It seems almost trite to say that there’s not much positive to be gleaned from Monday’s news about rating agency S&P downgrading South Africa to junk status. But I’ll try and give it a go, nonetheless…
About six months ago, most commentators seemed to be in agreement that a downgrade would in fact be inevitable when the time came for a formal review by S&P (which had been scheduled for early December 2016). Reasons for this consensus view were plentiful and compelling, with the country’s political stability appearing to be tenuous, economic growth being measly (although, crucially, not negative), several State institutions finding themselves in rather perilous condition, etc.
I am no economist, and I certainly know a lot less about the intricacies of country ratings than most of these esteemed commentators. But if there is one thing that I’ve learnt in my investment career, it is that 99% of the time, the market knows better than even the most brilliant analyst. Against this background, I was focusing simply on the rand – in my view, the single indicator which is usually the best barometer for what’s really going on in South Africa, as well as what the world thinks of the country and its prospects.
As readers will no doubt remember, the rand happened to be relatively strong throughout the second half of 2016: in fact, following the much-hyped Nenegate debacle of December 2015, the SA currency more than made back all the losses from that infamous incident. Looking at this from a distance, it therefore seemed pretty obvious to me: in aggregate, the market seemed to ‘know’ that a downgrade was in fact not going to happen – how else could one explain such relative currency strength?
Like any participant in financial markets, I’ve often been proven wrong, but for once I got the call right. We now know that S&P decided to “give South Africa a chance” and a downgrade never eventuated in December 2016. Cue celebrations and back-slapping all round; even President Jacob Zuma got in on the act as part of his most recent State of the Nation address, claiming at least some of the credit for this fortuitous outcome.
But December’s good news was not yet cold, when rumours started circulating about the minister of finance (once again) being in the line of Zuma’s fire. On this particular occasion, a lot of the smart money was on former Eskom CEO Brian Molefe being parachuted into Pravin Gordhan’s hot seat, not very long after resigning from his post at the power utility.
And yet the rand didn’t budge. On the contrary, it went on a tear, strengthening to 12.32 against the US dollar towards the end of March (a level not seen for the better part of two years). With this in mind, I was once again sceptical of all the rumours: surely the currency market appeared to ‘know’ once more that such gossip was simply malicious, and Gordhan’s position was in fact secure?
We all know what happened next, however. The market was indeed wrong on this occasion: Gordhan is now not only the ex-minister of finance, but also one of the most outspoken critics of his former colleagues in government (if you have not yet watched his full half-hour address at last weekend’s Kathrada memorial, do so – it is one of the most compelling speeches you’ll ever witness).
And then on Monday came the sudden announcement by S&P that South Africa is downgraded to junk status after all. It’s probably fair to say that we were all shocked by this news, but not really surprised about it.
What to make of the currency impact, however? At the time of writing, the rand was trading at 13.79 against the US dollar. This translates into a loss in value of some 2% since the news of the downgrade broke less than 24 hours ago, and it’s about 10% lower than a week before, when Pravin Gordhan was first recalled from his international roadshow.
Whilst no-one would paint such destruction in international purchasing power of the South African currency as good news, I will dare to ask the question: why is there such relative strength in the circumstances? Why is the rand trading so much better than it did after Zuma fired Nene 16 months ago, when it dropped as much as 15% following the news, and ended up trading at levels touching 16.80 against the US dollar? What does the market ‘know’ this time which might not be obvious to all of us?
In 2004, James Surowiecki published his famous book, ‘The wisdom of crowds: Why the many are smarter than the few and how collective wisdom shapes business, economies, societies and nations’. In a nutshell, the book illustrates how the average ‘guess’ of a large number of market participants will typically be superior to that of the vast majority of those surveyed, regardless of individual expertise.
What this really postulates, is that markets are in fact relatively efficient – most of the time, in any event. Accordingly, it’s pretty easy to lose your shirt by being contrarian and taking on the whole market by simply ‘betting’ against it:. Yes, if you happen to be George Soros, and you manage to break the Bank of England when the UK withdraws from the Exchange Rate Mechanism, it could of course make you a billionaire overnight, but for every such success story, there are probably a thousand other contrarian speculators who got cleaned out in short order. You won’t find many books about the losers, however, so most of them are not very famous a few years later… such is the nature of survivorship bias.
Bringing this back to the rand, I will ask the question once again: why is the rand so strong on Tuesday (in relative terms at least), given the magnitude of last week’s political developments and this week’s rating agency announcements? What does the market ‘know’ that we are not yet able to see?
Will Gordhan’s recent call for mass mobilisation end up being the catalyst for large-scale political upheaval? Will the National Executive Committee of the ANC bring the president to account, for once? Will Zuma and finance minister Malusi Gigaba survive? Or will we simply see the rand slip-sliding away from these levels (to paraphrase the famous song by Simon & Garfunkel)?
I guess only time will tell. But in the meantime, I will personally continue to believe and hope that the glass is in fact half full.
Deon Gouws is CIO of Credo Wealth, London