What Does The Ratings Downgrade Mean For You And Your Investments?
Last week kicked off with ratings agency Standard & Poor’s downgrading South Africa’s sovereign debt to junk status.
Other ratings agencies are now likely to follow suit.
So what does this exactly mean?
How is this going to affect you and your investments?
What can you expect from the market and your investments going forward?
And what can you do to fight back?
Let’s take a closer look…
What Does A Downgrade Mean?
Standard & Poor’s downgrade means that SA government bonds have dropped from investment grade to junk.
In other words, our sovereign credit rating is now more risky.
This means a number of things for the country…
Firstly, it means that the debt of the country is now more expensive to service.
This increase in borrowing costs means that the government will have to channel more money into paying debt.
The result of this is the government will have less cash to spend on other things, like infrastructure, to meet this rising bill.
Plus, many overseas institutional investors may dump their holdings of SA government bonds as their mandates may not cover holding junk rated bonds.
Secondly, in light of the downgrade, the rand is likely to weaken.
A weaker rand means that imports are more expensive.
This could lead to a rise in the costs of goods and services for you.
Or, to put it another way, inflation will start to climb to reflect this rise in prices.
To combat this, we could be in line for hikes to the repo rate and the prime rate, making borrowing more expensive for all.
And thirdly, the economy is likely to feel the knock on effect.
With the economy struggling to grow as it is, this ratings downgrade has the potential to stop growth altogether and even send the country into recession.
What The Downgrade Means For You
There are a number of knock on effects...
Knock On Effect #1: Rising Inflation
This equates into higher prices for you.
As you pay more for goods and services, the squeeze on your disposable income intensifies.
You’ll have less to spend as a result.
Knock On Effect #2: A Rise In Interest Rates
It’s more likely now that the repo and the prime rates will increase.
This means that your borrowing costs will also rise.
- Your bond repayments;
- Any short-term loan repayments;
- And the interest rate you pay on your credit card spend.
In other words, unless you have fixed rates on any forms of borrowing you have, you’ll be paying more to service your debt.
Knock On Effect #3: A Slowing Economy
Economic growth has already been under pressure for some time now, but with it likely to slow further, businesses are going to feel the strain.
This means that it’s more likely that you won’t see a salary increase at your next review.
And as businesses try to cut costs, job losses will be more likely.
Knock On Effect #4: Investments Struggle
As you may have already noticed, banking stocks are already paying the price of the ratings downgrade.
Over the past couple of weeks, bank shares have shed nearly 15% of their value.
With the economic future more uncertain, it’s likely that the local stock market will be more jittery.
A volatile market can make investors very nervous. There’s not much worse than watching the value of your portfolio ping pong up and down.
There is also the possibility that some international investors will pull out of their investments in SA.
A drop in demand for SA stocks will put downward pressure on stock prices, never mind the impact of a slowing economy on local businesses.
How To Contend With The Downgrade
The current situation isn’t good, especially with the potential knock on effects to your personal life and investments.
So how can you deal with it?
The good news is there are a few things you can do to help you ride out the storm…
Tactic Number 1: Stock Up On The Yellow Metal
In times of strife, investors turn to gold and gold is a great option for you at the moment.
This is mainly down to the fact that the gold price is in dollars.
Stocking up on gold means that you’ll gain if the rand weakens further against the US dollar.
If you already own gold, great. Considering buying more.
If you don’t, get some exposure in your portfolio now.
Tactic Number 2: Look To International Stocks
Try to bump up your holdings of international stocks.
Ideally, you want stocks that do a lot of their business in stronger economies and little in SA. This means that these stocks are immune to what’s going on here.
An easy way to do this is to buy into exchange traded funds (ETFs) that invest overseas. There are a number to choose from.
Or have a look at SA listed companies that earn a chunk of their cash overseas and have a substantial international presence.
These will also help to bolster your portfolio as they’re fantastic rand hedges.
Tactic Number 3: Don’t Hold A Lot In Cash
If you have a substantial amount of your wealth in cash, beware of the impact of rising inflation.
Inflation just eats into the purchasing power of your rands.
Consider investing it in one of the options we’ve looked at above or keep scouring for the best home for it.
To breakeven, you need to earn a rate of interest that is the same as the current rate of inflation.
Another option is to buy major foreign currencies with some of your cash to hedge yourself against a weakening rand.
For example, buy dollars, euros or pounds. You should be able to do this through your bank.
Tactic Number 4: Pay Down Debt
Before there are any changes to the repo and prime rates, start to put more emphasis on paying off debt you have.
Channel as much as you can into clearing your debt.
This will lessen the impact of any potential rate rises in the future.
What You Should Do Now
There’s no disputing that the South African economy is in for a rough ride ahead given what’s happened in the last week.
But as an investor, you shouldn’t lose sight of the long-term road.
With time, hopefully the country’s sovereign debt will once again achieve investment grade status and the economy will get back on track.
In the meantime, assess your personal finances and investment portfolio.
Take into consideration our tactics to deal with the downgrade backlash and make changes as necessary.
By doing this now, you can protect yourself from the uncertainty that lies ahead.
Until then, here's to profitable investing.
The Money Lab