South African Market:

June brought with it a few notable domestic developments prior to the world’s focus on the UK’s astonishing vote to leave the EU.

The month started with the much anticipated announcement from S&P which affirmed South Africa’s foreign currency bond rating at one notch above sub-investment grade, or “junk” status. In its statement, S&P warned that low GDP growth and rising political tensions could still see a downgrade in its rating this year (December 2016) or next year “if policy measures do not turn the economy around”. All eyes are on our political and business leaders as they scramble to make the case for not downgrading South Africa. Most of the published analyses implies that this is essentially a fait accompli.

Hot on the heels of the S&P announcement came the news that the South African economy shrank by an annualised 1.2% in the three months to March of 2016, compared to 0.4% growth in the previous quarter. Add this to the additional headwinds SA growth will face following the Brexit announcement which research shows will remove another 0.1% from South Africa’s GDP growth, and it makes the investment case for South Africa Inc. decidedly difficult.

Leading up to the Brexit announcement, the Financial Index was making steady gains for the month, up 2.1%, whilst the Resources and Industrial indices were in marginally negative territory. The Rand had gained ground against all the major currencies, trading at $14.31 to the US Dollar. The Brexit announcement changed all of that, and within two days the All Share index was down 7.1% for the month and the ZAR / USD back to $15.40, one of the worst performing emerging market currencies, due to our trade ties with the UK. Gold showed its defensive qualities and was up 9% for the month in the aftermath of the announcement. A number of SA Fund managers have held an exposure to gold over the last 6 months for the diversification that it provides.

By month-end the market’s initial reaction was muted somewhat, with the All Share index making up some of its initial losses, ending the month down 3% and the Rand strengthening to $14.73, assisted by the reporting of a bigger-than-expected trade surplus of R18.7 billion for May.

Global Markets:

News of Brexit shocked the world. Financial markets responded and the MSCI world index lost 7% in the first two days after the vote, Sterling collapsed to 30 year lows against the USD.

This crisis is a political crisis, and has brought new risks onto investors’ radars. The potential for additional fall out through contagion arises as the populist parties of other EU members may be emboldened by the British vote. It is expected that EU leaders will take a very hard line with the UK, to send a clear message to other members that being outside the EU is not better than being inside. Levels of uncertainty are high, which brings with it volatility.

Emotions aside, what does it mean for investors? We have digested pages of analyses on this topic over the week. The following points neatly summarise the consensus:

The UK is expected to go through a minor recession, and the Euro area is expected to go through a slowing of growth over the next 12 months. It is not necessarily the case that there will be a material impact on global growth as the UK contribution to global GDP is less than 3% of global GDP.
Central banks are expected to respond with commitments to supporting the global economy through any slow down with increased liquidity to the banking system, dampening investors’ fears.
The US will delay rate hikes and markets currently indicate that any interest rate move by the FED this year, is more likely to be down, than up.
According to JP Morgan, the direct impact of Brexit to U.S. corporate profitability will likely be contained, with S&P 500 revenue exposure at 1% to U.K. and 6 to 7% to Europe.
If concerns about a slowing global economy mount, capital flows to emerging markets will slow, meaning emerging market currencies will come under further pressure. Barclays emerging markets research team expect the Rand to move above $16.00 by year end. Other estimates are less extreme, expecting the Rand to trade around $15.00.
Although the SA economy’s growth is fragile, a hit to the Rand may well see the SARB increase interest rates again, but not before the election in August.
Above all, these events serve as a reminder that when investing one has to “expect the unexpected” and use the benefits of diversification to protect your assets from unforeseen events.

A well‑constructed investment strategy takes into account the fact that the investment will go through market shocks such as these. We simply advise riding through the volatility that may come. History has taught us that whilst corrections are worrisome at the time, they are a mere blip over the long term, and inevitably turn out to have been a great investment opportunity.