Nordic equities – Prevailing uncertainty
Earnings growth continues to provide upside surprises. The outlook is far better than we had dared to expect just 6 or 12 months ago. Inflation problems are quickly receding. Market worries are instead related to central banks taking too tough an approach to tackling inflation and thus hurting the economy more than necessary. Valuations are normal in historical terms. Investor sentiment is clearly vulnerable, and there are many dark clouds on the horizon, which suggests there will be high volatility at times. However, all in all we believe solid earnings growth will outweigh negative factors, which is why we have a cautiously optimistic stock market outlook for the rest of this year.
Holding off a profit plunge
There have been frequent warnings over the past 15 months of an imminent earnings recession, driven by the economic cycle. Strategists with a macroeconomic focus have warned that earnings forecasts need to be revised downward, particularly before each of the last five quarterly report seasons. Reality has again defied these gloomy forecasts. Not only was there an overwhelming preponderance of upside earnings surprises for the first quarter of 2023, but order bookings also showed remarkable growth. Nor was any deceleration apparent at the start of the second quarter. If they had any comment about April’s performance, manufacturers were consistently positive in describing the situation. Those industrial companies that dared to provide full-year forecasts have in many cases revised them upward. For Nordic industrials, we have revised our 2023 earnings forecasts 12 percentage points higher over the past three months, including an 8 point upward revision in the past month. These revisions over the past three months reflect adjustments both before and after the report season, whereas our revisions during the past month have been made only after quarterly reports were released. Following the latest upward revisions, we are forecasting earnings growth of 25 per cent for Nordic industrials this year. It is not just industrials that shine bright. Banks had another unusually good report season, with large upward revisions in forecasts. We have raised our 2023 earnings forecasts for banks by another 11 points over the past three months, with an 8 point upward revision in the past month. We are now forecasting earnings growth of 24 per cent for Nordic banks this year.
It has also been an impressive report season for health care, with plenty of positive news. We have raised our earnings forecast for 2023 by 8 percentage points over the past three months, with a 6 point upward revision in the past month. We now expect earnings growth of 26 per cent for Nordic health care companies this year.
Oil and shipping hamper performance
There are big differences between sectors. Given the differences in composition among the Nordic stock exchanges, we see that upward revisions in earnings forecasts predominate in Sweden, whereas the overall earnings forecast for the Nordics has been revised lower. The oil industry in Norway and one large Danish container shipping company account for most of the downward revision and for the 14 percentage point decrease in earnings forecasts for Nordic listed companies as a whole. Falling oil and natural gas prices and a normalisation of container cargo rates after several years of extreme rates, in turn, account for these downward revisions.
However, the most troubled sectors – real estate, residential construction and consumer goods – are not particularly important to the equity indices or aggregate earnings. On the Stockholm stock exchange, real estate and construction together with the consumer durables and retail sectors account for less than 13 per cent of the index. Industrials constitute 34 per cent, banks 8 per cent and health care 7 per cent. These strong sectors overshadow the above-mentioned problem sectors by a wide margin.
Many investors and financial journalists seem to focus excessively on the general economic trend in Sweden, which stands out negatively in an international comparison of forecasts, when assessing the outlook for listed companies. For major industrials in Sweden, domestic sales often account for less than 5 per cent of their total, and domestic sales are often related to products for another exporters.
Valuations are neither tempting nor discouraging
Share price valuations are currently within a normal range and are not causing either positive or negative stock market sentiment today. Large cap stocks on the Stockholm exchange are valued at a consensus price-earnings (P/E) ratio of 15.3 based on a 12-month forward consensus forecast. That is 0.4 percentage points below the average for the past 10 years. For the Stockholm exchange as a whole, the P/E ratio is 16.0, or 0.7 percentage points below the 10-year average. For the Nordic VINX index, the P/E ratio is 16.7, almost exactly in line with the 10-year average.
High valuations like those in 2021 can be a strong argument for negative investor sentiment towards equities, while low valuations like those in September 2022 can be a strong argument for positive investor sentiment. However, we believe today’s historically normal valuation levels in themselves do not provide material support for anything other than a relatively neutral outlook.
It can be argued that higher-than-average bond yields over the past 10 years should justify lower earnings multiples, but higher inflation may also lead to higher nominal earnings growth for listed companies, which should have the opposite effect. It was also hard to see any positive material effect on Nordic equity valuations when yields collapsed in 2014-2016. Swedish long-term yields, both nominal and inflation-adjusted, are back at about the same levels today that they were in 2013-2014. The same is true of equity valuation multiples.
While monetary stimulus measures in response to the COVID pandemic had a clear role in inflating the 2020-2021 stock market bubble, it is much more difficult to see clear effects on stock market valuations prior to this as a consequence of declining yields in 2013-2019.
Esbjörn Lundevall
Equity Analyst, Investment Strategy