How should we react in these circumstances?
Most fund managers and economists argue that the downgrade is already priced into the market. This is perhaps best illustrated by the fact that our 10 year bonds already pay a higher interest rate than Brazil or Mexico, both of which have already been downgraded to junk status.
The Brazil example is interesting. They were in a pre-downgrade situation similar to ours in early 2015. When the downgrade eventually happened, their bond rates and exchange rate both improved. So it may be that we are currently seeing a worst case scenario in our markets.
What South Africa is facing is a potential debt trap, where Government borrowings increase to unsustainable levels. Government debt was 26% of GDP in 2009, is currently 61% and a predicted 70% in the next 3 years. This means that Government interest costs have increased, and are consuming increasingly more of the budget, without economic growth to provide relief by way of increased tax revenue.
So, here is the investment conundrum:
- Developed market interest rates are at record lows, at levels which are unsustainable over the long term. US 10 year bond yields (until recently) have not been lower in the past 100 years. Much of Europe and Japan have negative bond yields. In other words, you pay the government to lend them your
- The growth in global market prices has really been a US game over the past 10 years, their longest sustained growth period in history. US share market prices currently are the most expensive they have been in history except for 1929 and
- Economic growth is expected to moderate for most major developed countries, which, together with increasing interest rates, could have the effect of putting pressure on share and bond
- Our local market has been flatlining for 5 years and our share prices are the cheapest they have been for a long time, with 80% of shares trading more than 20% below previous high
Forecasting the future is largely a futile exercise, exemplified by a 7% rise in the JSE in the past month, and an improvement in the exchange rate of 4% over the same period, in spite of a weakening of 4% after the Moody’s announcement.
You are best served by staying true to your long term strategy, which will include asset class allocation as well as local vs offshore allocation to deliver your long term objectives. Trying to navigate the noise of a downgrade over the short term runs the risk of producing an unsatisfactory answer.