LISTEN: Junk status and the rand

NASTASSIA ARENDSE:  Good evening and welcome to the SAfm Market Update with Moneyweb. My name is Nastassia Arendse and I’m joined in the studio by Wayne McCurrie, who is senior portfolio manager at Ashburton Investments. He is here to take us through the day’s market performance. Wayne, thank you so much for your time.

WAYNE McCURRIE:  Pleasure, yes.

NASTASSIA ARENDSE:  You are smiling. Is that a good thing?

WAYNE McCURRIE:  I’m just smiling because we’ve come to the end of a week without anything traumatic happening, which is good news. So maybe we should all smile for that.

But the market here was a bit weak today. The rand and bonds have been remarkably strong – remarkably. In fact, if you knew nothing about what happened in the past month, and you just looked at the price chart of the rand, you’d see a little bit of a wobble, but it’s come back quite nicely. You wouldn’t actually think anything had happened.

Now of course you don’t know, if there had been no reshuffle, how strong the rand might have been – that’s pure speculation. But overseas investors are just flooding into emerging markets because they can get a decent yield here. I suppose that’s the ultimate lesson or story to talk about when it comes to this work “junk”. Ultimately what junk boils down to is that the cost of money goes up, and the rand will weaken. But it will go to a level where people will buy it because they see value at a certain level. Let’s just say if all the rating agencies downgrade us to junk on all of our debt, it doesn’t mean we won’t get any money coming into South Africa. We might just have to pay more for it.

But luckily enough for all of us now, overseas investors are putting money into emerging markets, including South Africa, so we see the rand at – I think R13.12/dollar was the strongest today. I think it’s R13.16 now. And when you consider it, the rand did strengthen dramatically before all the recall and the cabinet reshuffle. But when you compare it to exactly a month ago, it’s not all that different. It certainly is still stronger on the year.

But on the share market there was some company news. Massmart came out with a sales update. They sort of hid it in their accounts. They didn’t make a Stock Exchange News Service or Sens statement on it, but it was quite frankly terrible. They are getting no volume growth. Their volumes are going backwards, they are selling less and less – and the market did not like it. It pushed the share down 8%.

Clicks came out with a result. It was actually quite good, but the market I think was expecting more than that, so it also came down I think 1 or 2%.

Phumelela, a gambling company, is doing well in its overseas operations, but the South African operations do not look good at all. In fact, they look quite poor. I think that’s also reflective of the consumer situation.

But in total the whole market was down about 0.5%.

NASTASSIA ARENDSE:  You were talking about the downgrade earlier and I remember seeming a Sens announcement from Pioneer Foods on the fact that they are axing their potential transaction –

WAYNE McCURRIE:  They cited it directly.

NASTASSIA ARENDSE:  We are starting to see the effects of the downgrade somewhere or the other.

WAYNE McCURRIE:  Understand, junk status in whatever format is quite simply not good news, and it has a negative effect. The extent of the negative effect I suppose we will eventually find out – what it’s going to be. But if your cost of funding, if the cost of borrowing money goes up, certain deals just are not viable any more. So you just won’t build that new factory, you won’t buy that new company, because it will cost you too much. Maybe the best example is property developers. Right now you can borrow money at, say, 9%, and you can build a building and rent it out and get a 9% return. So you break even in year one. Then, hopefully as the rentals escalate you make a bit of profit in year two, three and four, etc.

If that cost of funding goes up to 10%, you don’t make money in the first year, you lose money – and you might lose money in the second year, and you might lose money in the third year. So if your cost of funding goes up, projects are cancelled or deferred until things change, because the mere fact that the cost of funding goes us probably means lower economic growth, which means not higher rentals, but lower rentals. So the cost of borrowing money ultimately determines what happens in the economy. And if that goes up because of junk, the economy will slow down.

NASTASSIA ARENDSE:  Outside South Africa, other things are happening in the world. There’s the elections on Sunday, and then the UK came out saying that they are going to have the elections as well in July [June]. What are you reading in the geopolitical global environment right now?

WAYNE McCURRIE:  Lets deal with the UK calling a snap election. Obviously the prime minister there wants a firm mandate by a big majority before she carries on with Brexit, because the leave-the-euro vote only just won. It was not an overwhelming majority. They only just won.

In France there are three candidates. There is a far-left, a centre and a far right. This is the preliminary round on Sunday, and the two people with the highest votes go through to the final round in two weeks’ time. So you don’t get a result this Sunday. Now, if the centre candidate doesn’t go through and the far-left candidate and the far-right candidate go through, that’s very bad news for the European economic area, because they both want to leave for completely different reasons, but they both want to leave [the eurozone]. So we’ll have to see how that all pans out. There are polls and there are forecasts and there are analyses, and they were all wrong on Brexit, and they were all wrong on Trump. But for what it’s worth, they say the centre candidate is going to win. But we’ll have to see, because on Brexit and Trump all of these polls were wrong.

NASTASSIA ARENDSE:  True. Next week – one key piece of information or news that you are looking out for before I let you go?

WAYNE McCURRIE:  I suppose it’s not really a news result per se. We are just going to see whether our rand and bonds continue to rally – because at some stage a full junk status is going to be reflected in their prices. A junk status at the moment is not at all reflected in the current prices. So, very simplistically, the rand, if it was discounting full junk status, should be at R14.50 or R15/dollar. It’s not. It’s at R13.16. So something is going to change or we are going to see quite material rand weakness at some stage.

NASTASSIA ARENDSE:  We’ll have to leave it there. Wayne McCurrie is with Ashburton Investments.

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