Outlook: Nordic markets face headwinds from a position of strength

Macro view of the Nordic markets

Key market themes: Nordics in good shape and comparable to the US

The Nordics are entering the 2022 financial crisis from a position of comparable strength. While the region’s recovery from the pandemic was slow, the Nordics are back at a level similar or higher than pre-COVID, which is not the case for Western Europe that has different exposures to higher energy and food prices.

According to economic outlooks from two leading Nordic banks, the growth figures from 2019, 2020 and 2021 combined with growth expectations for 2022 and 2023 have the Nordics looking in good shape and can be compared to Europe or the US.

While Evli doesn't usually focus on GDP growth expectations or historical growth rates, the current account balances and budget balances are at a good level, aside from Finland unfortunately due to the long-lasting political inability to make structural reforms. The downward revisions that the banks have made for GDP growth expectations for this year and next year are between 0.5-1.0 percentage points. The average revised expected growth rate in the Nordics for 2022E is 2-3 percent.

Keep a close watch on the Nordic housing market

From a Nordic perspective, one of the key things to follow is the housing market. The market has been booming around the developed world thanks to abundant extra liquidity from the central banks, but the question is how homeowners and professional real-estate investors can cope with write-downs, higher leverage ratios, higher financing costs and harder refinancing outlook.

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. The underperformance reflects the regime shift seen in the SEK interest rate markets during the couple of months. Thus, for the real-estate sector, and equity markets in general, inflation and resulting interest rate expectations will be closely monitored by investors.

Nordic drivers are far more than just energy

Norway is an outlier on both a Nordic and global scale because of its vast oil and gas reserves. When analysing different sector exposures in H2 between the Nordic economies, energy is just one of several drivers.

Industrials is the biggest sector across the Nordics, aside from Denmark where healthcare dominates. In Carnegie’s Swedish Small Cap benchmark index, industrials carry a weight of over 30 percent, while energy is less than 1 percent. In addition, industrials make up almost a quarter of the weight of the index (VINX Small Cap Index) we use to track small and mid-cap companies on a Nordic level—finance, information technology, and healthcare each make up around 12 percent, whereas energy has only a ~5 percent weight.

From the country weight perspective, Sweden makes up almost a half of the benchmark, Denmark around one fifth, Norway and Finland ~12 percent each and Iceland just 3 percent. The export-oriented countries have produced many listed market leaders in different industrial and consumer durables niches. Consequently, Nordic small cap companies have offered and continue to offer alpha potential from several other sources alongside the energy sector.

Nordic Corporate Bond Markets

Norwegian and Swedish central banks step ahead of ECB

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.

While Finland is part of the eurozone, Sweden, Norway, Denmark and Iceland all have their own currencies and central banks. The Danish Krona is pegged to the Euro and Iceland has a small economy, so the Norwegian and Swedish central banks are the only meaningful independent Nordic central banks.

Even though the non-euro countries have no official synchronization with ECB rates, their economies all face the same inflation challenges so it is likely that we will see similar rate hikes of ~2 percentage points across all Nordic currencies.

In addition, as highlighted in The time is ripe for Nordic bonds blog, currency exposures are fully hedged at the fund level, with different currency areas within a portfolio enabling significant diversification in terms of sectors, economies and the use of monetary policies — these can provide stable returns over credit cycles.

Floating rate bonds avoid the negative price effect

Nordic bond markets are reacting to this tectonic change by widening their credit spreads in a similar way to the larger European credit markets. The non-euro markets are being supported by the fact that they consist mainly of floating rate bonds and are avoiding the negative price effect from rising interest rates, so they add very little duration to the portfolio.

Compared to a European corporate bond, Nordic bonds are a unique asset class because its market doesn’t have a benchmark for international passive asset management investors. Local investors with a "buy and hold" view dominate the market, keeping asset volatility relatively low, plus many Nordic companies are in the crossover segment (between BBB and BB ratings), which offers a higher risk-adjusted return.

Both the European and Nordic markets also have less liquidity now, which is typical during big market reactions. The last time price reactions were this high was at the start of the pandemic, but the liquidity situation is better now than back in March 2020.

Nordic companies currently in a good shape

From a corporate perspective, the main question for credit investors is whether the companies are in a good state of health or not, namely is the balance sheet solid? Regardless of the recessionary fears present in the market, it is clear to see that Nordic companies are extremely healthy.

Accounting for the current prolonged inflationary outlook and higher energy prices, there hasn’t been a significant change in credit quality at a company level. Companies have been able to adequately transfer inflation to their end clients. It seems that visibility is much better now than it was at the start of the COVID-19 crisis when many businesses came to a total stop.

At present, the best relative value in the Nordic bond market is being found in unrated Investment Grade-types on Nordic issuers and spreads have widened against similar risk-rated issuers. For the longer-term investor, the yield level for our crossover Nordic portfolio with average BBB-credit quality has risen to 4.30 percent. These levels were previously only seen during the worst moments of the pandemic.

It is also a good opportunity to build an investment position in Nordic bonds, with investors able to gain an additional 50-150 basis points of yield versus comparable euro-denominated European bonds.

As mentioned in The time is ripe for Nordic bonds blog, this extra yield has solid support because many of these are crossover companies, as well as companies that are high quality but unrated, which can easily find funding in a large market. In the current environment, this could be an intriguing investment opportunity.

Nordic Stock Markets

Negative correlation can lower overall portfolio volatility

The development of domestic economy is important, but it doesn't necessarily equal the development of domestic stock market. While the linkage usually holds for US, thanks to its vast home market, the export-oriented Nordics see many of their listed companies derive the bulk of their revenue from abroad.

In the short term, there might be a negative correlation between different Nordic equity markets depending on the macro environment. This is valuable in equity investing because you can lower your overall portfolio volatility by having a 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.

Closely monitoring when sectors and markets will bottom out

There is a clear trend currently visible on the stock market surrounding companies that benefited during the pandemic, especially the consumer discretionary sector. Even though companies from this sector might have been able to exceed analysts’ expectations when reporting their quarterly results, the reactions in the stock markets have been lukewarm, to say the least. The negative sentiment and estimate revision trend are expected to continue during the Q2 reporting season. How long this sentiment will continue is hard to tell, but changes in consumer confidence and possible bottoming of the sentiment are important pieces in the puzzle.

Currently, we are trying to ascertain whether we have reached the bottom in different sectors, markets or with certain companies, as well as what are the themes, factors or stocks that will be leading the next bull market. What we know from the future is that the companies that led the latest bull market are usually not the ones leading the next upward trending market.

When the market will turn is unknown, but decreasing inflation prints and stabilization of interest rate outlook will definitely play an important role.

Ville Tiainen, Analyst, Nordic Equities. Ville is following companies and sensing the next big trends in the Nordic and global market.

Jani Kurppa, MSc (Econ), Senior Portfolio Manager Evli Nordic Corporate Bond fund. Jani has almost 20 years experience in the fixed income markets, specializing in corporate bond portfolio management. Jani joined Evli in 2008.