Cabinet Reshuffle: how it impacts you

“Don’t get distracted, focus on the fundamentals”, says Mokgatla Madisha, Head of Fixed Interest at Sanlam Investment Management. The political situation in South Africa has been fluid for quite some time so the events of this week are not all that surprising. They serve merely to distract government and business from focusing on the real issues we need to solve if South African is to deliver the kind of growth that is going to reduce unemployment and poverty, he says.

The early market reaction to the cabinet reshuffle has seen a 5% weakening in the currency and 0.5% increase in bond yields. Relatively speaking, this is a much more muted response compared to when minister Nene was removed.

“The main difference between this week’s events and December 2015 is that the markets were better prepared this time around”, says Madisha.  Not only that, the economic backdrop is considerably improved, which  is to say that valuations of South African assets were at a discount, inflation is falling, growth is picking up and terms of trade are significantly better.

Focus on the fundamentals

Investors’ focus should be on the fundamentals first and foremost. Secondly investors should look for signs that current policies will be maintained. For the bond market, what is most crucial is that government should stick to the expenditure ceiling as outlined in their February Budget and look to reducing debt thereafter. If, however, the market gets hints that this will not be the case then asset values will re-price lower.

What about a ratings downgrade?

South Africa’s credit rating is up for review by Moody’s who will likely announce their decision next week Friday on the 7^th of April. The chances have now increased that they could downgrade South Africa’s credit rating by one or two notches. Moody’s rates South Africa local currency debt at Baa (or BBB) two notches above junk. The foreign currency debt is also rated two notches above junk. S&P is due to announce the result of their rating review in June. They have been more vocal than Moody’s or Fitch about the possibility of SA being downgraded to junk status and, given that SA is only one notch above junk by their assessment, they may well downgrade in June.

A downgrade will increase the cost of debt throughout the entire economy. Interest rates on government bonds will be have to rise to compensate investors for the increased risk and the Reserve Bank will have to keep interest rates higher than it ought to, to compensate for a weaker currency. A higher repo rate will result in higher borrowing costs for consumers too.

Impact on the markets

Says Rafiq Taylor, portfolio manager at Sanlam Multi Manager, “While there has been weakness in the markets, the investor community has not reacted too irrationally as additional news should dictate how they behave in the coming days and weeks”.

The reshuffle of cabinet impacted both equity and fixed interest markets, though not markedly, while the Rand weakened significantly. Within local equities, financials and property have lost ground, with local bonds following suit.

“The medium to longer-term repercussions are not known at this stage and it is only additional news that should dictate how investors behave in the coming days and weeks”, concludes Taylor.

However, we will be closely monitoring the situation both politically and how it affects client portfolios and investments.  In these times, it is important that investors have well-balanced, diversified portfolios across asset classes and managers who build portfolios with different approaches. More importantly, staying the course and not being reactive to news flow is paramount to preserving and creating wealth.