8 June 2015, Stockholm, Sweden | News
Stock market performance has been very favourable in recent years, with almost non-existent inflation and a large return in real terms. But how does the future look – does the stock market have more to give or are the best days behind us?
Interim reports from Swedish exporters for the first quarter showed excellent numbers on the back of a stronger dollar. In addition, central banks the world over are continuing with highly stimulatory monetary policy, contributing to the favourable environment.
According to Mikael Hanell, manager of the Catella Reavinstfond and Catella Småbolagsfond funds, central banks will continue their expansionary policies in the current situation, while investors, including the major life and pension companies, need to invest their money somewhere where they can obtain a return – which means it is largely ending up in the stock markets. We are living in a time of vigorous stimulus following a financial crisis, and this period is not yet over.
"The one country emerging from the other side is the United States, where interest rate hikes are currently under discussion, but in Europe, Japan and China we will see continued stimulus, which means there is a kind of cushion in the market. The stimulus will not be ended until there is a sufficiently resilient turnaround for there to be a certain amount of inflation in the system, making it possible to start upping interest rates without putting a stop to investments," says Mikael.
In terms of geographical markets, he believes that the weaker euro and stronger dollar will make US growth slightly lower in the future, at somewhere around 2 or 2.5 percent. Similarly, the currency change will lead to more growth in the euro area, and also in Sweden, which is a major exporting country with a relatively weakened currency.
One issue is the value that the stock market should assign to the profits being made on the back of a weakened currency. Should we consider these profits as a one-off effect, or should we continue to expect them in the future? Mikael believes that the currency gains will be incorporated into forecasts, which could possibly be a source of concern because these profits are not based on underlying growth. However, he suggests that valuations must be viewed in relation to current interest rates, making them much more realistic.
"It depends on what we regard as the required return when making a valuation. Interest rates are almost non-existent, so actually a p/e ratio of 25 would not be unrealistic – it's currently around 16. In a historical perspective the p/e ratios are slightly higher today, but if we place this in the context of historical interest rates it's absolutely not the case," says Mikael.
As to hopes and optimism for the various sectors, private consumption is a driving factor. Lower interest rates and lower oil prices are having an impact and larger disposable income will favour consumer-related shares, from clothing to entertainment and hotels. If we look specifically at Sweden, the construction industry stands out as lagging behind the existing strong demand. Mikael Hanell believes that further efforts will be made by government authorities to speed up construction.
The sectors that have done well globally include the pharmaceutical industry and the IT industry. In Sweden, Astra Zeneca was the target of a bid that was then withdrawn, but this still raised interest in the stock. Swedish Orphan Biovitrum (Sobi) is now the subject of concrete bid talks. Mikael has invested in both these stocks on behalf of the fund, and he regards the bid talks as part of a strong trend that began in the US, with pharmaceutical companies buying up research portfolios and with mergers of large pharmaceutical companies.
"We started investing in Astra Zeneca eighteen months ago, and we were not thinking about a potential bid. Astra Zeneca has shown that it has a large number of drug candidates in phase III that will be launched to market in the coming years," which is interesting, says Mikael.
With regard to Sobi, on the other hand, he was thinking about the possibility of a future acquisition. The reason for this is that Sobi's major product is in the field of haemophilia. Sobi invests in small, narrow groups of diseases where the drugs are very expensive. One of the company's drugs, Eloctate, has proven to sell very well; Sobi has an agreement with US pharmaceutical company Biogen Idec for the marketing rights in the United States, while Sobi holds the rights for the EMEA area.
"It was approved by the US Federal Drug Administration some time ago, and Biogen Idec has started selling. It has proven to be a real big seller, so it is not illogical for Biogen Idec to place a bid for Sobi, with its narrow product portfolio and where Biogen Idec was involved in the development. So we believe that Biogen Idec is one of the companies participating in the still-ongoing bidding process. Pfizer may be a name, but it could also be another party. We own a lot of shares in the company, and given this is what we are aiming for over the past three, four or five years, since we started to invest in the company, we want to wait it out and see where this is going," says Mikael Hanell.
Mikael describes this as one of the distinguishing features of Catella's Swedish equity funds, trying to find and stick with companies that have the potential to be acquisition targets or that can spin off profitable businesses. In addition to Sobi, there is Unibet, which spun off its sportsbook in the company Kambi. The challenge is having the resilience to hold on to companies we believe in, because structural changes often take time – sometimes considerably more time than you think.
"These companies have an additional story, something that's a game changer, where they can reveal values that perhaps many investors haven't noticed. Unibet has not been the best share on the stock market this year since it reports its earnings in pounds, which have strengthened over 30 percent against the Swedish krona this year, but if we consider it over the years that we've owned the share it's been a fantastic investment," says Mikael.
Catella's equity funds have also been successful through their holdings in automotive safety company Autoliv, which recently received an unexpected helping hand when one of its competitors, Takata, was forced to recall a large number of vehicles because the airbags did not work well enough.
Sectors such as IT and pharmaceuticals have shown the best growth in recent years. The proportion of IT stocks has been relatively large in the Catella Småbolagsfond fund, with holdings like Mycronic and IAR, which have grown vigorously. The Catella Reavinstfond fund, however, has a smaller proportion of IT stocks.
One important reason for this is that there is only really one major Swedish IT company, Ericsson.
"We have now started buying Ericsson again as we think its valuation relative to other large companies is starting to look attractive. We have not owned any Ericsson for the past eighteen months due to its declining sales in the United States, which have been a strong driver in Ericsson's sales growth for many years. The impact of the falling US market came much later than we thought, so we have actively chosen to wait before returning to the share. However, it is a fine company and a world leader – it was simply that the valuation was far too expensive," says Mikael Hanell.
The Småbolagsfond fund contains several IT companies. Mycronic, which makes mask writers for televisions and other displays, sells around four to five machines a year, but at a price that can amount to approximately USD 40 million each.
As for other sectors, Mikael Hanell talks about the energy sector, which has received a beating as the price of oil has fallen.
"I can imagine that the comparative figures for the sector in the first and second quarters of 2016 will be extremely easy to beat as the oil price collapsed at that time in 2015. I could imagine money being shifted back into this sector again towards the end of the second half of 2015."
But regardless of sector, is it small or large companies that will have the big profits in the future? Mikael believes the former, although he also stresses the importance of diversifying risks because small companies often fall more than large ones when the stock market wobbles.
"I must say that there is always more potential in small companies, and in any case some of these companies will become large companies in 10-15 years. But we also know historically that the market is much more volatile for small companies, liquidity is lower and the stock market climate must of course be right for these stocks to perform."
Mikael says that flows to equity funds have recently slowed, contributing to a somewhat more listless stock market. Among those contributing to the activity, however, are still life insurance companies and other participants that are obliged to deliver returns to their investors.
"If the stock market drops then it's a golden opportunity for them to buy shares and increase their equity weighting since they're not getting much from their bonds at the moment. Given this, plus the stimulus, I do not think we should be overly worried. What could potentially cause the stock market to drop would be some external factor, but I can't guess what that would be – unless it were Greece or further escalation of the conflict in Ukraine – but these are things we always live with.