in the form of credit de­fault swaps, ef­fec­tively the cost of in­sur­ance that pays out when there is a de­fault on a credit in­stru­ment such as a govern­ment bond. These too are be­ing priced in the range of other subin­vest­ment grade coun­tries.

So for all in­tents and pur­poses, SA is al­ready viewed as subin­vest­ment grade by the world. It is merely a mat­ter of time and for­mal­ity be­fore Moody’s confirms it.

That said, the sit­u­a­tion is dif­fer­ent now from what it was just a few weeks ago.

The Covid-19 pan­demic has done se­ri­ous dam­age to the world econ­omy, which will un­doubt­edly have a neg­a­tive im­pact on SA.

This al­most re­moves any hope that we had that SA would once again be able to dodge the down­grade.

On the pos­i­tive side, the world is focused else­where and perhaps the down­grade will not have as dras­tic an im­pact as it would have had be­fore the crash. The fact that mar­kets have crashed might work in our favour.

Al­ready SA bonds and eq­ui­ties traded at dis­counts to lower or equal qual­ity al­ter­na­tives in the out­side world, but now the mar­ket has rerated even lower (a po­lite way of say­ing crashed) and our lo­cal eq­ui­ties are of­fer­ing even bet­ter earn­ings mul­ti­ples than be­fore.

This might mean that in light of the now rapidly de­te­ri­o­rat­ing global econ­omy, SA — once con­firmed as subin­vest­ment grade — could look con­sid­er­ably more at­trac­tive to riskier in­vestors than it would have be­fore the crash.

There was al­ready an ex­pec­ta­tion that our lo­cal eq­uity and bond mar­ket would ben­e­fit once the down­grade is con­firmed, as higher-risk in­vestors seek yields and re­turns that could out­pace those of­fered by de­vel­oped mar­kets.

Now that as­set prices are dras­ti­cally lower, it might make them even more at­trac­tive in the long run, es­pe­cially when you con­sider the ab­so­lutely enor­mous scale of mone­tary stim­u­lus that hit the mar­kets over the past month in a co­or­di­nated push from mul­ti­ple cen­tral banks around the world.

Enough free money to fill up even Scrooge McDuck’s swim­ming pool vault, and near-zero, zero or neg­a­tive in­ter­est rates in al­most ev­ery de­vel­oped mar­ket around the world make a 10% yield on a “risk-free” govern­ment bond look mighty at­trac­tive.

Not to men­tion that SA is home to some of the most in­no­va­tive (and largest) com­pa­nies in Africa, and those com­pa­nies’ share prices are back down to 2008/2009 lows and are of­fer­ing p:e ra­tios vastly more at­trac­tive than those on of­fer in the de­vel­oped world.

This may be a rather strange sil­ver lin­ing to a grim dark cloud, but it may also cre­ate a huge op­por­tu­nity for long-term in­vestors who are will­ing to reen­ter eq­uity and debt mar­kets once Moody’s of­fi­cially down­grades us.

In a sense, when we are down­graded, it could come at the best pos­si­ble time for us.

While the world is falling apart and mar­ket par­tic­i­pants are scram­bling for the door any­way, who is re­ally go­ing to pay much at­ten­tion to the fringe emerg­ing-mar­ket coun­tries that are be­ing down­graded?

It may come at a time that global in­vest­ment sen­ti­ment is so low that the im­pact of the down­grade will be al­most com­pletely negated.

Fur­ther­more, once the global sen­ti­ment be­gins to im­prove again, sud­denly SA will be po­si­tioned as the most at­trac­tive subin­vest­ment-grade mar­ket out there and will very likely at­tract a large por­tion of the risky money.

So take heart, for things are dark­est be­fore the dawn and there is no time in re­cent his­tory that things have been darker than they are now. ●

While the world is falling apart and mar­ket par­tic­i­pants are scram­bling for the door any­way, who is go­ing to pay much at­ten­tion to the fringe emerg­ing-mar­ket coun­tries that are be­ing down­graded?

Pic­ture: 123RF — ESSL

A su­per­mar­ket’s meat fridges are empty as peo­ple stock up on food af­ter the SA govern­ment an­nounced mea­sures to curb coro­n­avirus in­fec­tions. Pic­ture: REUTERS/Ro­gan Ward

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