Amid the disbelief and the anger, there is also understandable concern. How did we get here? And where does this leave me and my retirement fund? Below, we briefly unpack the events that led up to this, examine the potential impact on the economy and your portfolio and advise what you should do, to get through this in the best possible shape.
The Cabinet reshuffle
On the last Friday in March, we woke up to the news that the President had relieved Pravin Gordhan from his post as Minister of Finance. Eight other cabinet ministers were also axed. What shocked was not so much Gordhan’s dismissal – which seemed inevitable following his abrupt recall from an international roadshow – but the ‘how’ and the ‘why’ of it.
The ‘how’ is that after his initial proposal met with resistance, President Zuma took the unprecedented step to reshuffle his Cabinet unilaterally, without the support of the ANC’s top 6 officials. He did do so in the dead of night, not even bothering to inform the axed ministers and deputies. While it is his constitutional prerogative to appoint and dismiss cabinet ministers, it is understood that he does so in consultation and agreement with his senior advisers. He is running a country after all, not a country club.
But the bigger concern is around the ‘why’. It is the fear of what lies behind these machinations that caused the rand to lose 7 per cent over the week, its worst fall since late 2015. It is the same fear that triggered the massive after-shock four days later, when S&P downgraded SA’s sovereign credit rating to BB+, otherwise known as sub-investment grade or junk. Fitch ratings followed suit a few days later.
Officially, the President removed Gordhan due to “irreconcilable differences”. The concern is that these differences relate to matters of policy not personality.
Like his predecessors, Gordhan was highly respected internationally for following sound fiscal policies. He reigned in public spending, curtailed financial support and debt guarantees for unprofitable state enterprises, enforced procurement rules, and rejected the ill-advised construction of a nuclear power plant. This steadfast course helped us avoid a ratings downgrade in 2016.
But this course does not sit well with the Presidency, evident by the political infighting that has dominated our news for the past two years. When Gordhan was finally sacked, the rating agencies saw it for what it was, a political move to insert a more compliant candidate.
Despite the “austerity” assurances offered by incoming Minister Gigaba, the likely outcome is a change in priorities, with less focus on governance and prudence, and more on facilitating government objectives. The ratings agencies have a genuine concern that the Ministry will relax its scruples, spend beyond its means, borrow more and possibly struggle to pay its debts. This makes it riskier for foreigners to lend us money, hence the de-rating.
Economic impact
The government debt rating is like a personal credit score. In simple terms, the downgrade means we have become less creditworthy as a nation. People will still lend us money, but we now have to pay a higher interest rate. As with the earthquakes, there was no immediate harm. Only the markets moved, and then not by much. But behind this façade, there is structural damage, and one way or another, we will all pay for it.
The share of interest payments in the national budget has already crept back up to 10%, and with the cost of our debt increasing, that number will go higher still. This means less money for other government departments, including education, healthcare and welfare.
Our currency has been devalued. This will make imports more expensive, with an almost immediate impact on the price of agricultural commodities and fuel. As poorer people spend relatively more of their income on transport and food, they will be worst affected by these developments.
The inflationary pressure created by a sharply weaker rand would force the Reserve Bank to raise interest rates, impairing economic growth and employment, just at a time when we were poised for an upturn. Many consumers are heavily indebted, and can scarcely afford their current interest burden. They will have to cut back on their discretionary spending, undermining business confidence.
As a once-off adjustment, this would be painful but manageable. The far bigger risk is that of a negative feedback loop. An economy that stagnates or goes backwards attracts fewer investors, pays less taxes, employs fewer people. The result: more currency weakness, more inflationary pressures, more rate hikes, more economic stress. We’ve seen this type of stagflation before, in the Eighties and it was ugly.
Market impact
The fall-out has been surprisingly benign. The market shifted, but there was no collapse. The JSE All Share Index is still up on the year. Bond prices fell by around 2%. The rand gave up 11% off its recent highs, but it is still flat year-to date. As far as volatility goes, we have seen much worse over the last three years.
But appearances are deceiving. With lower economic growth, the earnings of inward-focused companies on the JSE will come under pressure. Investors have already begun to discount this. The reason the JSE barely moved is that our market has significant exposure to overseas companies and many shares earn some of their revenue in hard currency. These assets perform well when the rand depreciates and offset negative performance of locally-focused assets.
Many foreign funds are not allowed to invest in junk bonds, but as the market had already factored in the likelihood of a downgrade, bond prices did not react so much. There could be much worse to come though. The S&P downgrade only refers to our foreign (dollar-denominated) bonds which make up less than 10% of government debt. But Fitch also downgraded our local debt. If another ratings agency (eg Moody’s) does this, we will be excluded from the World Government Bond Index, forcing many foreign bond holders to sell. This could dramatically lower the value of the rand and bonds and severely shock our economy.
Whatever the fall-out for the economy and the markets, the way forward is a sound investment strategy that promises an optimal outcome under any conditions. That is what we endeavour to do for you at 10X.
How did the 10X High Equity portfolio respond to the news?
Your 10X portfolios are well-diversified across asset classes, currencies and geographies. You own growth and defensive, local and offshore assets. Within the 10X High Equity portfolio (held by over 90% of our investors), around 50% of your investments have either direct or indirect offshore exposure, so you are well hedged against currency weakness and a local recession. In fact, during the week these events unfolded, it was up 2,3%.
A word of caution however: our market is impacted by both structural and cyclical factors. The latter relate to the outlook for global growth and commodities. The current commodity upswing has moderated the market fall-out from the ratings downgrade which means we may only see the full impact of the downgrade when that tailwind abates.
How should you position yourself?
The answer, in short, is ‘as you were’: saving in the present, investing for the long-term. As we often say, there is no way to predict these sudden market moves and little point reacting after they have happened – the new information is priced in almost immediately. The best thing therefore is to stay calm and stick to the plan.
Remember, the goal is to maximise your average return over your entire investment period, not for the next month or year. You have no reliable way of achieving the latter, but in trying, you will most likely sabotage your long-term effort.
So rather control what you can: your market risk and your fees. For long-term investors (investing for periods longer than five years), this requires a high allocation to equities within a well-diversified portfolio. Historically, a high equity portfolio is more profitable over periods longer than five years than a low equity portfolio, despite greater return fluctuations. And keep your fees low, as this the only known variable about your future investment return.
At 10X we do this for you. Our life-stage approach ensures you have the appropriate amount of market risk for your time horizon and our use of index funds ensures that you pay among the lowest fees in the industry.
By maintaining a well-diversified portfolio, staying invested in a time appropriate portfolios and minimising the amount of fees you pay, we expect to materially improve your retirement income one day.
“If you are going through hell, keep going”
We have been through a series of related developments over the past two years. Each time the markets and the currency reacted, and each time they recovered. Yet it would be foolish to believe these events are just more of the same. There is a real risk that this downgrade becomes a self-fulfilling prophecy that does serious harm to our economy. It may take years of proven fiscal prudence to reverse the negative perceptions about “policy change” and “state capture”.
On a more hopeful note, perhaps this will be a watershed moment, when the broad electorate finally recognises our president’s self-serving agenda. It may well mark the point he finally overplayed his hand, and will be brought to account, either by his party, or by the voters, or by the economy. If it brings positive change, then any short-term pain will have been well worth it.
For our investors, we re-iterate our fundamental belief: ignore what the markets are doing on a daily, monthly or even annual basis. The real money is in the long game. Follow Winston Churchill’s advice and keep at it, even during the hard times. Chances are you will barely remember these events by the time you retire.
