A year for stock picking

The recently concluded reporting season was generally strong, and many of the year-end reports were better than analysts had expected. The management outcomes for Catella's equity funds were also strong in the fourth quarter.

"On average, analysts' estimates have been upped slightly. The areas that performed better for us were largely construction-related, like Ahlsell, Nobia, Inwido and JM, which did well. Autoliv, Resurs Bank and Gränges were somewhat weaker. But overall it was an entirely acceptable reporting period," says Henrik Holmer, one of the managers of Catella Småbolagsfond.

In terms of specific trends, the managers particularly foresee strength for construction companies in Sweden, which are benefitting from continued high demand. Banks have also been very strong after long-term interest rates bottomed out and turned upward, and expectations of future interest rate hikes also increased. The only disappointing bank this time was, unusually, the normally reliable Handelsbanken.

Among the companies that came in slightly weaker were those disadvantaged by the rise in commodity prices during the second half of the year, and not able to compensate for it. This problem applies, for example, to some companies in the industrial sector.

Guidance from companies for 2017 has been important, and perhaps even more important than usual. In some cases, an unexpectedly positive outlook has been able to outweigh and offset slightly weaker results.

"We have seen downward adjustments of earnings for several years, attributed to falling interest rates. Interest rates are now rising, and all things being equal perhaps share prices should decrease. But now earnings are also starting to turn and the economy is looking better. For me, it is clear that upward revisions of earnings are taking the lead," says Martin Nilsson, the other manager of Catella Småbolagsfond.

The change in direction for interest rates has otherwise mainly affected real estate, which has had a tough time.

"The stocks traded on higher interest rates are in the real estate sector, particularly against banks. Real estate is hugely disadvantaged by higher interest rates, and fell back last year, while banks are benefitting particularly from the movement away from negative rates, and we have seen a significant recovery," says Anna Strömberg, who is part of the management of Catella Reavinstfond.

The beginning of last year, 2016, was clearly negative. Then came a turnaround with a shift from more growth-oriented companies to cheaper value companies. Have these companies also become expensive, or is this a change that will persist?

"A year ago they were cheap, but now I would say they are pretty reasonably valued. It's clear that the valuation gap against the expensive quality companies has narrowed. But, as long as interest rates are rising, value companies will benefit over growth companies, which have been driven by multiple expansion as interest rates have moved to zero," says Martin Nilsson.

Henrik Gripenvik, another manager of Catella Reavinstfond, points out that local Swedish trends often play a fairly small role for the really big companies - less than one might think.

"Most industrial companies are global and benefit not only from a positive trend in Sweden but also from US investment or the Chinese economy," he says.

As to Swedish interest rates, Cecilia Skingsley has said she expects us to start increasing them in 2019. What do you think?

"That's a tough question. We have seen that the direction of interest rates is changing, but a large increase in rates is not expected or probable, as I see it," says Anna Strömberg.

"But Sweden is a small country. Inflationary pressure is starting to come in the US, and even in China, and I don't believe we're immune to that. I think interest rates will rise – it's a change in the trend," says Martin Nilsson, who sees a risk of rising interest rates dampening Swedes' desire to spend, followed by a drop in the stock market.

"But it depends on why rates are rising. Whether it's because the economy is stronger, or because of inflationary pressures," says Anna Strömberg.

Swedish exporters have benefited from the Riksbank forcing down the krona.

"It's always difficult to say where a currency is heading, but we come back to the fact that Sweden is a small country with a small economy, and that the Riksbank has limited scope to act. We will be forced to raise interest rates apace with rises abroad, and so I do not anticipate any drastic changes in the exchange rate," says Henrik Gripenvik.

Among the recent changes made by Catella Småbolagsfond, a clear-out of the portfolio's real estate companies is particularly notable.

"The big change we made in the second half of last year was to not have any real estate in the portfolio, and this clearly benefitted the fund as those companies had a tough time in the second half. Then we bought a lot of cyclicals after the summer and these have performed very well, including Boliden, which issued one of the very strongest reports for the fourth quarter," says Martin Nilsson.

"We have a fairly high proportion of banks, and those are domestic by definition. And a very small percentage of real estate, just one company. Then we have construction-related, which we see as domestic rather than international exposure. As well as the major exporters, where we have been selective, but we have cyclical exposure as well," says Anna Strömberg.

Martin Nilsson raises a warning flag for 'high-multiple companies': fast growers that have shot skyward, partly because of the record-low interest rates. By high-multiple companies he means businesses, such as in pharmaceuticals and biotech, that sometimes have a p/e ratio around 40.

"They become very sensitive when interest rates start to tick upward. If they disappoint, the share price reaction can be very large," he says, pointing instead to the opportunities of finding undervalued companies with multiple factors, known as triggers, that could considerably boost the share price if they come about.

"We made investments last year in Holmen, which you could buy for 1 x book value. There are large numbers of value investments out there for those with a long-term stance, and I believe this will be what drives the stock market going forward. But it's not enough just for something to be cheap – there must be a trigger for the valuation," says Martin Nilsson.

In terms of sectors, Catella Småbolagsfond has the weight of its portfolios in consumer, IT and also industrials. There are plenty of banks among the major companies in Catella Reavinstfond, but Anna Strömberg says this is not about a general preference for the financial sector since this includes businesses such as investment companies, where Catella Reavinstfond has a very low percentage.

"Consumers, banks and industrials are our big themes," says Henrik Gripenvik.

Is there anything you are avoiding?

"Companies with problems and that are struggling with costs, since demand is not particularly strong. The rise in steel prices over the past six months is the largest since 2007, but it has not been driven by demand like it was back then. It's driven by duties, by capacity shutdowns and by companies merging, so these are completely different reasons. But prices are rising all the same," says Martin Nilsson

And anything you particularly like?

"On the industrial side, we have a large position in Volvo since we believe this company will continue on its path of successive performance improvements," says Henrik Gripenvik.

"SCA will split into two companies this year, which we believe will reveal value for mergers and acquisitions," adds Anna Strömberg.

Among the smaller caps, Henrik Holmer highlights technology company Tobii.

"Tobii is an interesting case among the small caps; it works with eye tracking. There are some very interesting applications and areas of business. The developments are very rapid."

Important information
Investments in fund units are associated with risk. Past performance is no guarantee of future returns. The money invested in a fund can increase and decrease in value and it is not certain that you will get back the full amount invested. No consideration is given to inflation. The Catella Balanserad, Catella Credit Opportunity and Catella Hedgefond funds are special funds under the Swedish Alternative Investment Fund Managers Act (SFS 2013:561) (AIFM). Catella Reavinstfond and Catella Småbolagsfond may use derivatives, and the value of the funds may vary significantly over time. The value of Catella Sverige Index may vary significantly over time. Catella Avkastningsfond may use derivatives and may have a larger proportion of the fund invested in bonds and other debt instruments issued by individual national and local authorities and within the EEA than other investment funds, in accordance with Chapter 5, Article 8 of the Swedish Investment Funds Act (SFS 2004:46). Catella Nordic Long Short Equity and Catella Nordic Corporate Bond Flex may use derivatives and may have a greater proportion of the funds invested in bonds and other debt instruments issued by individual national and local authorities and within the EEA than other investment funds. For more details, complete prospectuses, key investor information, and annual and half-yearly reports, please refer to our website at catella.se/fonder or phone +46 8 614 25 00.