Corrupt, downgraded and soon to be junk.
11 December 2015 00:43
As a boy I loved watching cowboy movies. Today's movie-goers probably won't relate but the highlight of the week was trundling down to the Royal Bioscope in Orange Grove, Johannesburg, on a Saturday with your kuif gleaming in the early-morning sun from all the Brylcreem you had just applied.
You would arrive early, long before the trailers started, as you had a lot of comic-book swapping to do.
There you would experience your first introduction to the world of commerce: trading popular comics for one, two or even for 3 of something not so popular.
There would be chicks, of course, but at that age the more you ignored them the cooler you were considered by the peers in your Kuifie Gang.
After the comic-swapping it would be time for the movie, with the obligatory barrel of popcorn and a large Coke.
Cowboy serials were the best. They would run for weeks and every Saturday it would end at some climax: just before the bad guy shoots the good guy or runs off with the oh-so-delectable female star.
For some reason there's been a scene running through my head over the last couple of months. It goes like this: it's a runaway train. Miles ahead the railroad track goes over deep gorge but the baddies have blown up the bridge and death and destruction awaits anyone who is on that train when it goes hurtling into the deep and dark ravine.
SA the run away train
Now for the harsh reality. South Africa has become that runaway train, heading towards the bridge that has been blown up. There is no other way to describe it: under the ANC-leadership of especially Jacob Zuma South Africa is now a runaway train, with no-one in control, heading almost surely towards a destruction that awaits at the bottom of the ravine. Economically, politically, socially, SA represents a runaway train. The baddies have blown up the bridge, are busy robbing the passengers and are about to leave with their bags stuffed to the brim.
And this time, there will be no cowboy who saves the day at the last minute, bringing the train to a juddering halt barely inches before the end of the railway line.
This is real life and we are all on the train, with no train driver or conductor.
I get the impression that the average South African has become desensitised by all the bad news. As a nation nothing shocks us anymore.
Let me give you some examples. Two weeks ago Transparency International announced that South Africa has overtaken Nigeria and Ghana as the most corrupt country in Africa, if not the world. I expected this announcement to be front-page news, with talk shows on radio and debates on TV about this, but nothing, nada, zip.
It reminded me of a talk by Dr Simon Marais, the late chairman of the Allan Gray Investment Group, at the Investment Forum at Sun City, nearly three years ago. The one slide that stood out in particular was the inverse correlation between investment returns and corruption. In other words, the higher the corruption the lower the investment returns in any country.
The investment returns of virtually all investment classes, whether it be money markets, fixed deposits but especially property and listed equities, are starting to reflect this pattern.
As honest and tax-paying citizens we might think we are not affected by corruption but dear gentle reader, this is where you are wrong. South Africa as a country and therefore most of its people are getting poorer by the day. Not marginally but dramatically!
The last five years in particular have highlighted this trend. Let's take equity investment as an example. Granted, listed shares on the JSE have proven to be a good hedge against inflation but this mainly due to the fact that our listed companies, in their wisdom, have moved most of their business offshore, earning in excess of 60% of their earnings from their offshore operations. The average return of the JSE over this period was 12.8% per annum for a cumulative return of 83%. Over the same time the average annual increase in the consumer price index was 30.7%. So listed equities was a good place to be.
The commodity index, which tracks the performance of mostly local mining companies, have lost on average 5% per annum for the past five years.
But it's when you compare the rand returns of the JSE with the similar equity investments of the world, ie the World (+ 192%) Europe (+159%) and the US (+281%) over the last five years that our returns start to look not so great. In fact, they look rather pedestrian.
Offshore returns have not only been boosted by the rand weakness, as some people seem to think, but also by far better returns in US dollar terms in these markets.
An offshore investment into the SA market on the other hand has made no money over the last five years; in fact it has lost an average 2.7% per annum in US dollar terms. In contrast, the MSCI World has been growing at 7.3%, Europe 4.9% and the US 13.33% per annum respectively.
Bear in mind that over 60% of all investments in the JSE is now made and owned by foreigners in one way or another. Much of this inflow was the result of SA being included in emerging market indices and index funds, and pension funds tend to follow the investment guidelines. Imagine what could happen to the JSE – your pension and retirement investments – if SA is downgraded? You will have to look for very defensive funds to protect your investments if this were to occur.
Residential property, the other cornerstone of wealth for the average SA investor, has been on a sideways trend for seven years and is still about 20% below the peak of 2007 in real terms. So there has been very little wealth creation from that source, and yet people still fall for the buy-to-let story. Just this week I managed to get rid of one of my rental properties in Dainfern ten months after it was sold! The delays were caused by the Joburg council, the gasman, the electrician, the buyers, the council, the gasman, the council…
Looming downgrade
Last week both Fitch and S&P issued their much vaunted respective credit and currency ratings on South Africa. S&P changed the outlook from stable to negative on its particular rating (hugely important) and Fitch, the smaller of the so called Big Three Ratings Agencies, downgraded SA's country and currency rating to one above junk. Both warned, in very diplomatic terms, that SA is flirting dangerously with junk status.
Former ANC insider and Reserve Bank governor Tito Mboweni earlier this week used the expression of "a dark cloud, mist or fog is gathering upon us as a country" during a graduation speech at the Wits University, warning that any downgrade of SA as an investment destination would be a financial and social calamity. He knows, perhaps better than most, how dependent SA really is on foreign investment flows and the goodwill of foreign capital.
Could the downgrade to junk status happen? If so, when could that happen?
I think the downgrade to junk status is almost baked into the pie, as the expression goes. At the heart of any attempt, however feeble, to stick to fiscal guidelines (don't spend what you don't have) would be some attempt by Treasury to rein in government spending. Thus far government has shown no inclination to stop spending. In fact it is making promises of free education, a minimum wage for all, a national health scheme while its appetite for a hugely expensive nuclear energy generation plan shows no signs of abating.
In the meantime business and consumer confidence is at 15 year lows, corporate cash balances at record highs and for the first time in 21 years Treasury has scaled back is forecast of revenue collections, down by 0.7% of total expected revenue.
But does the average investor fully understand the consequences of an investment downgrade? Does the average investment adviser? Or fund manager?
Let me stick my neck out and make a forecast. A downgrade to junk status by two of the three major ratings agencies could wipe 20-30% off the market capitalisation of the JSE, drop the rand to R18-20 against the US dollar and force the Reserve bank to raise interest rates sharply. It might be forced into scrapping the foreign investment allowance, seeing that the outflow of foreign investments (up to R24 billion in the third quarter) is busy spiking. Also this is just a matter of time if current trends continue.
Two countries have had their credit ratings dropped to junk in recent times: Brazil and Russia. Go and have a look at what happened to their financial markets, currencies and domestic economies subsequent to the downgrades for a trailer of what could be.
To Be Continued….
*Magnus Heystek is the investment strategist for Brenthurst Wealth. He can be reached at magnus@heystek.co.za for ideas and suggestions. He is currently cycling in Mauritius.
POSTSCRIPT: This article was conceptualised and written before the shock news of president Zuma's axing of finance minister Nhlanhla Nene. In the newer version of the movie the locomotive and first coaches are already plunging into the ravine. For them it's already too late….
Source: South Africa: The runaway train
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