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Bond specialist Andrew Canter, chief investment officer at Futuregrowth, explains why foreigner investors panicked at the firing of Finance Minister Nhlanhla Nene – and how confidence built up over 20 years can be destroyed virtually overnight. Canter worries trust in the fiscal prudence of the SA Government has been broken, so potential investors will now “think twice” about South African assets. But the good news is these events prove democracy is alive and well in SA, with the public outrage forcing a rapid reversal of President Jacob Zuma’s decision, something which Canter says was welcome but unexpected. – Alec Hogg
In this special podcast, ALec Hogg is joined by Andrew Canter, the Chief Investment Officer of Futuregrowth in Cape Town. Andrew, thanks for joining us on the line today. It’s been quite a watershed week. Not too many people have missed what went on in the share market because of the visibility of share prices, but it’s been just as bad in the bond market.
Indeed. The bonds had a very quick and nasty bear market. We’re talking 150 basis points straight up.
Just explain what that means (150 basis points).
Take for example, your R186/10-year bond. It went from a yield of about 8.60 up to above 10. I think it went to about 10.4 percent. That would have been a capital loss in the bond market of (I’m going to estimate now) probably 12 percent of the Bond Index in a three-day space.
Bonds. Why do people invest in bonds? What kind of investors go into them?
Your core holders of South African bonds are domestic Pension Funds where you’ll always have an allocation to bonds as part of your risk allocation strategy. Obviously, bonds generally act in a reverse manner to equities. When equities go up, bonds don’t necessarily rally. When equities go down, bonds usually do well. The other big holder of South African bonds would be foreign investors who again fit it into Pension Funds and long-term Insurance Funds as part of their overall strategy holdings of emerging market debt.
Would you be able to give us an understanding of how much of the South African government bonds are held by foreigners?
Off the cuff, no. I don’t have the number but it’s substantial. I’m going to guess it’s probably R300bn or something like that.
All right, so about one-third of the total.
Why was it important that we paid attention to this spike in the bond rates?
When you lend money to somebody/anybody, whether government or a corporate for 10/15/20 years you’re really making a faith statement in their future. You’re saying ‘I believe they’re going to be able to service this debt for 20 years and at the end of 20 years, pay me back my capital. What happened with politics last week: it certainly rattled the faith that people have in the South African Government as a long-term borrower. Will they pay me back? Will they pay me back in Rands that haven’t been inflated out of existence? When the past Minister of Finance is somebody who is a complete unknown and doesn’t come from a financial or treasury background, it doesn’t really make you want to lend money to Government for 20 years so you quickly sell bonds.
Was there a chance that had the decision not been adjusted in the way that it has with Pravin Gordhan going in, that when those bonds came up for renewal (in other words, rolling over) that foreign investors would say, “No, thank you.’?
Well, there are a couple of moving parts. South Africa is already on the cusp of being downgraded below investment grade by the international ratings agencies and we all know this, actually. This change – and if it really was what it looked like, i.e. a signal of lack of fiscal responsibility that lends to playing politics with the purse… That was going to be a serious problem. We would have been downgraded. We’re already on the cusp and if we’re downgraded, foreigners won’t buy South African bonds. What that means is net yields are going to be higher. The cost of financing, whether you’re buying a car, a house, financing a business, or the Government is financing itself, the cost of finances was going to keep on rising. In the absence of the reversal of this policy last night, you would have seen bond yields open up higher again this morning from 8.60 last week to 10.20/10.40 at the close of Friday.
It would have been up to 11 percent today. Nobody was going to get in the way of the freight drain because there was no reason to get in the way of it. The outlook was really deteriorating very quickly.
What did happen this morning?
The market stabilised. The news…the announcement of Pravin Gordhan being reappointed was taken as very positive in and of itself so the bonds actually rallied back down – something like 90 basis points of recovery. As the Rand also came off the 1/16 of a Dollar level back towards 1/15th of a Dollar level. So the market has recovered somewhat but let us be clear. It has not gone back to where it was a week ago. We’re still in a space of uncertainty. Confidence, although not shattered has certainly been badly bruised. There’s going to have to be some trust rebuilt by the Government in people who are holding its currency (the Rand) and people holding its debts.
How do they rebuild that trust?
The way they’ve done over the past 20 years, frankly. You can’t always be fiscally prudent because the economic cycle goes against you, the growth is low so you have to have more transfer payment to individuals. You show fiscal prudence while you do that rather than just playing politics with the fiscus. You just do that year after year and time after time. To me, that’s one lesson – there are several lessons out of this – but I’m talking about the political lessons. It was one economic lesson and my biggest fear now is that the psychology of inflation, the fear of fiscal imprudence, and Government imprudence is going to lead people to expect more inflation. Therefore you’ll have more inflation and therefore, you’ll have higher interest rates. The remarkable thing about the last two years as the Rand has gone down in a rather inexorable way is we didn’t get much inflation passed through.
Inflation is supposed to peak at about six percent in the first quarter next year and then recover. That’s not much at all, considering the Rand’s decline. Now, with this most dramatic event, the breaking of confidence, the psychology of inflation perhaps having been introduced, and the trust being broken in the prudence of Government; you could have systemically higher inflation. You have inflation back up to the high sixes, or seven percent or more and a requirement for higher interest rates in the economy. That’s a big cost to this economy.
Andrew, you explained that we haven’t gotten back to where we were before the firing of Nene. Is there any way of quantifying what this means – how much money the decision might have cost the country in the bond markets?
Oh, there probably is but how do you measure confidence? How do you impress confidence? I don’t think you can practically do so. If you were thinking of investing in South Africa…if you’re sitting in Europe and thinking of doing something here, you’re probably thinking twice about it. If you were a domestic manufacturer and you were about to build a new plant, you would think twice about it. If you think of lending money to a corporate, you’re going to think twice about it and charge a higher rate. If you think of buying shares, you’re going to think twice about it and maybe demand a higher return on equity/a lower PE ratio. There are tangible costs. It’s hard to aggregate them and the change in psychology on inflation alone because of the costs – higher interest rates costs and economy – is an enormous cost. It’s in the high billions. I couldn’t hazard a guess.
You did say that there were lessons to be learned from this whole episode.
The first lesson is that confidence that you built up over decades can be lost in a couple of days, and we can see that in spades. Another lesson we learned is that in a crisis, liquidity is your best friend. We learned it in 2008 and we learned it again now. When everybody’s running for the hills…if you’ve got cash to be able to deploy and do something, you can often pick up some pretty good deals if you’ve got the testicular fortitude to do so. The third lesson (and I think we all learned this lesson – me as much as anybody else) is that actually, it turns out that democracy seems to work. Even the most optimistic amongst us wouldn’t have anticipated a reversal of that appointment over the weekend but thankfully, it did happen and it does seem to be a sign that South Africa is a democratic country (with the populace).
A cocktail party conversation amongst non-financial people this weekend was about the Minister of Finance. That’s extraordinary in itself and the fact that it got airtime with Government at the senior levels…they realised the mistake being made on a long-term basis and they reversed it. It’s exciting. It’s exciting to see democracy in practice.
For a young democracy like this to learn those lessons early on is not a bad thing. Wednesday we’re expecting that there are going to be marches, probably the #ZumaMustFall shown on global television. Is this something that would spook international investors in the bond market?
It’s hard to say. Probably not. I’m not a political analyst and I don’t delve in those waters much but if you listen to the international press and read the articles, his reputation isn’t stellar. There’s not a lot of respect in that tone of voice and it would not be perceived as a bad thing for South Africa if the populace is marching. That’s not making a comment about what should happen with this administration. That’s just an observation.
Andrew Canter is the Chief Investment Officer at Futuregrowth.
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