The fund manager about Catella Hedgefond

. Investors relied on continued expansionary fiscal policy and the prospect of a gradual recovery in global manufacturing, especially the Chinese car industry, which saw a relatively large decline in production levels in 2018-2019. Confidence in this rapid recovery came to nought as the number of sick and dead in China rapidly increased and the authorities were forced to take drastic measures to prevent further spread of infection. The stock market's risk appetite also diminished even more as the virus spread and was discovered in neighbouring Asian countries as well as in Europe and the US. During the last seven trading days of the month, the index fell sharply to finally close -6.1 percent for the whole month. The Stockholm and Helsinki exchanges were down in line with the Nordic average (-6.4% for both), while Copenhagen performed slightly better (-4.3%). The Oslo exchange performed worst (-9.1%). The small cap index (CSX) lost 8.0% after having previously risen by 25% over some three months. Internationally, the decline was very similar, and MSCI World (-8.6%), S&P 500 (-8.4%) and Euro stoxx 50 (-8.6%) all fell steeply. Fear of a markedly weaker economy caused the US 10-year bond yield to fall from around 1.5% to 1.15%, while the German equivalent noted -0.61%.

Catella Hedgefond fell 2.51% in February, and unfortunately both shares and fixed income contributed to the decline. The explanation of the weak performance in fixed income was wider credit spreads in the wake of the turmoil around COVID-19 and our short position in interest rate risk, which had a negative outcome as interest rates fell during the month. The fund's long equity positions (including derivatives) contributed -4.4 percentage points and the shorts +2.4 percentage points. The largest positive contributors were short positions in index futures, long positions in Sdiptech (+18.5%) and Boozt (+12.8%), and a short position in Alfa Laval (-10.3%). The losers this month were long positions in Ambea (-23.3%), Wallenius Wilhelmsen (-30.1%) and H&M (-18.1%). These losses represent three-quarters of the total losses in the equities portfolio. Both Sdiptech and Boozt released strong reports for the fourth quarter, while Ambea's report was clearly negative, and work on restoring margins in the units it acquired from Aleris is taking longer than expected. This is obviously a disappointment, but our picture of the company's long-term value and earning capacity has only changed slightly. We have reduced our profit estimates by just under 5% and expect the company to earn SEK 6 per share in 2020 and more than SEK 7 in 2021. This means that it is trading at around half the P/E of a broader stock market index despite better growth and, in our opinion, greater transparency in the bulk of its earnings. Wallenius Wilhelmsen reported lower-than-expected volumes in the fourth quarter, at the same time as market concerns about the future of global trade in general, and maritime car transport in particular, intensified in the wake of the coronavirus epidemic. H&M released a quarterly report that was stronger than expected, but the share was nevertheless penalised by the company having to keep stores closed in China. About 10 percent of the company's stores are in China, but the country accounts for only 5 percent of sales. More difficult to assess is the impact of possible disruptions in production. So far, the company states that it does not expect any major problems due to the virus (it uses around a dozen factories in Hubei province compared to more than 600 in the whole of China), but this could of course change rapidly, especially if other parts of Asia are heavily affected by the epidemic.

The coronavirus has led to unusually high uncertainty in global assessments and no one can say with certainty how bad or how persistent the epidemic will be. At best, the number of those infected within the next few months will slow, and then the general effect will probably be weak economic activity in the first and second quarters, but then a recovery. However, if other parts of the world are forced to take the drastic measures we have seen in China, the consequences could be quite drawn out and would be most worrying for businesses with high debt that, due to a potentially paralysed situation, fail to receive the cash flows they need for interest payments. Fortunately, balance sheets in the Nordic countries are generally in good shape and the situation is not at all as alarming as during the 2008-2009 financial crisis.

In previous market newsletters, we have worried about what we see as historically strained valuation levels in the stock market. The downturn in February has certainly corrected this somewhat, but at the same time we are coming from a high level and profit estimates for the current year will need to be adjusted downwards significantly. For example, if we look at the OMXS30, the forward P/E 12 months is now in line with the average of the last five years (15x) while the much broader Stockholm Benchmark index is still trading at a high 20x earnings one year forward.

That said, the stock market is very oversold in a historical perspective, which suggests at least a short-term bounce-back. With more than 80 percent probability, the market usually returns 7 percent on average within 0.5-3 months of a similar decline to the one we have now seen. In support of this is the fact that interest rates are now even lower, that central banks are discussing further relief and that fiscal stimulus is being used to bridge the problems. Furthermore, the rate of coronavirus infection seems to be declining rapidly in China, and other countries such as South Korea are also showing some hopeful signs.

On the other hand, the damage to the world economy has already happened and growth outlooks for the first and second quarters must be substantially reduced with the risk of further negative consequences if it turns out that undetected deficiencies in corporate supply chains are revealed during the spring. On top of this, we have a cyclical upturn that has lasted for over a decade and has been stimulated by expansionary monetary policy of historical dimensions. Should the market's confidence in the ability of central banks to influence both the economy and the asset markets be damaged, risk premiums could quickly rise sky-high.

We are trying to be responsive and pragmatic in the current situation and will hopefully be able to exploit the mispricing that naturally arises during periods of high market turbulence.

Catella Hedegefond
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