The classic disclaimer that past performance (or even a lack thereof) does not guarantee future success (or lacklustre returns), now holds true as much as in the past. This means that past averages cannot be expected to predict with great conviction certain outcomes. However, this article expresses our view of what the recent credit rating (non-)event means to our portfolios. In short, it is our opinion that recent below average performance might not be expected in the next business cycle. Although we briefly introduce our views on other macro risks such as an expected synchronised slowdown in global developed economies and potential recessions, this article will focus on credit ratings applicable to South African bonds.
South Africa’s rating history
Back in 1994, South Africa’s bonds were downgraded to “junk” investment status by Fitch and S&P. Both of these rating agencies only rated our country as investment grade again between 1999 and 2000. Since that period our credit ratings have improved from junk to two or even three rating levels above it. Unfortunately, after the Global Financial Crisis (GFC) in 2008-2009, our bonds’ ratings deteriorated and they were eventually downgraded back to junk in the second quarter of 2017 by both Fitch and S&P. Moody’s, the third credit rating agency that is active in South Africa, has never rated SA bonds “junk”, although they have been threatening to do so for quite some time.
As such, March 2019 was dreaded by the market as Moody’s had a credit review scheduled and most industry analysts expected a Moody’s credit review from stable to negative, but still investment grade. Some analysts even believed they would finally rate our bonds junk for the first time.
This fear came as a result of higher SA government debt levels, translating into greater interest payments to be expected well into the future, thereby placing further strain on the country’s already limited resources at a time of greater corruption, lower levels of exports and fear of state-owned enterprises (SOEs) causing even more harm. Furthermore, 2018 was another year of anaemic growth, which was exacerbated by a particularly disastrous period in our market in 2018 when the SWIX returned -11.67% for the year and the three- and five-year annualised returns failed to outperform money market portfolios.
However, much to the surprise of the market, Moody’s did not change their ratings view from investable and a stable outlook, to either a widely expected negative outlook, or even a full downgrade to junk as some expected. What does this mean and why does it matter?However, much to the surprise of the market, Moody’s did not change their ratings view from investable and a stable outlook, to either a widely expected negative outlook, or even a full downgrade to junk as some expected. What does this mean and why does it matter?
Back to the current reality
By not being downrated (i.e. not rated from stable to negative, nor from investable to junk) by Moody’s, we have a bit of breathing space, but they can issue an update at any time, and the other rating agencies’ reviews are expected in June/July post the elections. It is possible that Moody’s is reserving judgment in order to review changes more critically post the election outcome in May.
Irrespective of the timing of the reviews, the rating agencies all have their own metrics and rating methodologies. However, we are of the opinion that their different views should move similarly over (enough) time. So if one rating agency’s view is improving, the chances are reasonable that the other two are also becoming at least slightly more positive.
The reality is that Moody’s is not only not downgrading – they are not downrating either by changing the status to a negative watch, while S&P and Fitch have done both. Assuming Moody’s sticks to its stance, what does this mean to the market and perhaps other rating agencies’ next set of reviews?
The downgrades by S&P and Fitch occurred during Q2 2017, which is now two years ago, and history indicates that S&P has on average waited six to eight years before bringing countries back to investment grade from junk status. This recovery is dependent on the progress made by the downgraded country to correct its shortcomings. Furthermore, past market events around credit ratings on average indicate that a country will move from a newly assigned negative view rating to a downgrade over 18-24 months.
This means that if we were to apply the assumptions of averages holding true, then if we take the past two years into account and incorporate 18-24 months, we may be right in the middle of the average recovery period, or at a point of being downgraded to junk status – the difference likely being determined by what the markets do in the interim. At the same time, the longer Moody’s postpones any negative news, the better the chances of the market recovery and future positive ratings being realised.
Therefore, the current stable view from Moody’s is truly received with a sense of relief.
Recent market performance has been atrocious, but using that as a low base combined with a potentially positive medium-term view on South Africa’s credit rating, perhaps creates a great opportunity for investment in local investment markets. The longer this momentum can be maintained, the better for our country and the more likely that the difference of opinion by rating agencies will start to converge towards a more positive view.
Therefore, no news is good news when it comes to Moody’s in the foreseeable future. Of course, global investment markets influence our domestic market and hence any potential global recession caused by a slowdown of growth or sharp increases in US inflation could materially change investment return outcomes in South Africa.
Where does this leave us?
It might come as a surprise that Moody’s already rated SA bonds with a negative outlook in June 2017, only to be rerated to stable in March 2018. This was despite all the recent issues seen in our market, but what is noteworthy is that 2018 delivered fewer “own goals”. SA had its first year in many where we avoided self-inflicted pain through the likes of what we saw previously (Nenegate, firepools, somewhat shifty Russian nuclear deals, trains which do not fit on our railways and late-night cabinet reshuffles, to name a few).
The first quarter of 2019 was the strongest quarter in a decade for SA stock market performance, albeit from a low base. Furthermore, bonds are offering real value over inflation and money markets offer stable yet more subdued returns. Further positives include low inflation figures. These fundamentals point to our view that there is good potential in our market to allow for a strong run barring any geopolitical stress and risks of slowdowns globally.
In terms of market noise, some investors will point to market-related stress, and have drawn comparisons between ourselves and the recently downgraded Brazil, but we would argue that the current economic environment is the best we have seen in years on a forward-looking basis. Most will know that SA Inc. has always been exposed to political risks, and that we have never truly had the opportunity to say that we are risk free. We don’t see decades of no returns in SA going forward. It is for this reason that we believe that the best way to make assets grow is not to time the market, but rather to invest through the market.
For those who wonder what happens to markets after being downgraded, it is noteworthy that Brazil recently had a massive outperformance with their stock market returning a very impressive 25.9% annualised since being downgraded to junk by S&P on 9 September 2015:
Performance from the Brazilian stock market does indicate that it is not necessarily all doom and gloom once downgraded.
Nic du Toit, CFA®
Regional Head: Investment Consulting
This communication provides information and opinions of a general nature. Simeka Consultants & Actuaries accepts no liability or responsibility if any information is incorrect or any loss or damage that may arise from reliance of information contained herein. It does not constitute advice and no part thereof should be relied upon without seeking appropriate professional advice.