What happens to the stock market and currency when there is a downgrade?

 

With a South African credit rating downgrade widely expected later in the year, what can we learn from other countries that have been downgraded in the past?

 

In the past 20 years, numerous other countries have been downgraded to below investment grade, including Brazil, Russia, Bulgaria, Hungary, Romania, Greece and South Korea.

 

We know that bond yields will likely rise, reducing the capital value, but what could happen to our stock market and our currency?

 

Below are the 7 countries’ stock markets in the 12 months before they were downgraded and the 12 months following the downgrade.

Nov2

 

The majority of these country’s currencies declined leading up to the downgrade. In the 12 months following this, some countries showed amazing returns from their markets (Brazil up 51% and S Korea up more than 70%), while others struggled.

 

The JSE has had a positive year, largely due to a handful of stocks. Our market is heavily weighted towards companies with earnings from offshore, so it is not clear how our market could react. It does seem unlikely though, that a downgrade of the SA government debt would have much of an impact on the prices of many of the global companies listed on our market.

 

Next we look at the currencies of these countries and how they reacted.

Nov1

 

With a South African credit rating downgrade widely expected later in the year, what can we learn from other countries that have been downgraded in the past?

 

Here there is a much clearer pattern. the currency seems to weaken up to the downgrade (as the Rand has done recently), but then strengthen in the first 3 months, while some continue to strengthen for longer.

 

As each country has its own circumstances and reasons for being downgraded, predicting the impact is particularly difficult.

 

While there is sure to be some volatility around the time of the announcement, we do however believe that the market and currency have largely priced in the news of the downgrade.