Every one of our investment decisions – from the strategic allocation of assets between equities and fixed-income securities to the choice of individual securities – is based on a combination of macro and micro economic information. When assessing macro-economic trends, we attach great importance to the information we receive on the micro-economic level.
Top-down analysis is preponderant in conjunction with the strategic allocation of assets, while corporate analysis is preponderant in the selection of individual securities. Every week, our managers analyse and compile assumptions based on growth, interest rate expectations, currency trends, and earnings expectations with respect to various geographical areas (the US, Europe, Japan, and the Nordic region, specifically Sweden). Assessments are carried out regarding the stock markets’ valuation levels, money supply and flows, as well as psychological and technical factors. The analysis results in conclusions regarding allocations in the portfolios. The equity model portfolios are thereafter adjusted to take into consideration, among other things, currency and business cycle risks.
Our assessment of the current investment situation is that there are significant risks on the downside in the international business cycle assessments and that the lingering effects of the financial bubble have probably been underestimated. Most macro-economic analysts and strategists have regularly been forced to revise their forecasts downwards, but are still relatively optimistic.
We are most concerned about the effects of a possible increase in unemployment, primarily in the US, but also in Europe, due to continued cut backs in companies in the prevailing weak market climate. However, rate cuts and stabilisation in leading indicators combined with early signs of optimism in some companies perhaps indicate the start of a new economic cycle.
All in all the signs on the micro and macro-levels indicate a ‘muddle through’ scenario. Our current investment strategy is based, in part, on the fact that growth expectations in the US and Europe are too high and also that analysts will further reduce earnings expectations for many Swedish companies.
These have enjoyed artificial stimulation thanks to the weak Swedish kronor, primarily against the US dollar. As a consequence, Q1 comparisons will constitute an unpleasant surprise in many cases. Thus, we attach great importance to stock-picking and pruning of stocks that have failed to perform.
Changes in earnings expectations are usually crucial for the stock market’s direction. Balancing the probable continued reduction in expectations, one should note the fact that analysts currently predict that earnings will increase by approximately 30% next year (excluding Ericsson) and that the valuation of the Swedish market indicates a potential of about 25 to 30%.
The risks are high but we believe them to be more than well-discounted through these very high risk premiums, especially in the longer perspective. In addition, the liquidity flow to the stock market will probably increase after a reduction in key interest rates and after having been significantly over-sold during September and October. Life assurance companies have been forced to sell stocks due to insufficient solvency margins, a factor which has contributed to the panic. From a strictly technical perspective, the downward trend since February 2000 has continued unabated, notwithstanding the recent significant upturn, which gives cause for particularly great caution when assessing the short-term trend.
Based on the relatively low valuation of the stock market, the money supply, the liquidity flows, as well as psychological factors, our conclusion indicates that we passed the lowest point of the stock market on 10 October and that the fundamental trend on the Swedish stock market will remain upwards. However, the upturn will lose steam towards the end of the year and become significantly more volatile compared with the past two months.
Notwithstanding an over-weight in equities in the allocation, the risk on the downside in the customer portfolios is at the same level or lower than the market risk. So now we have a large portion of value stocks in the portfolios, as well as a certain degree of liquidity. This means that we can rapidly adjust the tactical allocation and exploit possibilities in the market.
Gunnar Håkanson is head of equities at Catella Institutional Asset Management in Stockholm