Financial Mail - Investors Monthly
GRIM PROSPECTS
But take heart, for things are always darkest before the dawn
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?