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9 April 2018, Sweden | Mutual Funds | News

Stay on course in the stock market

The global economy has recently been shaken by US gambits over trade tariffs on steel and aluminium. China has responded by announcing tariffs on goods such as pork, but it is too early to draw parallels with 1930, when world trade shrank by 70 percent. Instead, the global economy appears to be facing an unusually resilient period, with a synchronised upturn in both the United States and elsewhere – and in a number of different industries. Danske Bank's strategist Mattias Sundling and Catella Fonder's Henrik Gripenvik, who manages the Catella Aktiv Sverige Hållbarhet fund, are quite unanimous.

In terms of trade tariffs, it seems that China has chosen to kick off with small and largely symbolic product groups, but this is naturally something that could escalate. Mattias Sundling says that soybeans and aircraft are two of the largest export products from the US to China, and tariffs on these would hurt.

The big question is, of course, will this escalate?

"There are parallels to 1930 and the catastrophic decisions that were made then, but I do not think this comparison fits. I think, rather, that this is something similar to the 1980s – when there were constant trade conflicts between the US, Europe and Japan, which was the equivalent of China at that time. Back then it wasn't enough to damage the economy, and I do not think it will this time either," says Mattias Sundling, who suggests this issue is quite nuanced.

US President Donald Trump sees every gambit as part of a negotiation, and his starting point is not necessarily wrong. China has been dumping in some cases, and the reaction of the United States is not necessarily mistaken.

"There's a lot of rhetoric in all of this, too. It's about a negotiating position, and we have often seen Trump start quite aggressively before toning down what he has to say," says Henrik Gripenvik.

Mattias Sundling does not believe the tariffs battle will have any major impact.

"I think Trump's economic policy will have a predominantly positive effect on growth. The crucial thing this year is his fiscal stimulus, partly through tax reforms and partly through the increase in spending – these are huge and overshadow just about everything else," he says.

Are you are saying that the stimulus could push up US stock markets?

"Yes, and it reveals that Trump's different aims conflict with each other. You can't say that we'll have a smaller external deficit while at the same time reducing cuts in the economy. Whatever he says, he will raise the external deficit given his tax cuts. But for the first time in this recovery, since April 2009, I think the US will grow by 3 percent – driven by this stimulus," says Mattias Sundling.

US stock market valuations are relatively high, but there are plenty of indications that US stocks may be a good investment going forward. Mattias Sundling says that Danske Bank is overweight in the United States because the country has better momentum in its indicators, currency and company earnings.

"There could be 20 percent growth in earnings per share in the US this year, partly due to the tax reforms," says Mattias Sundling.

An important issue for the future is, of course, whether inflation will accelerate. The beginning of the year has not offered particularly high numbers, yet there are concerns. Capacity utilisation seems to be quite high, and intensifying fiscal policy late in the cycle should actually lead to higher inflation.

But Mattias Sundling still does not think that will be the case.

"There seem to be large labour reserves, and wage increases are not gaining momentum. So I think it will continue, and this is also what the fixed income market is telling us. We were a bit worried about interest rates in January, but they have since fallen," says Mattias Sundling.

But there is full employment!

"That's the thing; I do not believe that there is full employment. There is a fairly low labour participation rate, so there are probably a lot of available resources. On top of this, digitalisation, demographics and other structural factors are holding back the pace of wage growth," continues Mattias Sundling.

"This is interesting because interest rates are back at the level they were at when the stock market stood at its peak. Clearly the market has receded on something other than higher interest rates," says Henrik Gripenvik.

The US market is heavily influenced by tech companies, which have taken a battering, partly following pressure from Donald Trump, who is clearly a thorn in the side of online retailer Amazon.

"I'm generally quite upbeat about the stock market at the moment, even though it may not be driven by tech. The economy is very strong. I think the market will be powered upward, perhaps not driven by tech but more by cyclical companies like the engineering sector," says Henrik Gripenvik.

Technology shares represent about a quarter of the S&P 500 index, and these companies have greatly contributed to rise of the US stock exchanges. It is relatively rare for technology stocks to underperform and for the stock market as a whole to rise, but Mattias Sundling says we are entering just such a period.

"Tech is a very disparate sector and there are lots of different things we are worried about, and a large number of threats to Google, Amazon and Facebook. I think that what is common for the whole sector is a raised political risk premium. These companies are too big and they face regulatory threats, either in terms of privacy or due to their monopolies. They have become a bit too big for their own good," says Mattias Sundling.

Henrik Gripenvik also believes that the engineering sector has more to give. Not least because its performance so far has mostly has led to companies replacing outdated equipment and topping up inventories, rather than investing in larger capacity.

"So this step is yet to come. Investment and capex budgets will increase for the year, and this will benefit engineering companies," says Henrik Gripenvik, adding that the biggest position in the sustainability fund is the classic industrial company SKF.

"We expect higher volumes, and there is a misconception in the market about the company's ability to raise its prices to counter raw material costs. The stock is very cheap, both relatively and in absolute terms. It has taken quite a beating, somewhat unfairly," he says.

Will SKF have any trouble with US steel tariffs?

"No, they have their own production there. SKF has been through a period when it has been very difficult to raise prices, but it has just entered the part of the cycle when these companies are traditionally able to push through their price rises. In addition, we like the mining exposure of Atlas Copco, Sandvik and also Outotec, so this is another area where we believe there will be fairly large investment going forward," says Henrik Gripenvik.

Both commentators have little time for the perception that a recession is knocking at the door just because the current upturn has lasted for so long. Time is no argument in itself, and a business cycle can last a long time.

In addition, the current cycle has not yet offered certain fundamental components.

"There has been almost no sales growth in engineering companies, and this has only got going in the past year. Capex and the machinery investment cycle have also hardly got going. So in that sense the recovery is still quite young. It's now that things will gain real momentum, now that all countries are better synchronised. So it's too early to leave the engineering sector, which I'm also overweight in. We have Konecranes, ABB and Outotec as our picks," says Mattias Sundling.

Outotec and ABB are also included in Henrik Gripenvik's portfolio.

"Yes, we have both. We have had Outotec for a while, ABB a little more recently. ABB is a classic late-cyclical case, but it's a more complex beast than many of the other companies," says Henrik Gripenvik.

We have been expecting European growth for quite some time, while unemployment has fallen from 12 percent to around 8.5. Is it now that the European economy is going to start really pulling forward?

"We should remember that for two consecutive years European GDP growth has been higher than that in the US, and people would have laughed at you in 2015 if you had predicted that. But the fact is that Europe's growth was higher in full years 2016 and 2017. The momentum is a little faltering right now, many indicators seem to have peaked if we look at Germany's IFO or Sweden's NIER barometer. I think that's the main argument for people's scepticism – people think, "The cycle has peaked so I'll sell now". But in twelve months I think it will be even higher," says Mattias Sundling.

Danske Bank is neutral at sector level when it comes to commodity stocks, as they "like steel but not forest products", as Mattias Sundling expresses it. Henrik Gripenvik is more upbeat about non-ferrous metals.

"We have been more optimistic about copper, zinc and that kind of commodity. Steel is quite exposed to what China is does, and they can be pretty changeable," says Henrik Gripenvik.

Oil has shifted violently in recent years and is now trading at levels around USD 60 per barrel. This price level is usually regarded as quite good, in terms of which producers can make a decent profit. Catella's sustainability fund avoids investments in fossil fuels, but Danske Bank has been overweight in the energy sector since early January. Mattias Sundling believes that the price will hold and may continue upward, helped by a strong economy.

Something that has been driving the Swedish economy is consumption, which seems to have slowed down even though the conditions may seem brilliant.

"The housing economy has obviously peaked and weakened, although this is not particularly visible yet. But GDP forecasts for Sweden predict exactly the same growth this year as last year, which feels overoptimistic. At Danske Bank we are a bit below those forecasts. The risks are on the downside," says Mattias Sundling.

"I can only agree. We have had an underweight in H&M because it is having structural problems in the transition to online and is lagging behind. And they seem to be lacking awareness of the problem – they should be cutting store numbers rather than increasing them as they are doing. And they need to do something about their inventory as they keep having to increase their discounting," says Henrik Gripenvik.

But you like Boozt?

"Yes, that's the flipside of the coin. It is benefitting from e-commerce. And we like Husqvarna, which is also included in this sector," says Henrik Gripenvik.

Catella's Arvid Lindqvist expects the housing problems to put a brake on Sweden's GDP growth in the autumn. And this would eliminate some of the consumption need. The question is whether this will be offset by exports for the engineering companies. Mattias Sundling does not believe so.

"Our official GDP forecast is 1.7 percent. Consensus, I think, is 2.7 percent," says Mattias Sundling.

"I think building-related is about feeling that we have reached the bottom with the estimates, and I'm not sure we're really there yet, even if things are starting to get pretty cheap," says Henrik Gripenvik.

When will it be time to pick up these shares then? There have been price falls of up to 60 percent for some housing developers.

"But there is no certainty that all residential developers will survive. It's companies like JM that we should buy at some point, but we think it's too early. Actual housing construction has hardly even started to fall in the way we think it will," says Mattias Sundling.

Banking and finance tend to be highlighted as sectors that benefit from higher interest rates, because these make it easier for banks to increase their margins. However, Mattias Sundling is hesitant about this sector, despite arguments that banks are cheap and also offer good yields, with dividends in many cases of 6-7 percent.

"But we have argued that there is a structural problem with banks – the yield curve is flattening and interest rates are not rising, there is some kind of correlation there with the net interest. We are worried about tougher competition for mortgage loans and about volume growth, it still looks very good but we are worried that it will slow," says Mattias Sundling.

Henrik Gripenvik favours non-Swedes from the range of Nordic banks.

"When it comes to banks we have preferred Danske Bank and DNB rather than Swedish banks. There are structural changes going on at Swedish banks, mortgage margins are very high, making it perhaps more interesting to game the challengers," says Henrik Gripenvik.

Danske has been overweight in the pharma sector for some time, according to Mattias Sundling, which he believes worked well even when the stock market as a whole was rising. He describes the sector as attractive, saying that the political pressure and the risk in the industry are exaggerated.

"We are overweight in pharmaceuticals, and have been for some time, which has actually worked well even when the stock market was rising. But many pharmaceutical companies have expired patents, so there are interesting product portfolios. I think the political pressure and the risk in the sector are exaggerated and forecasts are stable, so it has been an attractive sector," says Mattias Sundling.

Do you have any particular picks in the pharmaceutical sector?

"We have Novo Nordisk and Sobi," says Mattias Sundling.

"We had Sobi in our portfolio for a long time, but felt that at around SEK 140 when we exited it was more about the company being bought up than anything else. We really think that the care companies are more interesting, Attendo and, particularly, Ambea, which has taken quite a beating. Ambea could be traded north of SEK 100 in two or three years. It has very stable revenues and its forecasts could hold," says Henrik Gripenvik.

Sweden

Henrik Gripenvik

Fund manager
Direct: +46 8 614 25 56
Sweden

Mikael Wickbom

Senior Sales Manager
Direct: +46 8 614 25 51

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