Euphoria or logical response to higher earnings forecasts?
The Nordic stock markets delivered excellent returns in the first four months of 2021. Upward-revised earnings forecasts have fuelled the stock market, and many people now see light at the end of the coronavirus tunnel, which has further driven risk appetite. The outlook for the economy, inflation and the trend of interest rates and bond yields may be especially important this year. Robust growth continues to provide good prospects for cyclical companies, while the reopening of economies should be positive for many consumer-related companies. When growth occurs and some inflation creeps in, it is likely that the question of valuations will be more relevant. This is expected to be a hot topic during the second half of the year.
This is a summary – click here to read a longer article on pages 11-14 of the latest Investment Outlook.
Composition of the Nordic stock exchanges
The stock market as a whole has been strong this year, and there has been great focus on returns for various categories in the region’s equity indices, mostly for cyclical, defensive (quality), value and growth shares. The Nordic stock markets differ a great deal in their composition of these categories, which means conditions are different on each exchange in terms of the current macroeconomic situation and valuations.
"Three companies account for more than 50 per cent of market capitalisation in Denmark’s KFX index"
It is important to understand that the Nordic stock market indices reflect the largest and most frequently traded equities, which gives great weight in some markets to a particular sector or heavy exposure to a single company. The clearest example of this is Denmark’s KFX index, where the three largest companies account for more than 50 per cent of market capitalisation.
The sector breakdown for the four main Nordic stock exchanges gives an indication of their sensitivity to the business cycle, although we must always take into account exposure to specific companies and the fact that equity index components are subject to change. For example, five years ago banks and industrials were the two largest sectors in Sweden’s OMXS30 index, each with about 27 per cent. Today industrials account for 35 per cent and banks 13 per cent. Valuations do not differ that much between countries except that Denmark stands out, from a European perspective, with its high stock market multiples. This is due to the large role of pharmaceuticals and the fact that the industrial and commodity sectors include companies with less cyclical characteristics than normal. Norway has a large energy sector and many financials, whereas traditional industrials and IT have a low exposure. Finland has a large commodity sector, mainly in the forest product industry, but a low percentage of consumer-related companies. Sweden is dominated by industrials but also has a large share of consumer-related companies. Normally, the Swedish stock market is the one that is most sensitive to economic cycles, followed by Norway (where oil prices are crucial) and Finland.
Style rotation has fizzled
We have written previously in Investment Outlook about the “expensive has become more expensive” trend. What has that looked like in the Nordic stock markets this year?
During the first quarter of 2021, we saw some change in investment patterns as growth and inflation forecasts were revised upwards, leading to purchases of value and cyclical shares to the detriment of shares with higher valuations. Starting in mid-March, when US 10-year Treasury yields peaked, the 2020 winners took back control.
Sweden stands out amid the rotation
There has been a clear rotation this year in favour of value shares globally. However, there has been no rotation in Sweden, since growth shares have outperformed value shares. We see several possible reasons for this. The semiconductor shortage has generally hit Swedish industrials hard, since many have a relatively large exposure to the automotive industry. When AB Volvo announced in late March that it would stop truck production for 2-4 weeks during the second quarter due to a semiconductor component shortage, it worsened an already negative trend for a number of vehicle-related companies. Major fashion retailer H&M also lowered the value of the Swedish equity index in March due to China’s boycott of the company. Yet value shares have delivered very good returns this year in Sweden, in fact by far the best in the Nordic region and high on the global list. Growth shares, mainly IT and gaming companies, have performed even better. Evolution Gaming stands out as the biggest driver of the growth share index. We still see good potential for value shares in 2021 based on sharply higher growth, rising inflation and yields (in controlled fashion).
Reports have exceeded upward-revised forecasts
First quarter earnings reports so far have been robust. In many cases, investors that had clearly expected this chose to sell on the report date. Nonetheless, April as a whole delivered very good returns, with the stock markets in Denmark and Finland as the strongest performers.
In Sweden the small cap index rose by 7.8 per cent in April, after having lagged behind large caps early in the year. In May, SEB’s small cap barometer surged, which suggests that conditions for small caps are on the path to normalisation.
"More than 70 per cent of Swedish companies have delivered earnings that exceeded market expectations"
If we take a closer look at the Swedish stock market, 75 of 96 companies in the SBX index have reported their Q1 results at this writing. More than 70 per cent have delivered earnings that exceeded market expectations, while 22 per cent reported worse results. Companies have been good at keeping down costs, and in many cases margins are higher than expected. In general, there have been currency headwinds following a sharp appreciation in the Swedish krona, which will probably remain strong over the next quarter as well. In terms of sales, companies were more evenly divided, with 49 per cent reporting positive and 46 per cent negative figures and with many noting certain capacity shortages. It is clear that the next important step for earnings will be to increase total sales, a likely scenario since we now foresee strong growth and reopening of economies, while order books are filling up at a steady pace. Analysts are continuing to upgrade earnings forecasts since the reports came out, which is normally the most important driver for share prices.
One clear trend is that companies are warning about higher prices for input commodities and logistics. Equally clear is that they say they will be able to fully offset this with higher prices and have already started the process. This is very interesting since the producer price index confirms that scenario, while inflation expectations among consumers are on the rise. The question is whether we will ultimately see higher final prices for consumers, and if so what that will mean for future interest rates and yields.