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The downgrade and your investments

Will you feel it?
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In normal times, the decision by Moody’s to downgrade South Africa’s sovereign rating to below investment grade last Friday would have been headline news for days. However, with the world consumed by the implications of the coronavirus, the downgrade has taken second place.

To some extent this is because the impact that Covid-19 has had on markets has already far surpassed the likely short-term response to a downgrade. By the time of the Moody’s announcement on Friday, the rand, local government bonds and South African stocks had already been battered in the global sell-off.

SA asset performance to 27 March 2020
  1 January 2020 27 March 2020 Change
ZAR / USD R 14.11 R 17.36 -18.72%
10 year government bond yield 8.26% 11.63% -28.98%
FTSE/JSE All Share Index 57 084 42 946 -24.77%

It is therefore reasonable to ask whether the downgrade will have any additional implications for South African assets. With the rand, government bonds and South African equities already at these levels, is a downgrade a big enough event to push them further?

The market saw it coming

This is a particularly relevant question because it was not an unexpected event.

“The timing of Moody’s decision was unfortunate, but hardly unanticipated,” Cannon Asset Managers points out in a note.

“At the recent reading of the national budget, government made all the right noises about addressing the rating agencies’ concerns after Moody’s last rating review in November, but ultimately failed to give any evidence to its good intentions,” it added.

Read: Our uncertain future

When the market knows that something is going to happen, it has generally already factored it in to valuations. This is what analysts mean when they talk about the downgrade already being ‘priced in’.

“The downgrade has been widely expected since the budget in February indicated a worsening fiscal position, so it has been largely priced into the values of stocks, bonds and the rand,” says Andrew Davison, Head of Advice at Old Mutual Corporate Consultants. “This means that, for instance, the interest rates being demanded by bond investors already reflect the lower creditworthiness. This can be seen by comparing the interest rates on our bonds to other countries that are already sub-investment grade.”

Lessons from Brazil

The animation below compiled by Corion Capital puts this in perspective.

Source: Corion Capital

South Africa’s situation is reasonably comparable to Brazil’s when that country was downgraded in 2015. Yet, the local stock market and South African government bonds have already sold off more than their Brazilian equivalents did five years ago in the lead up to its downgrade.

Local bond yields are also substantially higher than for the country’s peers at the moment – even those with lower credit ratings.

It’s also worth noting is that, following Brazil’s downgrade, stocks and bonds actually rallied. This is because at this point of weakness, these assets are cheap and attractive to investors willing to accept some additional risk.

As Davison notes: “Although investors with investment-grade-only mandates will be sellers of South African bonds, other investors with less restrictive mandates will be potential buyers. In the sub-investment grade universe, South African bonds are likely to be very attractive on a risk-adjusted basis. So, demand might be quite strong.”

Looking at stocks

When it comes to the local equity market, the downgrade does mean that companies may face higher funding costs, and that could be challenging for those with weaker balance sheets. However, this is already a significant concern in the current environment.

Read: Moody’s downgrade compounds Covid-19 challenges

Prices on the local stock exchange therefore already reflect companies under pressure. This suggests that there is a margin of safety for investors.

“South African corporates have been operating in a weak environment for an extended period already and will find the environment very challenging with some demand capacity permanently leaving the market,” says Jason Liddle, head of institutional business at Sanlam Investments.

“We do expect this to be for a period of time only and that companies will recover over the medium term.”

Liddle adds that it is also worth noting that nearly 40% of the income earned by JSE-listed companies comes from outside of South Africa.

“Our stock market has therefore become less reliant on the fate of the local economy,” he points out. “This protects investors from rand weakness and South Africa-specific risks.”

The caveat

It is therefore possible that the downgrade will have no serious implications for South African investors above the risks that they already face from the Covid-19 pandemic. However, it may take a few months before anyone can say this for certain.

“Many analysts and commentators have suggested that the downgrade is already reflected in our market prices, and if that is true, then the agency will have finally called what markets have been saying for a long time,” Cannon Asset Managers notes. “But in good economics, there is always a ‘however’.

“In this case, the ‘however’ is that we will only know whether this is true when capital market participants begin responding to the rating assessment.”

As South Africa will only officially fall out of the FTSE World Government Bond Index at the end of April, the effects may be delayed. Investors may therefore have to wait until May before this question is fully answered.

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With a pandemic which has barely begun, wishful thinking?
The scales are bound to tip over and investments are bound to become worthless.
The world is entering a new age, a new dawn where bartering will once again rule the face of this planet.
America will destroy China who Trump blames to be behind this and many countries will fall including America.
The filthy rich will become poor and only the poor with ultimate survival skills will endure the hardships which awaits us all.

China will become a pariah state, going forward. And we as part of Brics, will have a dilemma, whose side to choose: China-aligned countries or Western-aligned.
The China blame game has started; US, UK and Australian commentators, with influence in their respective governments, want China to account. And China are trying to blame US Military for introducing the virus to Wuhan last year. But at same time, China are publicly stating they have banned ‘warm blood’ market trading….they said that after SARS outbreak in 2003, so we know what their promises are worth?

I don’t think it will be the end as we know it.

Reason.

Although there will be many many unfortunate deaths the virus will not kill everyone. In a year or two there will be a vaccine and by then many would have had the virus and built up immunity against it.

This will happen before all the wealthy people are poor.

“The Market” will pickup on this way before it happens and many us us will be left in the dust.

And yes. Many things will change. Some good some bad. Some good opportunity and others not.

Oh and hardships? Undoubtedly many.

“Die een se dood is die ander se brood”. The great flue pandemic of 1918 killed 6% of the population. According to current statistics, of those who get infected by the covid-19 virus, 4% die. Looking at the nominal count, this virus is nothing compared to the number of people who die of “regular” diseases. Simply compare the amount of covid fatalities to the diabetic epidemic. In 2016 alone, 4 million people died of diabetic type diseases. People do not self-isolate or go into lockdown because they touched a loaf of white bread or because they accidentally drank a sugary drink.

My point is- this is not the end of civilization as we know it. This is merely an excuse to print money. In other words, this event, this pandemic is an extremely bullish event because the actions of Reserve Banks will force share markets to make new highs before most people come out of self-isolation.

Inequality will increase as the wealthy become more wealthy. It is the poor who will suffer, as always.

In simple terms the rand weakening means:

Your house/stocks/business/salary/pension or any other assets are worth ~23% less in global terms.. and this doesn’t include the market rout over the last month.

About 1/3 or more of your consumables will rise about 30% or more over time.

Basically SA inc is worth 3/4 of what it was three months back.

The sell off is a COVID sell off. I smell a confirmation bias. Assets to continue bleeding, watch this space.

Surely the % change as reflected should all be calculated with 1 January as the base – thus the Rand /dollar change is -23.03% and not -18.72% and likewise for the bond yield calculation.

It’s something of an anomaly, but these calculations have to be reversed. Consider that if the rand went from R10 against the dollar to R20 against the dollar, you could not say that the rand had lost 100% of its value. If the rand lost 100% of its value, that would mean that it was worth nothing. So you have to use R20 as the base, by which calculation the rand would have deteriorated by 50% in the above example.

Past ratio: 1 usd / 10 zar
Current ratio: 1 usd / 20 zar

[Current Ratio] / [Past Ratio] = Effective change

/// back of the envelope math

(1/20) / (1/10) = 0.5 which is 50%.

You get the right answer, but in an incorrect way. Rands per dollar is fine for reporting, but not for calculating.

When determining ratios in terms of time, one always compares to the initial conditions (I am a very experienced statistician). Arithmetically, this gives the formula (final – initial) to get the absolute value, but then to get a ratio, compare again to initial condition. Thus we get (final – initial) / initial.

In this case, it is assumed that the dollar is constant and the Rand variable. So we say, initially, one Rand bought 1/10 of a dollar; and later, one Rand buys 1/20 of a dollar.

Thus in the formula, = ((1/20) – (1/10)) / (1/10) = -0.5 = -50%, which is a loss of half.

@The Navigator

You know that the formula I use shows how much of your buying power has changed while your one shows how much you have lost…

Literally you are arguing over the glass has lost half while I say the glass has half left.

Etienne, Yes, quite so.

No matter how you calculate it: die rand is in sy moer.

The government yield sounds good for savers but if they had the bond in December then all that has happened is their capital is worth less. Still receive the same Runt amount of income…

Ryk van Niekerk and Jaco van Tonder from Investec Asset management had a discussion on September 10, 2018 – Guaranteed life Annuities vs Living Annuities.

In the end – the best Investment a pensioner can make is to ‘’convince’’ himself that his/her pension decisions should be based on your current and future needs. I never liked the idea/argument that pensioners should be ‘’spoofed’’ by analysts talk that ‘’there’s also the downside if you take a guaranteed annuity and you unexpectedly pass away in the first year or two or three, all of that capital in many cases will be lost or a lot of it. So those are the main downsides.

Firstly, there are Guaranteed Life Annuities – that is sold with guarantees that these pensions ‘’won’t be lost’’ for periods up to the first 10 years. That I think covers all the concerns that pensioners might have pertaining to reserve funds for their kids etc. The so-called argument that all the capital will be lost with a Guaranteed annuity when you die methinks ‘’beats the object of the exercise’’ – pension should be applied and used as a pension, not life insurance and inheritance.

The Guaranteed vs Living Annuity arguments have been thrown around ad nausea. After every ‘’financial- and now medical crisis’’ that we go through, I pat myself on the back that I took the bulk of my pension in the form of Guaranteed annuities with ‘’reputable’’ companies. Under Living Annuities pensioners investments in Living Annuities are in the hands of Asset Managers like Allan Gray, Coronation, Liberty, Old Mutual, PSG, Momentum, etc.
The following statement was made (not exhaustive) by Brenthurst Health (BizNews 18 March 2020), which I find totally ‘’ misleading’’ hence my view as expressed below. Maybe they should volunteer more specific information with regards to their ‘’investments in high-Income funds’’ to back up their statement?
Brenthurst cautious asset approach protected investors – Magnus Heystek. I did a calculation whereby a pensioner’s etc funds were invested in the US one year ago and repatriated after the latest crisis. Although a 21.32 % gain was made on the exchange rate weakening in their favor it wasn’t enough to offset the 42 % loss that was made on the US$ equity investment (Source JSE Share Price Calculator).
Sasol must be one of the ‘’worst managed companies’’ in South Africa.
What type of management doesn’t hedge its risks?
What type of asset- and fund managers commit their client’s funds into a company like Sasol knowing that their money was at extreme risk do to Sasol’s ‘’reckless’’ no- hedging behavior? Did the fund managers (the likes of Allan Gray, Coronation, Old Mutual Investment Group, PSG, Discovery, Momentum, Investec, Absa, Nedgroup, Stanlib, etc., break the law Pension fund law by leaving pensioners money in that type of high-risk investments?
Pensioners with living annuities are carrying ‘’unbearable risk’’ due to the nature of the product (they lose most of their intrinsic value due to time decay and mismanagement) – it’s not suited/geared to withstand any type of financial, etc crisis. Fund and asset managers (with the help of their analysts), fell in love with the likes of Steinhoff and Sasol), at the expense of their investors.

My view again here is that the Regulators should investigate all these funds and Sasol due to their ‘’ delinquent’’ behavior, at the cost of mostly pensioners (in the short term).

“Although a 21.32 % gain was made on the exchange rate weakening in their favor it wasn’t enough to offset the 42 % loss that was made on the US$ equity investment (Source JSE Share Price Calculator).”

Where do you get your stats from?

02 April 2019:
USD/ZAR:14.21
S&P 500: 2867.24

02 April 2020:
USD/ZAR: 18.47
S&P 500: 2526.90

USD/ZAR over period: -30% (30% appreciation in USD terms)
S&P 500 over period: -11.9%

So net effect for USD investment in S&P = +18% (this is -11.9% + 30%)
If you do the maths properly, investment return is 22.22% over the period.

What you did instead to get your 42% loss was to look at an investment in the JSE over the period in USD terms. Which is even more frightening and highlights how Magnus was even more correct in his advice! In fact, after having done the exercise, I’m quite surprised that you’d still be well in the money (in ZAR) terms having invested offshore over the period.

I did not use a ”Skop skiet en Donner” approach when I did my calculations – I worked on a March 2019 USD/ZAR rate of 14.50 (source SARB Rates)-
I compared March 2019 against March 2020 – My exchange rates are correct (I used to be an FX Corporate/spot trader for more than 40 years)
Where did you check your US markets?
When I did the calculations they were down more 30 % – ”not a pretty picture!

As mentioned, if you used that JSE calculator to obtain your numbers and selected USD as your local currency (as you have basically stated), then that’s your return having invested your USD (i.e. from a US investor’s perspective) in the JSE.

Based on the figures that I’ve used, I’ve simply taken the closing prices of the instruments used, for those specific days, from http://www.investing.com

Don’t sweat it, I’ve got multiple years of experience as a currency and fixed income trader, but none of that’s needed for these calculations. Unless you were using US market figures from their peak, I cannot see how they were down 30% over the past 1 year period. Before their decline, they were up around 30% year-on-year.

There’s no shame in having to apologise to Magnus!

Skiet en Skop.

Let me tell you why I neither ‘’ don’t nor won’t’’ have to apologize to your mate Magnus (Magnus is this your pseudonym?)

Firstly: The devil is always in the detail – there are a lot of coveted analysts and economists out there – most of them Winners of The Economists of the year forecasters, etc. – some of them I know very well and were ex-colleagues of mine, etc. Magnus slated them in some of his articles, right here on Moneyweb, etc.
I also noted that Brenthurst Wealth did not feature in the 2019 and 2020 Raging Bull awards, while all their opposition did!

Secondly: I stand by my argument that the statement made (maybe not exhaustive) by Brenthurst Health (BizNews 18 March 2020), was totally ‘’ misleading’’. So far Magnus failed to ‘’volunteer’’ any information (specifically for the period at I mentioned – March 2019 vs March 2020)

Where are you now ‘’falling out with’’ 30% year-on-year US Market figures – well knowing that I alluded to March 2019 vs March 2020?

Let’s make the calculation it Simpler: I alluded to very short-termers in my post i.e. – the pensioners or the so-called investor in Living Annuities etc.

One Million Rand is invested in the US Market (on the Dow- make your pick – you don’t have to take Boeing)
Transaction Value Date: 20 March 2019
Spot Conversion Rate: USD/ZAR 14.50
Currency Amount: ZAR 1,000,000
Amount of US $ bought: USD 68, 965, 51
Value of US Assets bought: USD 68, 965, 51 (average of most shares on the Dow)
US Assets – Mark-to Market after crash (26 %) = US$ 50,506.89 (US $ 15,158.62 Loss on investment)

Transaction Date 22 March 2020: Repatriation of Funds.
Amount of US Dollars converted back to Rand: US$ 50,506.89
Spot Conversion Rate: USD/ZAR 17.30
Rand amount available after the conversion: UD$ 50,506.89 @ USD/ZAR 17.30
= R 878,531.35
Hence:
Pensioner Invested R 1,000,000 and only received R 878,531.35 back
A loss of R 121,468.65 was made!
And Brenthurst Wealth puts out a statement that claims that their ‘’cautious asset approach’’ protected investors?
That Magnus, with all due respect, I find totally unacceptable and misleading!

Firstly, no, I am not Magnus. It was tongue in cheek based on the fact that you clearly have an issue with him, as you have stated why. Initially you mentioned a 42% loss made on US investment that has now simply been swept under the rug and that is what I questioned initially. This figure seems to have been calculated erroneously or pulled out of who knows where, although as mentioned, I am pretty sure where your confusion comes from.

Even using your time periods and indices, which are very selective and conveniently ends up at the market bottom and worst loss result without the full impact of the USDZAR weakness taken into account, investing offshore (as proposed by Magnus repeatedly) far outperforms the relative local investment.

In future, it would help if you gave your US equity index levels used in calculations but nonetheless let me use your dates with the real values, for both the Dow and S&P – I will use your USDZAR rates for argument’s sake:

20 March 2019:
USD/ZAR:14.50
S&P 500: 2824.23
R1m @ 14.50 = USD 68965.51
USD/S&P = (68965.51/2824.23) = 24.419 units

23 March 2020 (since 22 March is a Sunday):
S&P 500: 2237.4
S&P 500 units * S&P level = 24.419 * 2237.4 = USD 54635.58
USD/ZAR: 17.30
ZAR value: 17.30 * 54635.58 = R945195.56

Loss in investment: (945195.56/1000000)-1 = -5.48%

20 March 2019:
USD/ZAR:14.50
Dow: 25745.67
R1m @ 14.50 = USD 68965.51
USD/Dow = (68965.51/25745.67) = 2.678723 units

23 March 2020 (since 22 March is a Sunday):
Dow: 18591.93
Dow units * Dow level = 2.678723 * 18591.93 = USD 49802.63
USD/ZAR: 17.30
ZAR value: 17.30 * 49802.63 = R861585.49

Loss in investment: (861585.49/1000000)-1 = -13.84%

Now anyone with any logic or financial knowledge knows that you have to compare this with the local investment opportunity (JSE) in USD terms. A fund manager is gauged relative to some benchmark, since Magnus proposed investing offshore, the relative benchmark would be a local investment in the JSE:

20 March 2019:
USD/ZAR:14.50
JSE Top 40: 50644
USD 100000 @ 14.50 = R1,450,000
ZAR/JSE = (1450000/50644) = 28.63 units

23 March 2020 (since 22 March is a Sunday):
JSE: 34406
JSE units * JSE level = 28.63 * 34406 = R 985086.09
USD/ZAR: 17.30
USD value: 985086.09 / 17.30 = USD 56941.39

Loss in investment: (56941.39/100000)-1 = -43%

Now, I do not know whether Magnus’s funds outperformed their relative benchmarks, but based on his advice regarding investing offshore, the results speak for themselves. The JSE loss in USD terms over this period is very similar to your initial figure for some other metric but this is frightening.

I would prefer the S&P loss over this period, heck even the Dow but the JSE has been slaughtered and I sincerely hope that you’re not overly exposed to that risk.

I would have to get Brenthurst’s latest fund factsheet to compare their performance relative to their own benchmark – as that would determine whether there is any truth in their statement that their cautious approach protected investors.

If you want to simply compare investing locally (JSE) vs offshore, then YES, their approach protected investors significantly! The out-performance is 29.16% (-13.84% – (-43%)) to 37.52% (-5.48% – (-43%)).

This is significant and that is what you measure a fund manager’s performance on, relative out- or under-performance.

The closest relationship that I have to Magnus is that I follow him on Twitter, but I do know a thing or two about finance.

*For the local (JSE) investment, you can just use the change in the JSE index level over this period, no need to do any USD/ZAR conversions:

(34406/50644)-1 = -32.1%

Either way, offshore investment outperformed local investment by a long shot.

End of comments.

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