Gavin Smith (Head of Africa, deVere Acuma), shares his insight into the recent S&P downgrade on the South African financial markets.
Investors in South Africa should brace themselves for even more volatility following the downgrade by S&P Global Ratings, announced on Friday. This comes as yet another blow to an economy already facing extreme pressure from low growth and over-indebtedness.
All eyes will be on the rand, South African banking shares and bond yields.
Gavin Smith, Head of Africa at financial advisory group, deVere Acuma, says the latest downgrade effectively means there is a higher risk that South Africa 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 sub-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 says.
“Markets loathe uncertainty and they typically respond to it with volatility. It can be expected that there will be market turbulence ahead.”
Foreign investors are likely to reduce their exposure to South African markets, which could result in a sell-off in the South African equity and bond markets, putting prices and yields under pressure.
“The longer-term effects will depend largely on how government reacts to the downgrade and with the ANC leadership conference next month, uncertainty will be at an all-time high,” says Smith. “Governments that have reacted swiftly, however – 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. But next moves remain to be seen.”
He’s 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.”
“Investors should not react emotionally to the downgrade, as history has shown that a long-term strategy linked to the levels of risk and outcome that investors aim for still remains the best investment strategy.” – Gavin Smith
However, Smith says 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.”
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.
Gavin Smith concludes: “Events like this reiterate the importance of getting good independent advice, the value of portfolio diversification and the avoidance of home bias.
“While we believe South Africa continues to offer good investment opportunities, the downgrade emphasises the inherent risks of having a home bias in any region and the need to diversify to hedge against local risks.”