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Nordic countries face the second half of the year with better expectations than Europe
Investment in Europe

Nordic countries face the second half of the year with better expectations than Europe

Sector diversification, de-correlation between stock markets, and the export orientation of Nordic companies, suggest a scenario of lower volatility that favours the Nordic equity investors.

23 AUG, 2022

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Imagen del autor

By Jani Kurppa


The economies of the Nordic zone countries - Sweden, Finland, Denmark, Norway and Iceland - face the second half of 2022 from a position of strength, but with the concerns of higher-than-expected inflation and higher interest rates, according to experts at Nordic asset manager Evli.


Solid growth expectations

Despite the region's slow post-pandemic recovery, the Nordic countries have returned to a similar or higher level than before, which is not the case in Western Europe, whose exposure to higher energy and food prices is another. The growth figures for 2019, 2020 and 2021, together with expectations for 2022 and 2023, make the Nordic markets a region with solid growth prospects, comparable to the US or Europe as a whole.

Thus, Current Account Balances and Budget Balances are at a good level, with the exception of Finland, affected by the prolonged political inability to carry out structural reforms. Downward revisions to GDP growth expectations for this year and next year are between 0.5 and 1.0 percentage points. The revised average growth rate in the Nordic countries for 2022 is between 2 and 3 percent.

Sectorial diversification

One of the keys to the strength of the Nordic economies is sector diversification, which brings value to investors. The different developments in each market depending on local circumstances, and the high weight of small and mid-cap companies, provide numerous investment opportunities.

For example, the housing sector. A rising market throughout the developed world, thanks to abundant additional liquidity from central banks. However, homeowners and professional real estate investors must contend with factors such as write-downs, higher leverage ratios, higher financing costs, and more difficult refinancing prospects.

The Nordic housing markets have risen sharply over the past ten years, and the pandemic generated additional momentum in almost all of them. In Sweden, where the sector has a notable weight in the equity indices of small and mid-cap companies, the performance has been below that of the overall index.

In the case of Norway, it is an outlier both on a Nordic and global scale, due to its huge oil and gas reserves. The exposure to the energy sector in the second half of the year of the Norwegian index is therefore relevant.

The Industrials sector is the most important sector in all the Nordic countries, with the exception of Denmark, where Healthcare predominates. In the Swedish small-cap index, industrial companies have a weight of more than 30%, while Energy accounts for less than 1%. In addition, the Industrials sector accounts for almost a quarter of the VINX Small Cap Index weighting; Financials, Information Technology and Healthcare each account for around 12%, while Energy only has a 5% weighting.

By country, Sweden weights almost half of this benchmark, Denmark about one-fifth, Norway and Finland 12% each, and Iceland only 3%. Export-oriented countries have many market-leading companies listed in different Industrial and Consumer Durables niches.

In conclusion, Nordic small-cap companies have offered and continue to offer investors high potential in Alpha, thanks to their sector diversification, in addition to the strong weight of the energy sector.

Interest rates hikes

ECB, Riksbank and Norges Bank are all expected to hike by 50bps in September. The 3 central banks are estimated continue hikes in fairly similar pace and reach terminal rates during H1 2023.

Finland is part of the Eurozone, but Sweden, Norway, Denmark and Iceland have their own currencies and central banks. The Danish krone is pegged to the euro, and Iceland has a small economy, so the Norwegian and Swedish central banks are the only relevant Nordic central banks.

Despite the fact that non-euro countries do not synchronize their interest rates with those of the ECB, all their economies face the same inflation challenges, so similar rate hikes of around 2 percentage points are likely across the Nordic currencies.

In the case of Evli's Nordic corporate bond strategy, currency exposures are fully hedged, with different currencies within a portfolio allowing for significant diversification in terms of sectors, economies and monetary policies, which can provide stable returns in any credit cycle.

Nordic bonds, unique asset class

Nordic bond markets are reacting to these sharp rate hikes by widening their credit spreads in a similar way to the large European credit markets.

Bond markets outside the Eurozone are taking advantage of the fact that the assets traded are mainly floating rate bonds, thus avoiding the negative price effect of rising interest rates, which is why they bring very little duration to the portfolio.

Compared to European corporate bonds, Nordic bonds are a unique asset class, because it is a market that does not have a benchmark for international passive management investors. Local investors who invest do so with a "buy and hold" perspective, which keeps volatility at relatively low levels. In addition, many Nordic companies fall into the cross over segment (between BBB and BB ratings), which brings a higher risk-adjusted return to investors.

Both European and Nordic markets are less liquid at the moment, which is common after sharp market movements. The last time prices moved so strongly was at the start of the pandemic, although liquidity in the Nordic markets is in a better relative position now, than in March 2020.

Nordic issuers: cross over, no rating

The main question for investors in Credit is whether or not the companies are in good health, i.e. whether they have balance sheet strength. In the case of Nordic companies, regardless of current recessionary fears, they are in very good health.

Given the current prolonged inflationary outlook and rising energy prices, there has not been a significant change in credit quality at the corporate level. Companies have been able to adequately pass on inflation to their end customers. This is different from the COVID-19 pandemic, when many companies came to a complete standstill.

Today, the greatest relative value in the Nordic bond market is to be found in Nordic issuers that are not rated Investment Grade, and spreads have widened against issuers with similar risk ratings. For the long-term investor, the level of yield on a cross over portfolio with an average BBB credit quality has risen to 4.30%, a level only seen before the pandemic.

A good opportunity for investors is to lock in a position in Nordic bonds, as they can earn an additional 50 to 150 basis points of yield versus comparable euro-denominated European bonds. This additional yield is supported by the fact that most issuers are either in the cross over segment, or are high quality but unrated companies that can easily find funding in large capital markets.

Nordic stock markets: de-correlation

The Nordic countries are very export-oriented, so many of their listed companies derive most of their revenues from abroad. In the short term, this may facilitate a negative correlation between the various Nordic equity markets depending on the macroeconomic environment. This factor can bring value to the equity investor, as overall portfolio volatility is reduced, due to the negative correlation between different countries or assets.

For example, Nordic economists have kept Norway's GDP revisions neutral or even slightly positive for 2022, confirming a negative correlation of Norway with its Nordic neighbors in a similar macro environment. Danish stock market has also outperformed (in local currency terms) Swedish and Finnish indices, which are considered more cyclical given their sector distribution compared to the healthcare-tilted Danish market.

Currently, the Nordic sector that has benefited the most is consumer discretionary, which benefited from increased demand during the pandemic phase. However, although companies in this sector have outperformed analysts' expectations for their quarterly results, market reactions have been tepid to say the least.

Negative sentiment prevails in the rest of the sectors, but it is uncertain how long it will last, as it will depend on changes in consumer confidence. It is therefore key to know when negative estimates of corporate results will bottom out, which will help analysts to anticipate which themes, sectors and stocks will lead the next upward trends in the market. For this scenario to be fulfilled, it will be key for inflation to fall and for interest rate levels to stabilize.

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