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South Africa: The runaway train

Corrupt, downgraded and soon to be junk.

As a boy I loved watching cowboy movies. Today’s movie-goers probably won’t relate but the highlight of the week was trundling down to the Royal Bioscope in Orange Grove, Johannesburg, on a Saturday with your kuif gleaming in the early-morning sun from all the Brylcreem you had just applied.

You would arrive early, long before the trailers started, as you had a lot of comic-book swapping to do.

There you would experience your first introduction to the world of commerce: trading popular comics for one, two or even for 3 of something not so popular. 

There would be chicks, of course, but at that age the more you ignored them the cooler you were considered by the peers in your Kuifie Gang.

After the comic-swapping it would be time for the movie, with the obligatory barrel of popcorn and a large Coke. 

Cowboy serials were the best. They would run for weeks and every Saturday it would end at some climax: just before the bad guy shoots the good guy or runs off with the oh-so-delectable female star. 

For some reason there’s been a scene running through my head over the last couple of months. It goes like this: it’s a runaway train. Miles ahead the railroad track goes over deep gorge but the baddies have blown up the bridge and death and destruction awaits anyone who is on that train when it goes hurtling into the deep and dark ravine.

SA the run away train

Now for the harsh reality. South Africa has become that runaway train, heading towards the bridge that has been blown up. There is no other way to describe it: under the ANC-leadership of especially Jacob Zuma South Africa is now a runaway train, with no-one in control, heading almost surely towards a destruction that awaits at the bottom of the ravine. Economically, politically, socially, SA represents a runaway train. The baddies have blown up the bridge, are busy robbing the passengers and are about to leave with their bags stuffed to the brim.

And this time, there will be no cowboy who saves the day at the last minute, bringing the train to a juddering halt barely inches before the end of the railway line.

This is real life and we are all on the train, with no train driver or conductor.

I get the impression that the average South African has become desensitised by all the bad news. As a nation nothing shocks us anymore.

Let me give you some examples. Two weeks ago Transparency International announced that South Africa has overtaken Nigeria and Ghana as the most corrupt country in Africa, if not the world. I expected this announcement to be front-page news, with talk shows on radio and debates on TV about this, but nothing, nada, zip.

It reminded me of a talk by Dr Simon Marais, the late chairman of the Allan Gray Investment Group, at the Investment Forum at Sun City, nearly three years ago. The one slide that stood out in particular was the inverse correlation between investment returns and corruption. In other words, the higher the corruption the lower the investment returns in any country.

The investment returns of virtually all investment classes, whether it be money markets, fixed deposits but especially property and listed equities, are starting to reflect this pattern.

As honest and tax-paying citizens we might think we are not affected by corruption but dear gentle reader, this is where you are wrong. South Africa as a country and therefore most of its people are getting poorer by the day. Not marginally but dramatically!

The last five years in particular have highlighted this trend. Let’s take equity investment as an example. Granted, listed shares on the JSE have proven to be a good hedge against inflation but this mainly due to the fact that our listed companies, in their wisdom, have moved most of their business offshore, earning in excess of 60% of their earnings from their offshore operations. The average return of the JSE over this period was 12.8% per annum for a cumulative return of 83%. Over the same time the average annual increase in the consumer price index was 30.7%. So listed equities was a good place to be.

The commodity index, which tracks the performance of mostly local mining companies, have lost on average 5% per annum for the past five years.

But it’s when you compare the rand returns of the JSE with the similar equity investments of the world, ie the World (+ 192%) Europe (+159%) and the US (+281%) over the last five years that our returns start to look not so great. In fact, they look rather pedestrian.

Offshore returns have not only been boosted by the rand weakness, as some people seem to think, but also by far better returns in US dollar terms in these markets.

An offshore investment into the SA market on the other hand has made no money over the last five years; in fact it has lost an average 2.7% per annum in US dollar terms. In contrast, the MSCI World has been growing at 7.3%, Europe 4.9% and the US 13.33% per annum respectively.

Bear in mind that over 60% of all investments in the JSE is now made and owned by foreigners in one way or another. Much of this inflow was the result of SA being included in emerging market indices and index funds, and pension funds tend to follow the investment guidelines. Imagine what could happen to the JSE – your pension and retirement investments – if SA is downgraded? You will have to look for very defensive funds to protect your investments if this were to occur.

Residential property, the other cornerstone of wealth for the average SA investor, has been on a sideways trend for seven years and is still about 20% below the peak of 2007 in real terms. So there has been very little wealth creation from that source, and yet people still fall for the buy-to-let story. Just this week I managed to get rid of one of my rental properties in Dainfern ten months after it was sold! The delays were caused by the Joburg council, the gasman, the electrician, the buyers, the council, the gasman, the council…

Looming downgrade

Last week both Fitch and S&P issued their much vaunted respective credit and currency ratings on South Africa. S&P changed the outlook from stable to negative on its particular rating (hugely important) and Fitch, the smaller of the so called Big Three Ratings Agencies, downgraded SA’s country and currency rating to one above junk. Both warned, in very diplomatic terms, that SA is flirting dangerously with junk status.

Former ANC insider and Reserve Bank governor Tito Mboweni earlier this week used the expression of “a dark cloud, mist or fog is gathering upon us as a country” during a graduation speech at the Wits University, warning that any downgrade of SA as an investment destination would be a financial and social calamity. He knows, perhaps better than most, how dependent SA really is on foreign investment flows and the goodwill of foreign capital.

Could the downgrade to junk status happen? If so, when could that happen?

I think the downgrade to junk status is almost baked into the pie, as the expression goes. At the heart of any attempt, however feeble, to stick to fiscal guidelines (don’t spend what you don’t have) would be some attempt by Treasury to rein in government spending. Thus far government has shown no inclination to stop spending. In fact it is making promises of free education, a minimum wage for all, a national health scheme while its appetite for a hugely expensive nuclear energy generation plan shows no signs of abating.

In the meantime business and consumer confidence is at 15 year lows, corporate cash balances at record highs and for the first time in 21 years Treasury has scaled back is forecast of revenue collections, down by 0.7% of total expected revenue. 

But does the average investor fully understand the consequences of an investment downgrade? Does the average investment adviser? Or fund manager?

Let me stick my neck out and make a forecast. A downgrade to junk status by two of the three major ratings agencies could wipe 20-30% off the market capitalisation of the JSE, drop the rand to R18-20 against the US dollar and force the Reserve bank to raise interest rates sharply. It might be forced into scrapping the foreign investment allowance, seeing that the outflow of foreign investments (up to R24 billion in the third quarter) is busy spiking. Also this is just a matter of time if current trends continue.

Two countries have had their credit ratings dropped to junk in recent times: Brazil and Russia. Go and have a look at what happened to their financial markets, currencies and domestic economies subsequent to the downgrades for a trailer of what could be.

To Be Continued….

*Magnus Heystek is the investment strategist for Brenthurst Wealth. He can be reached at magnus@heystek.co.za for ideas and suggestions. He is currently cycling in Mauritius.

 

POSTSCRIPT: This article was conceptualised and written before the shock news of president Zuma’s axing of finance minister Nhlanhla Nene. In the newer version of the movie the locomotive and first coaches are already plunging into the ravine. For them it’s already too late….

COMMENTS   26

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while I agree with everything that magnus says, I just find it amazing that commentators can be so sanguine about the “fiscal cliff” that is about to befall the country. accepting that further downgrades, interest rate increases, capital controls, further unemployment WILL be happening – what SHOULD be at the forefront is the protests and social unrest that will be playing out on your streets – day in day out – and as days follows night – the EFF and its fellow travellers will be making full use of these issues. so what should be the discussion is SURVIVAL – keeping you and your family out of trouble – but there is no discussion about this. just on-going talk abt what the govt shld be doing. well ladies and gentlemen – they won’t!

SA-the runaway train, planes, transport…the runaway everything.

Anyone out there who still thinks SA has a good future????? I doubt it. And remember all this time how many South Africans had to be persuaded to send some cash offshore. Frogs in the boiling pot – you are all going to die sad to say.

interesting perspective .. But what’s the point ?
If I earn rands , spend rands and invest in rands and my business is in a
“need to have ” space with a customer base that likes what I do and keeps coming back , then what’s the issue ??

My properties give me an income.
My business makes good money. And my accountant makes sure I pay almost no tax …all legal …
All that matters is my families prosperity and safety ..
We have private security …
There you go …
I’d rather live here than in Europe or , U.S. Right now

An unworthy thought comes unbidden into my head: wasn’t this destruction of SA by a bunch of ignorant and corrupt failed experiments exactly what apartheid was created to prevent? How could I even think such a thing? I probably need help…

On the other hand my doubtlessly more rational persona tells me that I should either use my UK passport now, or wait a while in the forlorn hope that the Cape will eventually secede. The one will only save me and my family; the other what remains of South Africa.

@pistov – you sir, like me, need to be careful of being smug. At least in our case we left Sa almost 30 yrs ago, have a house in Sydney, my own boutique accounting practice & earning more money than I ever have. You sir – all you have is a uk passport which entitles you to enter the uk – and that’s all. Plus you will need to live with a climate where for 8 months of the year you Don’t see the sun and if you do there is no warmth. We also have UK passports but after living there for 2 years we decided to stay in the southern hemisphere!

The twerp in Oz says you should be careful of being smug. I have never heard of such a smug person as him. He must bore the pants off his family and friends (if he has any, that is). Am I trying to rile Bobby? Yep, you bet I am.

The passengers in the last carriage of the runaway train will not miraculously be spared if the locomotive and first carriages go over the edge.

@Nathan. Don’t be a Dodo and ignore the horizon.

Just as easy as it was to replace Nene, that is how easy your properties can be seized by the state to “demystify “or balance whatever they seem fit.

Nathan, you seem to miss the obvious point that all your customers may not be in a similar position to you, which means their spending power will be dramatically eroded meaning that they will not be able to buy your product or service in the same quantity, meaning your income is eroded and you will no longer be able to afford that private security to secure your family’s safety and their prosperity takes a massive knock as well.

No man is an island and the hit on SA is a hit on you.

That same logic was applied in Cuba, Zimbabwe , Venezuela by way of example and look where that got them. When your currency is worth zilch you will have no security, prosperity or safety. I can only assume your remark was tongue-in-cheek, if not, you are info a rather rude surprise.

Do the ratings agencies re-evaluate their positions at set intervals or is it done on an ad hoc basis? If the former, when is the next assessment due?

There is no train. The train ordered was too tall at a cost of billions of rands and all of the tracks have been stolen by thieves.

The un/fortunate (which ever side of the spectrum you are) issue here is that a fair majority of the population did not grow up with bioscope movies, popocorn and a coke and therefore will always live in a “better South Africa”. Those people will always view the SA of today as better than the past, and will always show loyalty to those who brought them “out of darkness”. Essentially those in power will remain in power, at least for the next 4 years. It is up to each individual to brace for the fall or jump out the train and deal with the consequences. Either way it is not good to be South African today…

Which ANC leader is going to stand up again Zuma and save our nation and our economy before its too late? PLEASE BE A HERO !!!

“As honest and tax-paying citizens we might think we are not affected by corruption…”

Huh ? Really ? Who in their right mind thinks that ?
How condescending of you Magnus.

But this country, is in the hands of delinquent gangsters, determined to reap the rewards of their armed-struggle hard work and sacrifices made in overcoming Apartheid.
“Gentle reader” I cannot comprehend why the media isn’t reporting on Zuma’s speech after the main speech on Wednesday, because that was Zuma as open, direct, frank, ruthless and real as you will ever ever ever see.
In short, he ranted on and on about how Africans had forgotten where they come from and that this democracy was achieved through painful sacrifices, lives lost etc…, insinuating, as the gist of his statements that, therefore, him and his gang are entitled to help themselves to all they can as a reward for the agony and pain they went through, he will not be deterred, and any potential obstacle will be dealt with accordingly.

So we are all screwed, everyone, irrespective of race.

Show me where in the world a person with your qualifications is as wealthy as you! Stop bleating! Leave if it’s so gloomy. Problem is you can’t, because your still milking it here! With the safety of a house in Mauritius etc etc.

At Magnus…I just need some confirmation from you on this.

A while ago the credit act was amended so that once total debt cannot exceed 2x the principal amount?
Now let’s say the rand deteriorates to R1M to a USD (not impossible as it happened in Zim). If I bought a house for R1M via the bank and with increasing interest rates the amount due is capped at R2M (twice the principal)…could we then end up in a situation where the amount outstanding on our homeloans is less than the price of a loaf of bread!

If so, I can imagine the banks must be terrified of this scenario. The consumers will be happy 🙂

Whatever happens, earning hard currency is always important, as is diversifying globally for investments. Offshore earnings gets to buy us twice as much security as before, so live and work like an expat…

and lastly, Warren Buffet’s quotes on fear and greed come to mind…

So now I am almost a billionaire but in Rands thanks to transferring a little money overseas. No investment skill required just filling in the SARS forms for years and years for the entire family. All legal. Of course a billion rand is worth pretty little so maybe I will soon be a trillionnaire and be able to buy a box of matches with a few million rand. Dreadful totally broken dysfunctional wrecked country.

Could all the Hyestek critics now please reveal themselves once more. The Rand is mo@r toe , what now?

I think you will find here that there are a lot of people who could thank Magnus for banging on about offshore investment. So obvious but doggedly rejected by die-hard patriots. Heads out of the sand now – game over!

What a negative article. This guy needs to go live overseas for a couple of years so he will realize that South Africa is not the only country that has issues. As for the rand, all emerging markets are currently experiencing downward pressure on their currencies, not just South Africa.

Interesting points Magnus.

Couple this with the fact that the market cap of the JSE is less than 1% (and dropping) of the market cap of all the world’s stock markets put together, it is clear that one had to be sensible and hold a reasonably diversified portfolio even in the best of times.

Unless of course we know no better than the MTNs, Sasols, ABILs, Lonmin etc….

Mr H may have a point,but I wouldn’t rely on his financial advice; it left us having to work instead of retiring. You can make a small fortune by following his advice, but only if you’ve invested a large one!

End of comments.

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