On 8 July this year I wrote a blog called “Trying to make sense of this market routing”. The JSE just experienced a big fall and everybody was worried. I explained that if you see different scenarios developing in the equity market and Bond market, trust the Bond market. The Bond market is much more sophisticated than the equity market, mostly because there are very few retail investors. The Bond markets are driven primarily by professional institutional investors. The Bond market was stable at 8.5% at the time and the JSE soon recovered. The same happened in August and the JSE again recovered.

This time it is different. Both Bonds and JSE equities fell heavily since Wednesday’s shocking removal of respected Finance Minister Nene by President Zuma acting on his own without notifying cabinet who sat a few hours earlier. The brunt of the decline is felt by Banking shares with Firstrand for example falling 15% on Thursday alone and continuing to slide on Friday. The graph below shows little movement in the yield on the All Bond Index (ALBI) in July and August when the Financial 15 Index fell heavily. This time is different, the yield on the ALBI shot up to nearly 10%. The benchmark RSA 186 Bond was already trading at 10.35% on Friday, from 8.5% on Wednesday. This is a massive bear market.

JSE All Bond Index Yield & JSE Fini 15 Index

JSE All Bond Index Yield & JSE Fini 15 Index


Why is this a Rubicon moment:
There can be only one explanation for this hasty move to replace Nene. The SAA board has until 21 December to negotiate with Airbus or default. Nene refused SAA board permission to renegotiate the contract which had a big saving included which will fall away if not complied with. That is why Zuma hastily replaced Nene with an unknown person who will toe the line. The other issue was of course Nene’s resistance to the Trillion nuclear deal.

What are the implications of Zuma’s actions?
1. We will get a downgrade to junk status by Rating Agencies which means that our debt will become more expensive. In fact our Bond yields are already reflecting junk status, we don’t have to wait for the agencies.
2. Interest is already the biggest expenditure item on our budget. That will rise, making the Budget Deficit even bigger.
3. That means tax increases next year is a certainty, income tax and even VAT.
4. The Rand is in free-fall. This will push up inflation which will cause interest rates to rise.
5. Higher taxes and interest rates will hurt consumers, sending South Africa into a recession in 2016. Retail shares and Banks will be at the forefront of this decline.
6. The SA Inc part of the JSE (Industrials and Financials) will enter a Bear Market and the bottom cannot be called.
7. Even Mining shares, traditionally considered Rand-hedges, will not protect investors because foreign investors will sell to get out of South Africa.
8. Foreigners own more than 50% of the JSE and a big percentage of our Bonds. Their selling will put more pressure on the Rand. Many US and UK Pension Funds invested here are not allowed investments in countries with Junk status. They will have to sell and are already selling.
9. Our Current Account deficit is big, 4% of GDP. This deficit can only be funded by portfolio flows and investments by foreigners because we have very small foreign currency reserves. This has now turned to outflows which means the Rand must take the full pain of adjustment. Raising interest rates to 25% and trying to protect the Rand is useless as 1998 showed. The Rand can go anywhere.
10. Real Rand-hedges will go up as the Rand weakens. They are ETFS like the DBX trackers, Naspers, Richemont, BAT, Steinhoff and many more.

Quo Vadis?
We advocated investing offshore and in real Rand-hedges like DBXUS for years. It is not possible to call a bottom. It will get a lot worse before it gets better. But, we survived the 1985 Rubicon speech, we survived the 1987 crash, we survived the 1998 crash, we survived the 2008 global financial meltdown and the European crisis. We will survive. It will just be a lot less painful if #ZumaMustFall.

Gerhard Lampen.
Head Sanlam iTrade Online.