A swift and decisive change in monetary policy around the world, involving inflation almost out of control, continues to reverberate in various corners of the market, and international equity ETFs are no exception.
Higher Interest rates in the US designed to suppress persistent inflation seeped into currency rates, pushing developed world currencies to record lows against the mighty USD. Meanwhile, growth concerns caused multiples to compress and pushed equity valuations significantly lower. In the case of Europe, the energy crisis amid geopolitical headwinds also contributed greatly, resulting in the euro trading at par with the dollar, a level not seen since the early 2000s.
In my May article on the iShares MSCI Sweden ETF (NYSEARCH:EWD), an index-tracking ETF with a portfolio of 46 stocks in the current iteration, I warned that forecasted higher inflation and softer economic growth amid a U-turn in monetary policy were a bearish combination capable of sending Swedish stocks and the krona were already in trouble. even lower.
It seemed that I identified the risks correctly as since then EWD price is down nearly 14% while the S&P 500 is down just 71bps. Overall, since the start of calamitous 2022, EWD is down 20% and has been the worst performer in the Nordic peer group that encompasses the iShares MSCI Denmark ETF (EDEN), the Global X MSCI Norway ETF (NORW), the iShares MSCI Finland ETF (EFNL), and also behind the US market represented by the iShares Core S&P 500 ETF (IVV), as well as the global non-US stocks of the iShares MSCI ACWI ex US ETF (ACWX).
A contrarian would justifiably point out here that the time has come for stocks listed in Stockholm, as the drop is simply horrible and therefore seems exaggerated. However, I am not so sure as there are still risks from both SEK and Swedish companies in the short term, so I will not update EWD to Buy today.
Bulls could point to the decidedly aggressive Riksbank here as a strong supporting factor. Certainly, the central bank did what was necessary to stifle inflation. In September, explaining that “inflation is too hot”, decided to increase the policy rate massively, by 100 bp, now standing at 1.75%. However, the large increase was not enough to send the SEK/USD rate significantly higher. In fact, the drop continued well into October.
What are other factors weighing on the krona and Swedish stocks? European energy crisis, among other things. This is somewhat contradictory since the country has abundant water resources in the northern part, and the populous southern part (including Stockholm) has nuclear power plants that meet a high demand for electricity. For example, from the BP World Energy Statistical Review 2022, more than 29% of Sweden’s primary energy consumption in 2021 was covered by hydropower, while nuclear power was responsible for 21% of the total 2.28 exajoules. Compare this to Germany’s 12.64 exajoules, of which a measly 1.4% was hydro and 4.9% nuclear. However, this is far from the whole story. The problem is that the power grid in the south of the country relies in part on imported energy, so high natural gas prices could easily seep into bills, thus affecting activity and contributing to the possibility of a recession. Which is certainly a bearish factor for crown and EWD positions as well.
Speaking of a recession, the central bank has already significantly lowered its GDP growth outlook for next year from the 0.7% expected in June to a 0.7% contraction mentioned in its September press release. This is a direct consequence of both high prices and higher interest rates. With the medium-term outlook for the policy rate also updated, the regulator made it clear that suppressing inflation would require more decisive action.
There are other factors to consider. For example, the National Institute of Economic Research recently released an October 2022 Economic Trend Survey titled “Very Weak Consent in the Economy.” The main conclusion is that the ET indicator decreased sharply, by 6.2 points to 84.6, the change similar to that reported in September when it slipped by 6.4. This is a vivid summary of the gradual deterioration in the economic outlook, with retail and services especially slow, most likely due to the painful combination of inflation and higher interest rates.
Among the key losers is the construction market, as builders’ expectations for the next twelve months are at their lowest point in thirty years. And given that almost half of Swedish mortgages have a variable rate, this is not a surprise.
However, this has not yet been fully reflected in the financial results. For example, Skanska AB, a construction and development company that represents approximately 1.1% of the EWD portfolio, recently released its third quarter report, in which almost all metrics are quite strong, especially when you consider account its “historically high order book”.
However, the fact is that Skanska operates in the Nordics, Europe and the US, with the latter accounting for over 46% of Construction segment operating income in 9M 2022, so its results do not look as affected by the weakness of the real estate market in Sweden. . Also, on page 4 of the 9M reportthe company mentioned that the outlook for the next twelve months for residential development in Sweden, Norway and Finland remains weak.
Regardless, stocks are down over 26% YTD in Stockholm at the time of writing as the market has been pricing in an economic slowdown.
Importantly, while EWD has comparatively little exposure to homebuilders who will feel the ripple effects of the Riksbank’s fight against inflation, financial institutions such as Nordea Bank (~7.1% weight) represent around 29%, and for them, higher rates are not necessarily a net positive despite anecdotal evidence suggesting that it is too much. In fact, this is a double-edged sword, as they can suppress loan growth despite helping to increase net interest income.
On the bright side, October’s confidence indicator for manufacturing fell 4.5 points to 105.1, but remains “stronger than normal.” For heavy industrial EWD which has ~37.7% of net assets deployed in the sector, this is positive.
It’s no surprise that Swedish stock investors are feeling sad. Sky-high inflation and the Riksbank’s efforts to tame it did little to support the bruised corona, but contributed to the economic slowdown which manifested itself in a significant deterioration in sentiment as discussed above, with a recession risk not to be ignored in the midst. of the domino effects of the European Union. energy crisis. I am not a SEK bull at the moment.
That said, I see little reason to move away from SEK and Swedish equities entirely, considering their historical weaknesses offer an opportunity for patient investors.
9.9x EWD Rate of earnings on price could be one of the reasons. Amid economic woes, the ratio has shrunk phenomenally this year; on Jan 12, it stood at 21.75x, indicating that a value opportunity likely arose. However, I would like to reiterate a point I made in the previous article. Compression of earnings in the midst of a recession could result in a decline in stock prices, even if the P/E remains very low.
In general, investors who have a horizon of more than two years and who are willing to tolerate losses could consider dollar cost averaging in case the Fed’s hard line continues to affect developed world currencies and in case of Sweden entering a recession.
In short, I maintain a neutral rating on the Swedish equities in the EWD portfolio despite the positives that exist due to the decidedly aggressive Fed, a factor that bodes badly for the krona in the first place.