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With the recent release of the Public Protector’s report on state capture and a looming downgrade to junk by Standard & Poor’s (S&P), it’s gloomy right now in South Africa. But is it the end of the world?
The short answer is that this is ‘Certainly not’. In fact, we may be at the start of a recovery in our local market and our currency and we have some evidence to support the theory – Brazil.
But first it is important to understand that markets tend to price in the future. The impending downgrade to junk and state capture are not events that just appeared out of nowhere – they have been brewing for a while. All investors have had them on their radar for a year or more, so they have been positioning their portfolios accordingly and as such the news is being priced in.
Wayne McCurrie, fund manager at Ashburton Investments, tweeted: “The credit default swap spread for SA bonds is higher than six countries that are junk status. So a downgrade already in price.”
Back to Brazil. S&P downgraded the country to junk status in September last year, with Fitch and Moody’s doing the same in December and February respectively. The Brazil São Paulo Stock Exchange Index (IBOV) was trading at just over 43 000 on the last trading day of 2015. It is now trading up at almost 65 000. Although to be fair, it was almost 70 000 just before and again after the 2008/9 financial crisis, whereas our local market is only just below the all-time highs.
Brazil’s parliament also voted to impeach president Dilma Rousseff at the end of August for illegally manipulating government accounts and back then the IBOV was trading at around 58 000.
So despite all that bad news, the market has had one of its best years ever.
Turning to the Brazilian currency, the real: it started the year at 3.95 against the US dollar and is now trading around 3.25.
So what does this mean for South Africa? If we take the Brazilian example and accept that we’re in a similar position with junk status looming and a president under investigation, when the news really breaks (that we are downgraded to junk status), we could be in for a rally on both our stock market and the currency.
Locally our market is not cheap, but it is important to consider two issues: First, the overall market has pretty much gone sideways since mid-2014. The impact of this sideways move in valuations is that while prices have done nothing, earnings have been increasing (even if modestly). So the sideways move has improved valuations for our market.
Second, Naspers* has an excessive price-to-earnings ratio (P/E), and with a 19% weighting in the Top40, skews the overall P/E of our market.
In other words, our market is offering better value than it did back in 2014. So, while many are concerned regarding junk status and our president, with both factors appearing negative on the surface, it could be a case of the news now being confirmed and markets now looking forward to a more positive future, although challenges will persist. Foreign buyers will potentially swarm in (strengthening the rand) and buy our listed stocks (pushing the JSE higher).
So the bottom line is that, maybe it is darkest before the dawn, and while there is a lot to be concerned about right now and we’re not exactly Brazil, maybe we should also be expecting a stronger rand at below R12/$. Maybe the JSE will be hitting 60 000+ sooner than we think. I am not rushing out and buying, but certainly I am keeping a close eye on things and expecting a positive 2017 for our market.
*finweek is a publication of Media24, a subsidiary of Naspers.
This article originally appeared in the 17 November edition of finweek. Buy and download the magazine here.
