THE PREGNANT PROPERTY PAUSE
The saying “pregnant pause” normally relates to speechmaking or coaching. But the recent months have been pregnant as everything but the stock market has taken a pause.
Consider this…….
- In four months the global markets have lost 10% of their value except for China which almost halved very early in the year.
- Commodities like iron and copper lost half their value and this was reflected in Kumba and the like.
- Then, as if nothing happened, everything retraced their steps and we reverted to close just under 53000 on the JSE late Friday 22 April 2016.
- The Rand peaked at R16 to the US$ and is now trading in the R14’s.
- Inflation is growing rapidly as price increases take hold.
- The drought has been bad and we are importing Maize.
- Fuel breached $30 and then proceeded to breach $45 – a 50% increase in two months.
- Our political arena has been blasted by bad news and gone into a pregnant pause.
- The Manifestos of the parties are being presented to crowds who are to be convinced who to vote for in August.
- Syria has a fragile ceasefire in place.
Apart from that, little has happened in 2016?!
Latest news from ooba is that house price increases are slowing with the average purchase price increasing by 6.2% compared with Q12015. Given an inflation rate of 7%, this means real price growth is negative. We knew this would happen if Inflation jumped steeply but negative real growth was not expected until Nenegate in December and the Rand’s sudden fall. Affordability criteria have stiffened and larger deposits are required to bring Buyers in line with higher prices coupled with higher interest.
Uncertainty is never pleasant and its effects can be felt like tremors throughout the country. It would also be foolhardy to expect that we have now settled down to business as usual. This brings me to a large dose of good news.
Messy indeed!
But here’s a thing, there have been two interesting pieces of information on the downgrade that many await anxiously.
RMB surveyed 432 people to assess their views of a downgrade. 84% thought that a downgrade would occur. Ninety four percent felt that the downgrade would have a negative impact on their business. The good news is the corollary of this finding – if the majority of people expect a downgrade then the market would adapt, or better still, the market would have adapted to the expectation of a downgrade. Therefore, the market has possibly already adapted to the downgrade and so little impact would be felt.
My view on this was that the market could not have “downgraded itself” or else the strengthening of the Rand, for instance, would not have occurred in the past few weeks. It seems that something bigger is at play relative to the SA economy, such as commodity prices rising, a weakening of the US$ exhibited by the stagnant interest rate stance of the Federal Reserve, and a declining JSE.
Then arrives an article in Moneyweb Today, When a Downgrade Hits dated 24 April 2016, that seems to provide a far deeper insight into the possible harm of a downgrade. However, this study of real countries that have endured such an event, shows a much more positive view of this eventuality. I cannot improve on Patrick Cairns article so I have copied it verbatim and present it with gratitude to Moneyweb Today and Patrick.
When a downgrade hits
Patrick Cairns
While there is some disagreement around when South Africa’s sovereign debt rating will be cut below investment grade, the market consensus is that it won’t be avoided. In either June or December Standard & Poor’s is likely to be the first agency to announce a downgrade. Minister Pravin Gordhan and the team around him will continue to work valiantly to avoid this, and they may well succeed in at least improving sentiment. However the honest assessment is that it is probably already too late, and they don’t have the tools on their own to do everything that is necessary to prevent the move.
South Africans should therefore prepare themselves for what happens next.
Many pundits have suggested that the immediate impact of a credit downgrade would be a flight of capital, a spike in bond yields, rapid currency depreciation and a fall in equity markets. However, the head of fixed income at Prudential, David Knee, says that an historical analysis of other emerging markets that have suffered a downgrade from investment to sub-investment grade actually reflects something different. “Markets are very good at anticipating what’s going to happen, and they price that in,” Knee explains. “They tend to perform poorly in the run up to a downgrade, but actually in the 12 months after that these assets generally perform better.” He studied a group of emerging markets that had all been downgraded from investment to sub-investment grade, and looked at how their bond yields, currencies and equity markets performed in the 12 months before and after the move. These countries included South Korea, Brazil, Russia, Greece and Uruguay.
The table below shows the changes to ten year bond yields in these countries immediately before and after they were downgraded. The chart is indexed to the downgrade point.
The general trend is clearly that yields expand leading up to a downgrade, but generally recover afterwards. “In Russia, for example, ten year bond yields were 6% lower a year before the downgrade, and subsequently in the 12 months afterwards they rallied 4%,” Knee points out.
He noted that the exceptions are Greece, where yields continued to rise, and Uruguay, where yields spiked so high that they wouldn’t have fit onto this chart. These were however countries that suffered a series of downgrades over a short period of time. “In a world where you get even a half-baked policy response, asset prices improve,” Knee says. “And we would say that there is a reasonably good chance that South African assets post the downgrade will perform okay.”
The chart below showing the real effective exchange rates of the currencies of these countries tells a similar story.
“There have been some examples where currencies have done poorly, but overall the average currency on a real effective exchange rate basis has increased relative to where it was at the time of the downgrade,” Knee says. “South Korea’s currency actually went up by 40%.” South Korea set the standard for how to deal with a downgrade, having managed to regain investment grade status in one year. “That shows that if you can get your policy response right, things can move very well for you,” says Knee. “But even some of those countries where the policy response hasn’t been fabulous, like Brazil, their currency has actually rallied in real terms.”
Given that the Rand has already depreciated by 50% since 2011, Knee believes that there is already a lot of bad news priced into it.
The effect of a downgrade on equity markets in these countries has been more mixed, but as the chart below shows, big losses are rare.
“If you look at the average, equity markets approaching the move to sub-investment grade tend to have modest bear markets and then track sideways for the 12 months afterwards,” Knee says. “There certainly isn’t a catastrophic decline.”
This suggests that a downgrade will probably not be profoundly negative for financial markets in the short term. What will really matter is the longer term policy response and how South Africa goes about getting back to investment grade status.
“There are significant concerns that are very valid about being downgraded, particularly because if you want to get yourself back on track it takes a long period of time and its incredibly painful from a macroeconomic perspective,” Knee says. “But in terms of the financial markets, the interest rate markets have done a lot of the heavy lifting already and the currency too. “With equities I think it depends an enormous amount on what happens to the US dollar and commodity prices,” he adds. “The South African market in our view does look slightly expensive on a real yield view so the market is vulnerable to bit of a re-pricing to get it back to fair value, but it is certainly not a train smash.”
Almost without exception, countries that are downgraded to sub-investment grade go into recession. It also takes them many years to earn back their credit rating [Minister Gordhan put this at 5 years when questioned on the time]. This is the real challenge that South Africa faces, the policy response will be critical. “There is a very tough road to tread and none of the policy decisions are going to come easily,” says Knee. “National Treasury and the Reserve Bank are world class institutions, but they’re not really in a position to lift potential growth for South Africa, which is what needs to happen. That needs to come from other government departments and other initiatives.”
What an amazing study and article!
Where does that leave us in the Property industry?
- If the Rand declines, interest rates will increase in order to quell inflation.
- If rates rise, affordability will decline and existing bondholders will sweat a little more.
- My view that rates will rise this year by 2% stands. We are currently at 1.25% increase and I cannot see that the SARB detracts from its path. In fact, I sense that the SARB is showing the Rating Agencies that it is independent and that it is willing to take tough decisions when they are well considered in the Monetary Policy Committee – in that sense, I believe they are part of the solution in the short term, even though SA is bleeding for growth and employment.
- House prices will continue to decline and affordability stress will continue to rise.
But, we will have a market in property no doubt. And sales will remain in place, slower than now, but ever-present. Affordable housing will continue fairly unabated because government will continue to be a net employer though it may shed a few thousand jobs over time [remember, Minister Gordhan must cut government expenditure and part of that could be job freezes in non-essential posts]. It seems that fuel prices are the outlier and we should watch that trend carefully. Remember too, that only 10% of our debt is foreign and the balance is Rand-denominated. That means cost of funding may rise but the funds’ capital that is denominated in Rands, will not rise if the Rand weakens.
Anything can happen and may, But my sense is that Minister Pravin Gordhan and his team are the “men for the job”. If anyone was going to avoid a downgrade it would be him and if anyone is going to execute a recovery [like South Korea], he will. We have to remain hopeful that the rest of government and our politics, in general, remain on a steady and even upward, path of care and concern for our country. Anything less could harm all our peoples irretrievably.
There is nothing like a positive attitude at times like these. It seems cheesy, but we need to ask ourselves whether we are part of the solution or part of the problem. It is so easy to fall into the trap of negativity but it is men and women who have confidence and even faith, that lift the spirits of each other even under trying circumstances. In fact, now that I think of it, read Man’s Search for Meaning by Victor Frankl if you have any doubt.
Pregnant Property Pause? You bet! Watch this space……
Go well and see you again @ the Junction. Homeloan Junction, of course.
Yours in Property.