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)
2
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.
3
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
4
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.
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