Trouble Lurks For This Emerging Markets ETF

The iShares MSCI South Africa ETF (NYSEArca: EZA) is down more than 39% over the past year and on Monday, the lone exchange traded fund dedicated to Africa’s second-largest economy slumped to a new 52-week low as investors are becoming increasingly concerned South Africa is heading toward a downgrade of its sovereign debt rating.

South African stocks have proven particularly vulnerable due to the country’s status as a major producer of precious metals, such as gold, palladium and platinum. Inflation has been rising after a drought in the south pushed up food prices. Additionally, oil prices have been rebounding. The rising inflation will have an effect on consumer sectors. [South Africa ETFs in Focus]

When Standard & Poor’s downgraded Brazil’s sovereign credit rating to junk status in September, market participants immediately began pondering which emerging market would be next to suffer the junk downgrade fate. South Africa was one of the first to be mentioned.

“South African assets are likely to remain under pressure from a toxic combination of heightened political concerns, poor economic fundamentals, and growing [debt]downgrade risks. While today’s “flash crash” was overdone, the likely direction for the rand seems clear … The rand has been one of the worst performers in EM, and that is likely to continue. Our emerging market FX model has South Africa near the bottom of our league table with VERY WEAK FUNDAMENTALS. In 2015, the South African rand (ZAR) was the third worst performer in EM, down -26% vs. the U.S. dollar (USD) and behind only the Brazilian real (BRL) (-33%) and Argentine peso (ARS) (-35%). This continues in 2016, with ZAR the worst EM currency at -8% year to date. USD/ZAR made a new record high today near 18 with a “flash crash” during the Asian session. The pair has since fallen back, but we expect further dollar gains ahead,” according to a Brown Brothers Harriman note posted by Dimitra DeFotis of Barron’s.

In December, Fitch Ratings pared its rating on South African debt to just one level above junk while S&P reduced its outlook on the country’s bonds to negative from stable.