Lockdown and Downgrades: What does it all mean
At the beginning of the year, GIB and its asset managers were of the view that global economic activity was beginning to show signs of improvement with eased trade tensions, improved manufacturing activity and accommodative central bank policy. We all were convinced that 2020 was going to be better than 2019, especially for emerging markets.
Since then, the situation has changed dramatically and the world is busy adjusting to two shocks; a global pandemic and an oil price war. Both shocks are creating extreme volatility to the prices of major resources in response to the changes of global supply and demand.
The avoidance of a global recession balanced with the wellbeing of their citizens is the primary concern of most nation’s leaders, as global lockdowns are enforced to flatten the curve of infection rate of the COVID-19 pandemic.
Cyril Ramaphosa instituted a directive for a 21-day national lockdown to help slow the spread of the coronavirus in South Africa. The national lockdown of all non-essential businesses and services was effective from midnight 26 March and, following this unprecedented course of action, announced a two-week extension until midnight on Thursday 30 April.
GIB supports the lockdown measures taken by national government and welcomes the amended regulations which will assist in securing critical mining infrastructure and mitigate the severe impact of these measures on the lives and livelihoods of employees, host communities and suppliers.
By now all are well versed in the effects of the life altering pandemic that is COVID-19 and the severe impact it has had on financial markets.
The GIB Investment team, which has witnessed multiple crises over three decades of managing clients’ retirement savings, firmly believes in not compromising long term retirement goals during a downturn, by not participating in or encouraging irrational behaviour.
This behaviour is most prevalent when investors follow unnecessary selling trends of valuable long-term growth assets and then emotionally purchase assets that appear attractive in the short term which, unfortunately have no long term growth possibilities.
WHAT HAS HAPPENED OVER THE LAST MONTH?
Global and local equity markets initially plummeted approximately 35% (which have since shown signs of recovery). What this means is that the market believes that COVID-19 will erase over 35% of company profits.
Interest rates have fallen and extreme monetary and fiscal stimulus is being triggered globally. The South African Reserve Bank (SARB) has already cut interest rates by 2% and various Solidarity Funds have been created to assist with economic hardships.
South Africa’s largely anticipated downgrade became a reality on 27 March when Moody’s finally downgraded South Africa to sub investment grade Ba1 with a negative outlook, citing a weak economy and an unreliable power sector.
Fitch also decided to review their rating, and have lowered South Africa’s long term foreign and local currency debt rating further in to non-investment grade by one notch to BB from BB+. According to Fitch, the downgrade is a result of the lack of a clear path for government’s debt stabilisation, as well as the ensuing impact of the COVID-19 shock on public finances and economic growth.
HOW DID THE MARKET REACT TO THE DOWNGRADES?
The market’s reaction was as one would have expected, with volatility and selling by foreign investors. Having said that however, we can be encouraged by two key reactions from stakeholders that influence the direction of the market.
There was no immediate rebalancing of the FTSE World Investment Grade Bond Index at the end of March. This has provided some time for the current market volatility to settle.
The SARB has purchased bonds in the secondary market ensuring that there is sufficient liquidity to allow the market to function.
HOW WAS THE SOUTH AFRICAN BOND MARKET IMPACTED?
The SA bond market continues to be under significant pressure. Foreign bond holders have been inclined to favour liquidity, leading them to sell a number of South African bonds. This, with a worsening growth outlook and its negative impact on a strained fiscus, has led to a re-pricing of bonds.
HOW WAS THE RAND IMPACTED?
When currency markets re-opened in Asia on Monday 30 March, the effect was immediate. The rand fell to a record low, weakening beyond R18 to the USD for the first time, extending its decline this year to 22% and it has since tested the R19 level.
WHAT ARE DESTINY’S UNDERLYING LOCAL MANAGERS’ VIEWS ON THE DOWNGRADES AND THEIR WAY FORWARD?
Coronation views 10 year SAGB’s as very attractive, “we currently trade at a yield of 11.6% while we expect inflation to average close to 4% in SA over the next two years. This implies a real return of over 7%. Credit markets are very unattractive, and we would wait for a significant widening in credit spreads before allocating more capital”.
Fairtree had expected a downgrade this year and were therefore most cautious on the banking sector as their credit rating is married to SA’s sovereign rating and thus are usually the most impacted by a credit downgrade. Fairtree further noted that “we also expect further rate cuts given the potential for negative GDP figure this year, low oil and thus low inflation. Low interest rates have a negative impact on the banks and cause margin pressure and lower earnings. That is why we held an underweight position in the large 4 SA Banks starting this year and recently reduced exposure even further”.
Laurium Capital believes that government has three available options (or a combination thereof) to assist with paving the road back to investment grade:
South Africa will need to find a source of financing that is willing to lend government money at significantly lower rates (e.g.BRICs, Developmental financing institutions or the IMF).
Government will need to effect somewhat dramatic changes to the expenditure budget. This would require a significant change in the current ideology of the country’s ruling party.
Significant economic growth – this would also require greater growth-friendly policies. Moody’s made reference to structural rigidities in the labour market and the crowding out of the private sector by government.
WHAT IS THE WAY FORWARD?
On the evening of 21 April, President Ramaphosa stated “the pandemic requires an economic response that is equal to the scale of the disruption it is causing”. This economic response will be divided into three phases of which the first phase beganin mid-March when government declared the Coronavirus pandemic as a National Disaster. This included a broad range of measures for businesses, communities and individuals. We are now embarking on a second phase of government’s economic response to stabilise the economy and address the extreme decline in demand and protect jobs. He announced an unprecedented stimulus package which is a R500 billion (approximately 10% of GDP) social relief and economic support package to address the stresses placed on the South African economy as a result of the lockdown.
The relief package will address the healthcare sector requirements and will ultimately take care of the people of our nation that need it the most, in the form of various grants and tax reliefs to individuals and businesses. We all eagerly await the third phase of the economic strategy which will be implemented to drive the recovery of the economy as South Africa emerges from the pandemic.
It is in times like these that it is prudent to remain rational, act responsibly and do what is best for our clients’ capital. GIB is steadfast in its philosophy, as well as in constantly looking for opportunities to generate growth despite the panic currently being experienced in financial markets
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