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Nov 27, 2017 - South African government bonds will remain part of the Citigroup World. Government Bond Index (WGBI), but
INVESTMENT NOTE 27 NOVEMBER 2017

SAFE FOR NOW, BUT RATINGS RISK REMAINS DAVE MOHR & IZAK ODENDAAL, OLD MUTUAL MULTI-MANAGERS

27 NOVEMBER 2017

WEALTH INTELLIGENCE WEEKLY INVESTMENT NOTE

into the WGBI. Moody’s will wait to see whether Government announces credible fiscal consolidation measures and economic reforms in the February budget. Failure to do so will lead to a downgrade.

SAFE FOR NOW, BUT RATINGS RISK REMAINS

WHAT ARE THE IMPLICATIONS? The rand briefly lost around 2% against the dollar after the announcement, but the overall market impact of the downgrades was limited as markets respond to the factors that give rise to ratings changes – the growth and fiscal outlook – long before the ratings agencies do. Much of the bad news, including the downgrades, have been priced in. In terms of the local economy, the main impact is negative sentiment. There has been an unusually high level of attention given to what used to be a fairly arcane corner of finance and South Africans have spent the better part of the past two years worrying when the sword will drop (and we will have to wait a few months more). There is no doubt that this has damaged

After a round of credit ratings reviews by the three major ratings agencies,

business and consumer confidence. But the downgrades have also

South African government bonds will remain part of the Citigroup World

played a role in keeping interest rates higher than they need to be.

Government Bond Index (WGBI), but only just. The immediate risk of forced selling as a result of being excluded from this index has therefore

RATES UNCHANGED

abated for the time being. While each of the agencies has its own

Ahead of the ratings reviews, the Reserve Bank’s Monetary Policy

specific methodology for assessing creditworthiness, the common thread

Committee (MPC) kept the repo rate on hold as widely expected.

through all three reviews is that economic growth is too low, leading to

The Reserve Bank has also for long been concerned that potential capital

pressure on Government’s finances, worsened by underperforming State

outflows due to downgrades could cause a sell-off in the rand. The firmer

Owned Enterprises (SOEs).

global oil price has also emerged as a factor that will not only raise the

Fitch kicked off the much anticipated (or dreaded) round of ratings reviews

domestic inflation profile somewhat, but could also lift global inflation, prompting faster interest rate increases in other countries, in turn causing

by maintaining South Africa’s BB+ rating with a stable outlook. Fitch noted that while the fiscal outlook weakened, the ship could be steadied

capital to leave South Africa.

after the ANC’s elective conference. Failure to implement credible fiscal

The Reserve Bank lifted its inflation forecast somewhat, but the extent of

consolidation measures in February’s Budget could see the outlook

the increases is limited by conservative assumptions on electricity tariff

changed to negative. To change the outlook to positive, the first step

increases and global oil prices. Inflation is expected to remain below,

to regaining investment grade status requires improving governance

but close to the 6% upper end of the target range throughout 2018 and

(including of SOEs), reducing the budget deficit and, crucially, accelerating

average 5.5% in 2019.

economic growth.

Headline consumer inflation fell to 4.8% year-on-year in October from

DEEPER INTO JUNK STATUS

5.1% in September. Food inflation has moderated to 5.3% from 11%

S&P Global Ratings were not so kind, cutting both South Africa’s local

at the start of the year. Petrol inflation was 10.8% in October. It will dip

and foreign currency ratings by one notch. It means the local rating

to around 8% in November due to base effects, but because of the

drops to BB+ and is no longer investment grade, as expected.

current average under-recovery of 70 cents per litre, petrol inflation could

The foreign rating downgrade was unexpected, and places South Africa

rise to 15% in December.

on par with Turkey and Brazil at BB, two notches into so-called junk status. Importantly though, S&P has a stable outlook on both local and

CORE INFLATION AT FIVE-YEAR LOW

foreign currency ratings, implying that the worst is over. Unless there

Core inflation – excluding food and fuel prices – fell to 4.5%, the lowest

is a further substantial deterioration in governance, debt metrics or growth,

level in five years. Over this five year-period, core inflation did not exceed

there is no need for further downgrades as the rating already reflects

6%.The big swings in headline inflation over this period were mainly

the current reality.

caused by food and oil price volatility, worsened by the big fluctuations

MOODY’S ON HOLD

in the exchange rate. But the fairly steady path of core inflation indicates a lack of underlying inflationary pressures, partly because of a weak

Moody’s decision was therefore key. Moody’s placed South Africa’s

economy.

rating on negative watch, which means the next move is a downgrade. But the rating for both local and foreign currency bonds remains investment

The other notable driver of inflation over the past five years has been

grade at Baa3, and therefore the local bonds still qualify for inclusion

electricity tariffs, rising on average 8% (13% over the past ten years)

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WEALTH INTELLIGENCE WEEKLY INVESTMENT NOTE

TABLE 1:

although the pace of increase has slowed to 2.2%. But electricity tariffs are not linked to domestic demand, and firms and consumers have very

SOUTH AFRICA’S LOCAL SOVEREIGN CURRENCY RATINGS

few other options. It can therefore be considered to be closer to a tax than a price increase. What the SARB is concerned about is whether there are second-round effects of firms hiking their output prices in response to higher tariffs. There is little evidence of this. Nersa is expected to make

S&P Global

Local Currency Outlook Rating

Investment grade

BB+

No

Stable

an announcement on Eskom’s application for a 20% tariff increase

Moody’s

Baa3

Negative watch

Yes

in early December.

Fitch

BB+

Stable

No Source: Ratings agencies

The Reserve Bank’s view of economic growth is “subdued but positive”. The 2017 GDP growth forecast was bumped up a touch from 0.6% to 0.7%. From this depressed level, real growth is expected to almost

CHART 1:

double to 1.2% next year and 1.5% in 2019. These numbers are similar

CONSUMER INFLATION AND THE REPO RATE, %

to the three ratings agencies’ forecasts. The SARB’s composite leading indicator increased further in September, confirming that growth is picking

7.5

up moderately.

Repo rate

Headline consumer inflation

Core inflation

7

For the first time, the Reserve Bank also published a forecast of interest

6.5

rates, generated by its economic model. It suggests three 25 basis points

6

increases in the next two years. Importantly, this is what the forecast

5.5

model suggests the MPC should do, not what the MPC plans on doing

5

or believes it should do. Interest rate decisions are based on incoming

4.5

data and therefore the MPC meets every two months to assess the latest

4

numbers and how they impact the outlook. However, the general public

3.5

is unlikely to understand this distinction, and likely to believe that the

3 Nov 12

May 13

Nov 13

May 14

Nov 14

May 15

Nov 15

May 16

SARB is signalling higher rates, and adjust behaviour accordingly.

Nov 16

May 17

Nov 17

Source: Datastream

This could achieve the aim of higher interest rates, without having to actually hike rates. But unfortunately it does mean that rate cuts are all

CHART 2:

but ruled out, despite inflation expected to be within the target range over the next few years.

SA RESERVE BANK COMPOSITE LEADING ECONOMIC INDICATOR INDEX

THE KINDNESS OF STRANGERS Given our domestic frailties, South Africa continues to rely on the kindness

101

of strangers. Strong global growth could help lift our own growth rate above the anaemic levels currently predicted. Crucially, demand for high

99

yielding emerging market assets still outweighs domestic factors such as 97

politics, fiscal risks and downgrades. Within our peer group, South Africa has gone from one of the best-rated to the worst-rated in terms

95

of the spread (extra yield) investors demand over US bonds. But as long as this demand persists – which in turn will depend greatly on the path

93

of interest rate hikes in the US, global growth, and investor risk appetite - South Africa should benefit from capital inflows, irrespective of its rating.

91 Nov 12

RESPONDING TO DOWNGRADES

Jul 13

Mar 14

Nov 14

Jul 15

Mar 16

Nov 16

Jul 17

Source: Datastream

The muted market response to the downgrade reiterates that investors should not over-react to negative news headlines. Often, as is the case with the ratings changes too, the bad news is already reflected in market prices. On Monday morning following the weekend’s ratings announcements, bond yields were lower and the rand had strengthened. Investors’ longterm returns often suffer greater damage from knee-jerk responses to such events, than from the events themselves. However, if there were to be further negative surprises, one would expect the rand to come under pressure. Our strategies currently have more than 50% exposure to randhedges directly and indirectly and should benefit from currency weakness.

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27 NOVEMBER 2017

WEALTH INTELLIGENCE WEEKLY INVESTMENT NOTE

EQUITIES - GLOBAL DESCRIPTION

INDEX

WEEK

MONTH-TO-DATE

YEAR-TO-DATE

1 YEAR

Global

MSCI World

US$

2 053.0

0.98%

0.79%

17.25%

19.85%

United States

S&P 500

US$

2 602.0

0.77%

1.05%

16.21%

18.00%

Europe

MSCI Europe

US$

1 761.0

1.32%

-0.51%

19.71%

26.51%

Britain

FTSE 100

US$

9 881.0

1.35%

-0.77%

12.13%

16.21%

Germany

DAX

US$

1 450.0

2.04%

1.54%

19.33%

40.91%

Japan

Nikkei 225

US$

203.0

1.82%

4.78%

20.44%

25.80%

Emerging Markets

MSCI Emerging Markets

US$

1 152.0

1.41%

2.95%

33.64%

35.21%

Brazil

MSCI Brazil

US$

2 038.0

2.62%

1.34%

21.89%

23.52%

China

MSCI China

US$

90.3

1.62%

5.61%

54.22%

49.59%

India

MSCI India

US$

587.8

1.33%

0.13%

31.49%

36.69%

South Africa

MSCI South Africa

US$

544.0

0.93%

6.46%

19.82%

26.51%

CURRENCY INDEX VALUE

EQUITIES - SOUTH AFRICA (TR UNLESS INDICATED OTHERWISE) DESCRIPTION

INDEX

WEEK

MONTH-TO-DATE

YEAR-TO-DATE

1 YEAR

All Share (Capital Only)

All Share (Capital Index)

Rand

60 324.0

0.33%

2.28%

19.09%

19.31%

All Share

All Share (Total Return)

Rand

8 551.0

0.33%

2.32%

22.40%

22.86%

TOP 40/Large Caps

Top 40

Rand

7 645.0

0.17%

2.74%

26.32%

26.03%

Mid Caps

Mid Cap

Rand

15 937.0

1.78%

0.61%

0.80%

4.72%

Small Companies

Small Cap

Rand

19 947.0

-0.65%

-4.15%

-2.31%

0.17%

Resources

Resource 20

Rand

2 417.0

2.87%

3.01%

23.45%

16.39%

Industrials

Industrial 25

Rand

16 047.0

-0.57%

2.78%

33.14%

34.92%

Financials

Financial 15

Rand

8 639.0

0.48%

3.45%

10.70%

14.53%

Listed Property

SA Listed Property

Rand

2 312.4

-1.96%

-0.33%

9.96%

16.55%

WEEK

MONTH-TO-DATE

YEAR-TO-DATE

1 YEAR

0.95%

1.24%

8.64%

6.73%

WEEK

MONTH-TO-DATE

YEAR-TO-DATE

1 YEAR 6.04%

CURRENCY INDEX VALUE

FIXED INTEREST - GLOBAL DESCRIPTION

INDEX

Global Government Bonds

Citi Group WGBI

CURRENCY INDEX VALUE US$

946.5

FIXED INTEREST - SOUTH AFRICA DESCRIPTION

INDEX

All Bond

BESA ALBI

Rand

556.2

0.29%

-1.02%

4.29%

Government Bonds

BESA GOVI

Rand

554.5

0.28%

-1.04%

4.38%

6.15%

Corporate Bonds

SB JSE Credit Indices

Rand

124.4

-6.28%

-6.33%

-13.93%

-19.87%

CURRENCY INDEX VALUE

Inflation Linked Bonds

BESA CILI

Rand

239.6

-0.98%

-3.51%

-2.47%

-3.30%

Cash

STEFI Composite

Rand

380.4

0.14%

0.47%

6.79%

7.57%

COMMODITIES DESCRIPTION

INDEX

WEEK

MONTH-TO-DATE

YEAR-TO-DATE

1 YEAR

Brent Crude Oil

Brent Crude ICE

US$

63.9

1.82%

4.69%

12.04%

30.33%

Gold

Gold Spot

US$

1 288.0

-0.46%

1.34%

11.90%

8.78%

Platinum

Platinum Spot

US$

943.0

-1.15%

2.39%

4.43%

2.95%

CURRENCY INDEX VALUE

CURRENCIES DESCRIPTION

INDEX

WEEK

MONTH-TO-DATE

YEAR-TO-DATE

1 YEAR

ZAR/Dollar

ZAR/USD

Rand

14.13

-1.05%

-0.07%

-3.10%

-0.06%

ZAR/Pound

ZAR/GBP

Rand

18.85

-2.07%

-0.42%

-11.41%

-6.74%

ZAR/Euro

ZAR/EUR

Rand

16.88

-1.29%

-2.47%

-14.44%

-11.66%

CURRENCY INDEX VALUE

Dollar/Euro

USD/EUR

US$

1.19

-0.84%

-2.10%

-11.60%

-10.92%

Dollar/Pound

USD/GBP

US$

1.33

-0.95%

-0.27%

-7.77%

-6.27%

Dollar/Yen

USD/JPY

US$

0.01

-1.11%

-2.22%

-4.44%

-2.22%

Source: I-Net, figures as at 24 November 2017

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27 NOVEMBER 2017

WEALTH INTELLIGENCE WEEKLY INVESTMENT NOTE

THE WEEK AHEAD SOUTH AFRICA •

Trade balance



Credit growth



Government revenue and spending



Producer inflation



New vehicle sales



Absa manufacturing purchasing managers’ index

US •

New home sales



House prices



Personal income and spending



Personal consumption inflation



ISM manufacturing index



Car sales

EUROPE •

Eurozone money supply and credit growth



Eurozone consumer and business confidence

JAPAN •

Inflation



Household spending

The Old Mutual Wealth Investment Note is published on a weekly basis to keep our clients and financial planners informed of what is happening in financial markets and the economy and to share our insights. Markets are often very volatile in the short term and similarly, economic data releases or central bank actions may cause concerns for investors. This does not mean that investors should take action based on the most recent events. It is better to be disciplined and remain invested in well-diversified portfolios that are designed to achieve long-term objectives. Our Strategy Funds are actively managed, with asset allocation changes based on valuations and in anticipation of future real returns, and not in response to the most recent market noise. The future is always uncertain and that is why our Strategy Funds are diversified and managed with a long-term focus.

Old Mutual Wealth is brought to you through several authorised Financial Services Providers in the Old Mutual Group who make up the elite service offering. This document is for information purposes only and does not constitute financial advice in any way or form. It is important to consult a financial planner to receive financial advice before acting on any information contained herein. Old Mutual Wealth and its directors, officers and employees shall not be responsible and disclaims all liability for any loss, damage (whether direct, indirect, special or consequential) and/or expense of any nature whatsoever, which may be suffered as a result of or which may be attributable, directly or indirectly, to the use of, or reliance upon any information contained in this document. 5