Prepare for volatility after S&P downgrade

Cape Town - Investors in South Africa should brace themselves for more volatility following the Standard & Poor’s downgrade of SA's foreign currency debt to "junk status" and expect the rand, SA banking shares and bond yields, among others, to remain under pressure.
Gavin Smith, head of Africa at financial advisory group deVere Acuma, said the downgrade effectively means there is a higher risk that SA will not be able to repay its debts, which results in it paying a higher premium to borrow money.
“Looking at the experience of other countries in similar situations, a downgrade to non-investment grade triggers an increase in the cost of credit which, in turn, creates a number of challenges including currency devaluation and rising inflation and interest rates,” he said.
“Investors should remember, however, that the rating relates to SA’s foreign debt only, and this has largely been factored into the market for some time now, and therefore we do not expect significant short term effects.”
However, in his view, one can expect to see foreign investors reduce their exposure to South African markets, which could result in a sell-off in the SA equity and bond markets, putting prices and yields under pressure.
“The longer term effects will depend largely on how government reacts to the downgrade. Governments that have reacted swiftly - with the implementation of austerity measures, fiscal discipline and a growth strategy - have been able to regain an investment grade, but this is never reversed quickly,” said Smith.
He is advising investors to ensure there is enough diversification in their investment portfolios, both in terms of geographies and asset classes.
“We want to emphasise that investors should not react emotionally to the downgrade, as history has shown - even in situations like this - that a long term strategy linked to the levels of risk and outcome that investors aim for still remains the best investment strategy,” said Smith.
However, he added that the downgrade should give investors cause to reflect on whether their strategy is still appropriate.

“If investors feel it is time to take less risk, they should speak to their financial adviser about plotting a robust and workable strategy going forward,” he said.
"While the market is so volatile, this is not the time to make big changes to portfolios and convert to cash, for example, as timing market fluctuations is always difficult, especially in more volatile conditions."
Events like this reiterate the importance of getting good independent advice, the value of portfolio diversification and the avoidance of home bias, in his view.
“While we believe SA continues to offer good investment opportunities, the downgrade emphasises the inherent risks of having a home bias and the need to diversify to hedge against local risks," he concluded.

According to Richard Beddow, CEO of ForexPeople, the rand movements are shadowing the see-sawing nature of the political drama that has been playing out since last Monday.

Daily moves of 30c to 40c to the dollar have become the norm. For instance, on Tuesday it opened at R13.90 closed at R13.50 and headed back into the R13.80s by midday Wednesday.
"We don’t see the decisive end to the political turmoil that many are hoping for and as a result, ongoing uncertainty through to the ANC Conference in December is going to make this sort of volatility standard," said Beddow.

"The reaction that we have seen is that there has been a significant increase in the number of SA resident individuals utilising their annual foreign investment allowances to move funds offshore or into local FX-denominated accounts."

He said this may be in anticipation of the rand weakening to levels over R14 and R15 to the dollar as seen last year, but there is also a wariness that the SA Reserve Bank (SARB) may come under pressure from the new Treasury to review the annual individual investment allowances.

"Our corporate clients, whether importers or exporters, are hedging more than usual to insulate their businesses from the stormy days, weeks and months ahead," said Beddow.

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