The big economic stories of the past few months have been unsettling for investors, and the uncertainty they have caused in investment markets looks set to continue.
South Africa may, for now, have avoided the disruption of a credit rating downgrade, but the Brexit vote led to a notable increase in volatility. It remains to be seen if Brexit was a only blip, or will prove to be a game-changer, but it did show that there are risks in both developed markets and emerging markets.
Brexit, market volatility, rating downgrades and emerging markets were discussed by a panel of experts at a Coreshares investment seminar held in Sandton recently.
South Africa escaped a downgrade of its sovereign credit rating in June, but the possibility of a downgrade has not gone away, because the ratings agencies will review our economy at the end of this year.
South African government debt is currently rated as investment grade by the three major ratings agencies: Standard & Poor’s, Moody’s Ratings and Fitch Ratings Company.
If a country’s debt is downgraded to speculative grade, it means that the risks are higher that its government could default on its repayment obligations. Speculative-grade is commonly called “junk” status. Debt becomes more expensive when it is rated as speculative, and foreign investors demand a higher return for the extra risk they are perceived to be taking.
A downgrade could damage the South African economy. The rand could depreciate, interest rates could rise and new investments in the economy could dry up.
Standard & Poor’s rates the sovereign debt of 130 countries. Since the mid-1970s, the ratings agency has downgraded countries’ debt from investment to speculative 21 times. Seven of those 21 countries were subsequently re-rated as investment grade, but it took them quite a few years to regain that status. Colombia, for example, took 13 years to regain an investment-grade rating, Konrad Reuss, the managing director of Standard & Poor’s in sub-Saharan Africa, said.
Bucking the trend was South Korea, which took just two years to return to investment grade. The country achieved this because it swiftly implemented the appropriate policies, Reuss said.
There are a few good things happening in South Africa, Reuss said, but more positive developments are needed to avoid an investment downgrade.
The positives are the open engagement between business, the government and organised labour, and the government’s renewed focus on small business.
The big problem, as economist Mike Schussler sees it, is the lack of growth. The South African economy contracted in the second quarter of this year, our growth outlook has been downgraded, and the global growth picture is not good.
The uncertainty in the global economy as a result of events such as Brexit will affect us in the short term, and the growth outlook for the next two to three years will get worse before there is any hint of it improving, Schussler said.
One country that didn’t escape a rating downgrade this year was the United Kingdom. Following Brexit, Standard & Poor’s downgraded the UK’s rating from AAA to AA.
The decision by the British electorate to leave the Eurozone seems to have taken markets and businesses by surprise. How the exit will happen is unknown. No real plan beyond the vote is evident, Reuss said.
Schussler said Brexit has made the risks in the developed world more apparent, and this could result in investors viewing emerging markets more positively.
The Brexit vote shows that political instability is not confined to emerging markets, Mark Mobius, the executive chairman of Templeton Emerging Markets Group, said in an investment update.
Reuss is reluctant to assume that emerging markets will benefit from the current environment, because he believes that emerging markets have their own challenges. China, for example, is no longer growing at very high levels.
Schussler divides emerging markets into two categories: those that depend on commodity exports and those that consume commodities. Lower commodity prices hurt the former but help the economies of the latter. South Africa something of a hybrid of the two.
Other than gold, commodity prices are weak, Schussler said. We might not be dependent on one commodity, but South Africa still needs commodities, he said.
Prolonged period of uncertainty
Global growth is slow, the South African economy is barely growing and has been facing headwinds for the past few years, and investment markets are volatile. There is no clarity on what will happen in the next few months.
We will have to live with a prolonged period of uncertainty, Reuss said.
Despite the turmoil in the UK, markets are not expecting a gloom-and-doom scenario, as was the case in 2008, Lesiba Mothatha, the chief economist at Investment Solutions, said at the Coreshares conference.
Mothatha is positive about emerging markets, and said that valuations (share prices relative to their potential earnings) in these markets show that shares are cheap.
Despite the immediate effect of news on financial markets, investors should take a long-term view when making decisions. In challenging times, it is important that you save, stick to your long-term goals and diversify across asset classes to reduce risk.