Nordic equities – challenges remain
SEB lowered its earnings forecasts for 2024 slightly after the third quarter corporate report season, but we still expect earnings growth of close to 8 per cent for Swedish companies in 2024 and 11 per cent in the Nordic region. The consensus also anticipates similar earnings growth in 2024, but earnings forecasts have been steadily adjusted downward this year. The downward revision trend in Sweden is especially clear if we disregard the effect of the weak Swedish krona by looking instead at earnings in euro terms. Consensus forecasts are the most reliable indicator of earnings growth in the near term, but we believe that there is unusually great uncertainty at present. The pattern over the next few quarters may be significantly different compared to the cyclical turning points over the previous 20 years. There is thus an unusually high risk of further downward revisions over the next few quarters, which may well dampen stock market sentiment.
Rates have probably peaked, but high real rates a concern
US market yields fell sharply in early November following signals from the Fed, which the market interpreted to mean that the central bank is now finished with its key rate hikes in this cycle. The fixed income market has currently factored in a nearly 1 percentage point cut in the Fed’s key rate in 2024, though probably not until the second half. US monetary policy and the American fixed income market have a large impact on the world, especially Europe, and long-term yields have fallen relatively far from their October peaks.
We have probably seen the worst regarding interest rates and yields, and some relief is expected in 2024. This is very favourable for the stock market and explains November’s strong start. The rate/yield upturn in 2022-23 has been a major impediment for the stock market during that period. It is thus tempting to conclude that, with yields having peaked, stock market lows should also be behind us, but we fear that may be a hasty conclusion. The latest downturn in yields was preceded by a very sharp upturn in the late summer and autumn. The upturn in real interest rates was especially noteworthy.
Real interest rates are still very high in a short-term historical perspective, and since there is a significant time lag before their impact on listed company earnings is apparent, we fear the stock market will remain unstable for the rest of this year and in early 2024.
Interest rate upturn is slowing green transition
The sharp decline in the share prices of green or environmental tech companies is partly a function of higher return requirements, which have led to lower valuation multiples, but this collapse has largely been caused by a sharp deterioration in market conditions. The most dramatic example in the Nordic countries is the Danish renewable energy company Ørsted, whose share price fell nearly 80 per cent from its peak, wiping out nearly DKK 450 billion of its market value. In comparison, the largest Swedish company on the Stockholm exchange, Atlas Copco, today has a market value equivalent to DKK 485 billion, and the second largest, Investor, is worth DKK 420 billion.
Ørsted was a pioneer in building offshore wind farms and continues to be a leading player in their design, but it also invests in onshore wind power and solar farms. Offshore projects in particular are large and complex and take a long time to build. Like virtually every other industrial firm, Ørsted has been affected by cost increases in recent years as well as company-specific problems. Most importantly, Ørsted is caught in a bind when capital costs increase dramatically because of higher interest rates and bond yields. Revenue is based on long-term fixed rate contracts for the electricity that will be generated. Consequently, several large projects that have already been launched are no longer economically viable. Like many of its competitors, the company has been unable to renegotiate its electricity rate contracts and has instead chosen to abandon projects, leading to billions of DKK in losses. The steep fall in Ørsted’s share price is not just because of the losses already reported, but also a deterioration in its potential to build new projects that will generate profits as well as lower profitability in existing projects.
Selective bargains among squeezed small caps
Small cap shares have performed much worse that large cap shares, not just in the Nordic region and Sweden specifically but also in the US. In Sweden, valuations for small caps are still higher than for companies in the OMXS30 index of most actively traded equities, making it hard to argue that they are especially undervalued as a group, although the small cap index has fallen 30 per cent since January 2022 and the OMXS30 has slumped only 10 per cent. This is partly explained by the greater negative impact of the economic slump and interest rate increase on small companies, which have had slower earnings growth, especially during the past 16 months. The other explanation is that a number of the larger companies in the small cap index, whose shares are often especially popular with small cap funds, still have valuations at very high multiples. Some of the more expensive equities are valued at higher P/E ratios, based on forecast record earnings, than such US growth standouts as Nvidia and Tesla. This has pulled up the overall P/E ratio for the index. Below the surface, however, a lot of small cap equities have become really cheap.
One sector that we think is especially attractive today, and where many shares are valued well below a reasonable long-term level, is real estate. Over time, real estate companies should have valuations relatively close to net asset value. If they are significantly cheaper, they will be bought up by someone who wants to own the underlying assets and can get them at a discount. If listed real estate shares are generally valued far above the market value of their assets, this will instead attract new companies and funds to the stock market until the supply of real estate shares corresponds to investor demand and a more balanced valuation is reached again.
Esbjörn Lundevall
Equity Analyst, Investment Strategy