Outlook 2019

Three of Catella's fund managers gathered to predict the new year. A couple of their forecasts are that central banks will hold off rate hikes, or even cut policy rates, and that value stocks are currently better buys than growth stocks.

In the fourth quarter of 2018, the world's stock exchanges were substantially shaken while the US Federal Reserve continued its plan for higher interest rates. However, January has been all the brighter in the markets since the Fed switched to a more dovish stance.

The background is the long and sluggish recovery that has characterised the world economy since the financial crisis of 2008-2009, during which stock exchanges have done well on the back of monetary policy stimulus.

According to Anders Wennberg, one of the managers on Catella's hedge team, 2018 was marked by the Fed continuing to raise interest rates and tighten liquidity by selling back government bonds and withdrawing money from the market. Such actions usually lead to weak players facing problems, he reasons.

"We have seen it in Argentina and Turkey, within shale gas, Norwegian which is issuing new shares − they are having problems with liquidity. It affects Swedish housing prices, newly floated shares, and so on. While the strong markets, especially the US, and strong sectors like tech and IT have continued upward," he says.

During the final quarter of last year, there were additional concerns in the form of signs of slowdown in several economies, not least China. From a situation of a synchronised upswing in the world economy, the situation has changed to a synchronised decline.

"It has definitely turned. Powered by higher interest rates, slowed economies in China and emerging markets, and concerns about the trade war," says Anders Wennberg, adding that the Fed's softer attitude since the turn of the year has calmed the markets a lot. According to Anders, however, it is too early to rule out the changes being the start of a major slowdown.

"We may even get some economic growth going forward but still not get any profit growth in the companies. We can see that wage inflation is rising, mainly in the US. Trump's trade war and import tariffs affect inflation and input costs for companies. There is a risk that there will be pressure on margins in the future for many companies," says Anders Wennberg.

According to Thomas Elofsson, who is one of the managers of Catella's fixed income funds, it now seems most likely that the next interest rate change from the Federal Reserve will probably not be an increase, but a decrease. The central bank's schedule still includes hikes, but this could quickly change.

"I think they are done for now. Inflation is not a big problem and China is considerably weaker than expected. And there is great uncertainty until we know what tariffs there will be. But my guess is that the next movement will be a reduction, sometime in the second half of the year," he says.

One contributing factor to the stock market turmoil at the end of last year was the upturn in US long-term interest rates, with the 10-year yield reaching 3 percent, at which point it could be seen as an alternative to equity investments. Martin Nilsson, who manages Catella's small cap fund, sees a clear link between the stock market trend and interest rates.

"Of course interest rates played a part in the stock market turmoil. Another important thing was the positioning of investors. When we entered the rather sharp downturn in October−November, people were quite optimistic, and in October many investors were taking on more risk. At the end of the year, it was more about reducing risks in general," he says.

There is now essentially full employment in the US, which has led to signs of wage inflation, not least in low-wage groups. There is even wage inflation in China, which makes it more difficult to import deflation from there in the form of cheap products. The uncertainty about where the ongoing trade dispute between the US and China is heading means that, in future, we will have to keep track of which companies have their costs under control, and which risk being affected by lower profitability as a consequence.

"2019 and 2020 will be years in which it will be very important to keep track of which companies have cost problems and which can pass on costs to the customer. And which companies may have a good cost trend because they use a raw material that is falling in price," says Anders Wennberg.

For Europe and Sweden, the question is whether central banks will dare to raise key interest rates, in addition to the recent hike by the Riksbank. Thomas Elofsson believes that the window has closed for the central banks this time.

"I do not know whether I believe the ECB will raise this year, it is a little on the late side. At its most recent meeting last week, it rather signalled that more stimulus is coming. My guess is that it is trying to postpone the hike that it communicated would take place this autumn. The Riksbank would probably like to raise rates again to reach zero, but that will be tough if the Fed is perhaps closer to a cut than an increase and the ECB postpones its hike. I think it would be difficult for Sweden to raise rates on its own," he says.

Stimulating growth will be a difficult challenge for central banks going forward, believes Thomas Elofsson. Debt has become higher than ever before and the world economy can be described as a slave to stimulus. Every blip in the growth curve creates nervousness: how much stimulus can be provided from the current position?

Really good stock market development may need additional stimulus, according to Thomas Elofsson, and the one with the greatest prospect of being able to deliver this is currently the Federal Reserve. Anders Wennberg points out that a weaker stock market does not necessarily have to be linked to weaker development for the economy as a whole.

"The labour market and employment could hold up well, and we may get tax cuts with the new government in Sweden. The stock exchange has been very strong since the financial crisis in 2008-2009, without any particularly good momentum in the economy. The stock market could now stand still for a number of years, without there necessarily having to be a weak economy," he says.

The stimulus from the world's central banks during the years following the financial crisis has meant that the markets have almost bathed in liquidity. There have been too much of the good times, believes Anders Wennberg, who points out that liquidity has led, among other things, to excessive investments of doubtful value. A company like Facebook has 20 billion dollars in annual investment budget, and huge money is being spent on data centres and various cloud storage solutions.

For Sweden, the stimulus has contributed to a weaker krona, but according to Martin Nilsson the value of this is limited for most of the really large listed companies that have operations worldwide. However, it may have been favourable for medium-sized companies that export and perhaps have only one factory located in Sweden.

Looking ahead, the managers believe it is time for so-called value stocks to outperform growth stocks. The valuation difference between these two categories has increased for many years as growth stocks have performed much better, but now it may be time for the valuation gap to begin to shrink.

"We think it might go down and we would rather buy value than growth. We can note that some companies considered to be growth companies, like the US company Nvidia, a graphics card processor manufacturer, issued a profit warning yesterday. It was a fantastic growth company until just a few months ago, but now seems set to have fourth-quarter sales that are down almost 25 percent. The status of being a growth company can change, and shares like this fall more than 50 percent fairly quickly," says Anders Wennberg.

Martin Nilsson highlights Swedish SSAB as a good example of a value share. The company is trading at low multiples and its latest report, which was slightly worse than expected, did not lead to any share price fall.

"The report was 4-5 percent worse than market expectations. At the same time, it issued guidance for a fairly positive first quarter and this was enough to lift the share 5 percent. Some shares have become so cheap that they only have to show a reasonably positive outlook and have a valuation that is not stretched, and the shares rise. If you are valued as a growth stock and the growth slows, you will be punished hard," he says.

According to Anders Wennberg, the focus in the current reporting period is on companies' prospects ahead, towards the second half of the year and into 2020. The preference for value stocks means that the managers also prefer to choose companies with good dividends but, according to Anders Wennberg, there is a difference between different dividend policies. Companies such as H&M, which distribute more than their profit for the year, are not viewed with the same benevolence as companies with dividends that are well financed by profits and cash flows.
Among the sectors on the stock exchange, Martin Nilsson chooses to highlight forest products, where he believes that companies are attractively valued today after trading down considerably during the past autumn.

"This is a sector I strongly believe in for the longer term, as there is a transition from plastic to more sustainable alternatives. This is positive for forest owners and companies that process the raw materials. The shares have factored in a considerably poorer market. Stora Enso is trading at a p/e ratio of around 10-11 with a dividend yield of 5 percent. In the small caps fund we have bought a lot of SCA, which we think is attractively valued," he says.

Anders Wennberg points to Essity, which manufactures products such as napkins, diapers and sanitary towels. The company had a difficult 2018, mainly due to higher pulp prices. Since then, pulp prices have declined, while the company has started to implement some price increases.

"They should be able to get 20 percent profit growth in 2019," he says.

He also claims that non-life insurance should be able to do well in 2019, after a tough 2018 when large amounts of snow during the spring meant unusually many car crashes. Forest fires during the summer further contributed to poor results in 2018.

"Due to this, the non-life insurance companies have been able to push through price increases of 3, 4 or 5 percent, sometimes even more. It takes time before this can filter through, but it will come through in 2019 and 2020. Unless there are huge amounts of snow, earnings will show positive development in the coming years," says Anders Wennberg.

Another gratifying holding for the managers recently has been the online retailer Boozt, which pleased the market with strong figures for December and was rewarded with a substantial share price increase.

Commodities are a highly cyclical sector and, in the case of metals, performance is also extremely dependent on China, which accounts for more than half of the consumption of certain commodities globally. Lundin Mining is a favourite of Martin Nilsson in this sector.

"I like Lundin Mining, which has a market value of about 3 billion dollars and just under 1 billion in net cash – a huge amount of cash in relation to the market capitalisation. The multiples for this company are becoming attractive and are historically low. It is a classic value company," he says.

When it comes to shipping, Anders Wennberg emphasises that this is really about several widely different sectors, with dry cargo having had a tough time recently. However, Catella Fonder owns shares in Flex LNG, a company that transports natural gas. There, too, the development has been downward lately, but according to Anders Wennberg this is very much due to the unusually cold winter in North America, which has led to the country wanting to keep the natural gas for its own use. A switch to milder weather should mean an improvement, as well as the structural factor that exists in China's need for conversion from coal to natural gas in order to improve the environment and air quality in the country.

For the engineering sector, which is particularly large in Sweden and partly dominant on the stock exchange, the reporting period has so far provided positive figures from Sandvik and Atlas Copco. However, a slowdown can be seen in some areas and Atlas guided in its report for somewhat weaker demand during the first quarter.

Real estate can be attractive as a sector to rely on when the stock market is unsteady, but Anders Wennberg says this can be a risky strategy.

"If the economy seriously slows down in Sweden, vacancies will rise. If liquidity becomes a little worse, it will not only be more difficult for real estate companies to borrow, with higher credit spreads as a result, it will also be more difficult for start-ups to get financing and, if they pull back their growth, less office space will be needed. At the same time, a lot of projects will be completed in Stockholm in the coming years, so I do not feel this is the right place to hide," he says.

A better choice for the cautious may possibly be care companies, which have stable profits and ever-growing needs to meet.

"We are holding on to care companies. We believe this is a structural trend. These are very stable companies with stable revenues, and this will continue to be appreciated by the market," says Anders Wennberg.

Finally, the inevitable question. How will the stock market perform this year?

Anders Wennberg: We will have to measure from this point since it has already risen by an annual return. But I wonder whether it won't finish down. It will be a messy year and the markets may be a little too optimistic.

Martin Nilsson: I say that the stock market will end up 5-10 percent for the full year.

And interest rates?

Thomas Elofsson: The ten-year rate will be slightly higher. I do not expect rates to be raised by the ECB or the Riksbank, and I expect a cut by the Fed.

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