Remaining steady during debt downgrade

Almost every South African will be aware that the international rating agencies could potentially downgrade our local government debt to sub-investment grade, commonly known as “junk status”, in the next couple of days.

It’s also crucial that investors and South African citizens remain calm and make informed choices in the event of such a decision.

If the South African government loses its investment grade credit rating, large international bond funds (both actively managed and index tracking funds) will be forced to sell out of South African bonds if their mandates don’t allow for exposure to sub-investment grade instruments. This could result in a weaker currency as more than R150 billion would be traded for global currencies.  This in turn could result in higher inflation for South Africans as the Rand cost of imports (such as oil) would rise.

This could lead to the South African Reserve Bank placing a hold on the current trajectory of decreasing interest rates. This comes at an unfortunate time as South African consumers are under pressure with unemployment on the increase on the back of a lacklustre economy.

The potential downgrade could affect South African based investments such as shares, property, cash (in real terms) and bonds. This could result in lower returns from local asset classes, particularly those that are dependent on the local economy.

Amidst all of this, perhaps not surprisingly, there is an opportunity for investors.

In excess of 60% of the earnings on the local equity market are now derived from sources outside of South Africa.  Why is this important? Given the scenario above where the currency weakens, the Rand value of these companies’ earnings will benefit directly and share prices are likely to move higher. This will result in appetising returns to investors who are willing to take the risk.

When the market closed on June 15 2017, the FTSE/JSE All Share Index (Alsi) had shown a 0% gain year to date. Even going back three years to the middle of 2014, the market showed the same 0% gain.

From that low point, however, the JSE has suddenly come to life. Over the next 124 trading days, the All Share Index gained over 18% to pass the 61 000 level which is a historical high for our market.

It has been a sudden turn around for a market that has been in the doldrums for so long. It’s true that a lot of this momentum has been due to the price gains in Naspers but amongst the winners for the year was other large, multinational companies, deriving earnings from offshore.

These numbers reveal two important investment lessons.

Investors need to be patient.

Equity markets move in unpredictable ways, but over time they trend upwards. To gain from the good you have to be prepared to stomach the bad.  Returns don’t come in a straight line.   While the JSE is up strongly for the year, February (-3.1%), May (-0.4%), June (-3.5%) and September (-0.9%) were negative months. Investors have to sit through the negative months to benefit from months like October and July (+7%).

Missing out on such strong short-term rallies can substantially reduce long-term returns from equities. Over time there are more positive than negative months, but trying to time the market successfully and consistently is not possible.

Market rallies can sometimes be so sharp and unexpected, that there is no way to see them coming.

For many investors, it is more comfortable to sit on the side-lines, waiting for better news before getting back into the market. Markets often move before popular sentiment changes, as is apparent with the surge we saw in local markets over the last couple of weeks without any improvement in the political or economic situation. This is because the global backdrop matters more for the JSE than local developments, despite the fact that local investors often obsess about the latter. By the time the news is more positive, the market has already priced in the new reality and investors would have missed out.

From the FPM team, we recommend investors stay invested according to their investment strategy as to make any irrational changes now, could result in missed opportunities.

This article is a general information sheet and should not be used or relied on as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted. (E&OE)