Mar 20, 2020
The South African budget was a positive surprise – for the first time National Treasury set out a plan to deal with the real fiscal problem – the public sector wage bill. The political intent will be tested over the coming months, but we are cautiously optimistic. Moody’s has recognised the “execution risks” in the budget, but we expect the rating agency to give it time and consider the progress of expenditure cuts in November. While this may mean a stay of execution at its March review, it is a very close call.
However, on the international front, a combination of a poor market set-up (i.e. stretched consensus positioning) and a deterioration in the global growth outlook on the back of Covid-19 escalation, has dominated hearts and minds. The virus spreading meaningfully outside of China has forced markets’ previous assessment of this being a very temporary Chinese economic shock into something broader. The overwhelming consensus coming into this year was that global growth would rebound on the back of Phase 1 of the US/China trade deal, and indeed, the data was leaning very heavily in that direction. The market got over its skis in its positioning (long equities/long credit/emerging market search for yield), and the subsequent positioning adjustment has been brutal (taking SA assets with it). We think there is genuine economic damage here, unquantifiable at this stage, but monetary and fiscal policy should hopefully soften the blow. We have already seen decisive action by the US Federal Reserve, the Bank of England and the People’s Bank of China.
The current market turmoil follows a prolonged downturn in local credit markets. Many companies were already struggling with anaemic revenue growth and rising costs. And consumers were under similar pressure, exacerbated by job cuts. The local credit markets are shielded to some extent by a reduction in lower rated issuers over the last few years, with better quality banks, insurers and corporates dominating the environment. In addition, bank regulations following the global financial crisis in 2008 resulted in increased capital and a better matching of assets and liabilities, which is positive for credit. Securitisation methodologies were also made more conservative, improving the credit profile.
Our positioning in Credit Income/High Income has been very defensive for some time, given the already tough economic backdrop. We have avoided lower rated corporates and property companies as well as sectors such as retail. Liquidity has been prioritised. Our focus now is both on downside risk and the opportunities that should arise from the stressed environment. We expect new issuances to be at higher spreads and we may see some forced sales of credit.