Market outlook 2016

The events that have rocked the markets recently are Chinese growth, which is slowing, and the US economy, which has shown declining trends. Things become particularly difficult when these two macroeconomic factors occur simultaneously. US industry is being impacted by a sharp decline in oil prices, while the dollar has strengthened.

Private consumption otherwise remains a strong driver of the US economy, and car sales were at record levels last year. Some commentators have even begun to wonder whether American car loans might start to resemble a housing bubble.

"The biggest issuer of subprime loans in the US automotive sector is Santander Consumer, and the bank's share price fell nearly 20 percent a few days ago. There has been a huge upsurge since the financial crisis, and car sales have taken off," says Martin Nilsson.

When the decline in oil prices started, and for much of the downturn, they had a perfect negative correlation with the S&P 500 index, so they moved in completely opposite directions. This was the case from a level of USD 150, right down to USD 40. But when oil prices moved lower still, the relationship changed and they switched to instead having perfect correlation with the S&P 500.

"There are two main reasons for this: first, deflationary pressures in the world economy that accompany the oil price decline; and second, the fact that when you trade oil below USD 40 a barrel, many producers begin to have difficulties, and this is a sector with a very high level of borrowing. If prices remain low, banks with a high level of lending to companies in the sector will experience bad debt losses. This is one reason for banks performing so badly in the US," says Martin Nilsson.

What is the most important? The effects of lower oil prices and increased scope for consumer spending, or that the oil industry is taking a beating, which also affects the debt side?

"Ultimately, I absolutely believe that the positives outweigh, so the consumption part," says Martin Nilsson.

The slowdown in China has been in focus since last summer, with stock market slides accompanied by somewhat calmer periods. Actually, however, the slowdown in the country is nothing new – it has been happening for a long time, according to Martin Nilsson. This has also been apparent in the reports of Nordic companies. It is likely, moreover, that the actual growth rates in China are lower than the official figures.

But the falls in stock markets are new. The average p/e on the Shenzhen stock exchange was 70 before, and it has fallen sharply.

"The Chinese stock market is highly speculative. If we look at last year, we had a sharp rise and then a crash at the end of the year, which continued into this year. But it is easy to forget, with all the media coverage, that the Chinese stock markets were actually up last year," says Martin Nilsson.

For the remainder of the year, the issue is whether China will make a comeback as a driver of the world economy. The question of why China is not using stimulus is often incorrectly asked – the country is still using a lot of stimulus, but sometimes in new areas. When there were weak car sales figures in late summer, for example, the government was quick with incentives to stimulate demand, which had a rapid effect. Martin Nilsson says that the automotive industry is an example of an ideal sector for stimulus, since it has both a consumption element and an industrial element.

Other markets include Brazil, which is a major oil nation under intense pressure. The country is working hard with oil reserves located in deep water and with an economy that has taken a beating. Russia is also a major oil producer and has political problems. The question is how these two countries will handle the coming year. Martin Nilsson believes this will be governed by how things go for the key commodities.

"What matters is actually how commodities perform. If we examine the emerging markets boom that we experienced, it was actually a China boom, and other countries followed on its coat tails, including Brazil, which earned a lot of money from iron ore and oil. Brazil's problem is that its deep-water fields are high-cost fields. Much of its production has a breakeven level significantly above the current price. Looking at the Nordic companies with large exposure to Brazil, they unanimously say that 2016 will be much weaker than 2015 – and 2015 was already a poor year."

In the Nordic Long/Short fund, you have caught on to the fact that companies with greater exposure to these countries have underperformed, and have had more short positions. Do you think this pattern will persist?

"If we look at the beginning of this year, it is fairly similar in relative terms to last year. At that time, there was a strong stock market early in the year, driven mainly by cyclical industrial companies. This year we have had a weak stock market, but it is first and foremost cyclical industrial companies that have performed well. Generally speaking, smaller companies are doing better. It is worth noting that two of the worst reports so far are telecom operators, where you can hide when things are turbulent. But both TDC in Denmark and Tele2 in Sweden have fallen by more than 10 percent on their reports," says Martin Nilsson.

It is often said that it is time to buy when there is blood in the streets, but you make it sound like we are not really there yet.

"If you have a long horizon, as we do, I think that many cyclical companies have come down to attractive levels. But that does not mean that their profits will shine this year. As usual, it is important to buy quality and companies with strong balance sheets. We have topped up the portfolio on the long side with companies that we think are attractive.

Norway has been Sweden's largest export partner, but has had a tough time. Its currency has softened and the oil industry is weak, as are subcontractors in oil services. Shipping has also performed poorly for some time. A question many are asking is whether this could be contagious on the economy, so that Norwegian banks also have a tougher time.

"The banks have lending to shipping and oil services companies. But there are parts of Norway benefitting from this, although they are much smaller. One sector experiencing a boom is salmon, which benefits from a weaker Norwegian krone. We also have a company called Tomra, which we have held for a fairly long time. It works with recycling and does not have anything to do with shipping or oil," says Martin Nilsson.

According to the Swedish National Institute of Economic Research, Sweden is entering a boom. The growth rate for the past twelve months is 3.9 percent, while the Riksbank has a negative interest rate. Is Riksbank Governor Stefan Ingves unable to revive inflation? According to Martin Nilsson, we have to realise that the Riksbank's ability to influence inflation is limited.

"The housing crash in the United States and the financial crisis was the first part in a series of events that have created deflationary pressures. The euro crisis was the second part, and the third part, which we are going through now, is weakening in emerging markets. This is difficult for an individual central bank to combat," says Martin Nilsson.

Sweden has recently received a record number of asylum seekers, and the total is likely to reach around 160,000 for 2015. This influx will affect the economy, both on the cost side and the consumption side.

What are you doing to take advantage of the propensity to consume?

"We have companies on the long side of our portfolio that are consumer-driven, especially with Nordic and European exposure. We have a lot of construction companies, and we saw NCC issue a fantastic report that swept up many of the other construction-related stocks that we have. Areas where we are being cautious are large industrial companies and, selectively, pharmaceuticals," says Martin Nilsson.

Other areas that may be interesting in 2016 are actually cyclical companies in general and Finnish companies in particular.

"I believe there will be very good opportunities this year to buy into cyclical companies, although I think it is too early yet, and we are talking mainly Swedish cyclical companies, but also some Finnish. The Finnish market has been in recession for four years, largely because of poor export markets, Russia's slowdown, etc. Many companies there are starting to look attractive, and this is probably the great opportunity we envisage this year."

Among the possible short positions, Martin Nilsson mentions service companies in the pharmaceutical sector.

"One company that recently published its report is Getinge, where we have been short for quite a while. We believe its valuation is far too high, analysts are overly optimistic and the underlying trends remain negative," he says.

The fund also has short positions in some of the major engineering companies.

Something we have not mentioned is Europe as a whole. We are seeing improvements in a number of countries, notably the UK, Ireland and Spain. Could this be interesting?

"Absolutely. Construction looks very positive in large parts of Europe, and Europe is an attractive market to invest in. The risk being talked about is naturally Brexit (the possibility of the UK leaving the EU), which could be a source of concern this year. I saw one opinion poll that asked voters: If there are no concessions from the EU almost 80 percent wanted to leave. If things were to remain unchanged 60 percent wanted to leave, and if there were big financial concessions most wanted to remain," says Martin Nilsson.

Your stock market outlook for 2016, where do you think we will end up?

"I believe we will land in positive territory, and the trend will be the reverse of last year. We will see a positive second half, driven mainly by a better European economy. So I say plus, but I do not believe it will be a great year for stock markets. We will have positive growth of around 6 percent."

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