My 2016 Local Financial Markets Playbook

gingerbread-aA few days ago I read an article that contained a sentence which I consider to be profoundly disturbing written by a prominent economist:

“I am convinced the rand’s undervaluation will correct but I am unsure how it will correct.”

In August of last year I predicted a US Dollar / Rand rate of at least R15 when it was valued at R12.50. Market commentators often refer to the Rand as unjustifiably depreciated but the end of year rate was R15.49.

At least one trading desk ran the joke “sell EM if you have, sell EM if you don’t” two weeks ago in the midst of a huge selloff. Well done to all who saw the opportunity.

It is my belief that the Rand’s value will deteriorate further during 2016. I have prepared a list of key risks which South Africa will face this year:

  • A credit rating downgrade regarding our foreign debt as sub investment grade. Local currency credit should remain investment grade.
  • Confirmation if Jacob Zuma’s intention is to serve as state president for a further term come 2017. This would be oppositional to our Constitution.
  • Additional rate hikes by both the Federal Reserve as well as Bank of England which cause their currencies to become more attractive.
  • Increased nationwide food and water shortages with El Niño conditions estimated to extend well into 2017.
  • The introduction of winter season with arguably less electricity generation by Eskom, a situation which has not shown improvement since 2013.
  • Further slowdown of China’s economy which adversely affects demand for commodities.
  • Unforeseen expenditure to bail out state owned enterprises such as an effectively insolvent South African Airways.

South Africa’s contingency reserve is already depleted and we are only just starting a new year with these problems. On the other side of the spectrum are a few scenarios which can greatly help the Rand:

  • The replacement of President Jacob Zuma.
  • A significant increase regarding the price of oil could result in the return of investor appetite to emerging markets as a whole.
  • India could replace China’s previous demand for commodities due to infrastructure renewal.
  • Strength as a result from a local credit rating downgrade being avoided.

USD / ZAR Forecasts:

  • Good Case: R19 by the first half of 2016.
  • Good Case: R21 by the end of 2016.
  • Excellent Case: R18 by the end of 2016.
  • Bad Case: R28 by the end of 2016.

Excellent Case = Replacement of President Jacob Zuma with a more capable successor.
Good Case = Avoidance of a foreign credit ratings downgrade.
Bad Case = Foreign credit ratings downgrade.

Economic Forecasts:

  • GDP growth of between 0% and 0.5% with the start of a recession in the second half of the year.
  • Retailers will experience tremendous pressure from rising interest rates and lack of disposable income available for consumers. Higher levels of inflation will cause sales volume to decrease.
  • Banks should encounter increased non performing loans.

Should spare capital need to be allocated then an ideal financial advisor would make offshore products available as an option as well as possess multi asset capabilities. Actions by the Reserve Bank can be taken advantage of but be wary because carry trades here are no longer effective, as Japanese investors have recently discovered. Interest rate increases at these levels will likely harm economic growth and cause no swing to reach our inflation target.

Usually a backdrop of rising interest rates would dictate otherwise but offshore real estate is still the asset class of choice in my opinion. A REIT structure can form the composition of the asset holding thereby avoiding the need to be a landlord. One good balance would be to also tilt towards shorter duration T – Bills.

Global equity indicies have fallen quite substantially but are only slightly lower than fairly valued. Should the trend continue then a tentative entry towards developed world indicies is warranted.

This would not be a time to panic because the sale of securities can often initiate a Capital Gains Tax event which can erode returns. Always seek advice from a suitably qualified and independent financial advisor before making any decisions.

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