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Equity Monthly: Is Sweden signaling spillover into services?

In this month’s equity update we focus on Sweden as the country’s latest Services PMI figures are suggesting potential spillover effects from the manufacturing sector and potential deadly catalyst for equities.

As regular readers of our views on equities know we have been defensive on equities for more than a year. The last two months we raised the concerns that equities are detaching from the realities of macro risks while acknowledging the momentum in equities. The broader narrative supporting equities is central bank easing, hopes of more fiscal impulse and lastly the “phase one” trade deal between the US and China.

This first week of December has seen yet another rollercoaster event on the trade talks from Trump signing the Hong Kong bill agitating the Chinese side, to both sides saying that trade talks are progressing before Trump the other day said “trade deal might wait until after 2020 election”, before both sides again yesterday said talks are advancing. The facts are that the US has a 15 December deadline on additional tariffs on Chinese goods, and given Trumps unpredictable nature and his recent action to slap tariffs on steel and aluminum on Argentina and Brazil, he could surprise the market by raising the tariffs on 15 December. In this event equities would hurt as liquidity is typically declining leading up the Christmas holiday period. But for now this week’s trade headlines have not really tested the market as shown by the spread between the VIX Index and the two-month futures contract.

Another
concern that investors should take note of is equity valuations. S&P 500 is
now seeing a valuation that is the highest since 2001 (excluding the Jan 2018
observation) highlighting stretched market conditions and lower implied
expected returns. Based on the current valuation level in the S&P 500 we
observe historically a 0.5% real return annualized with a +/- 2%-points uncertainty.
This means that investors buying into current valuation levels are pursuing
momentum effects rather than long-term return expectations. These moves never
end good.

But the
central question for investors should be whether yesterday’s weak Swedish PMI
Services print for November at 47.9 is a sign of emerging spillover effects into
the broader economy. If Sweden leads Europe and potentially the US due to its
pro-cyclical characteristics then yesterday’s print is ugly reading for
investors. Sweden’s economy is approaching activity levels not observed since
the euro area crisis in 2012. If the spillover effects from the
manufacturing recession are real and growing then the global economy will be
hurt badly. Policy rates are already low providing little firepower for central
banks so fiscal will have to take over to reverse the bleeding.
But fiscal
moves slower and is certainly behind the curve in many countries, most notably
Europe, which means macro weakness in 2020 could be worse than most think
today. Watch Sweden is our only message in this monthly equity update.

As we have
argued many times recently negative rates have hit the end of the road. It’s
clearly not strengthening the credit channels and the banking sector business
model is not working on the current monetary policies. In our view, led by the
Riksbank, ECB will begin next year to forward guide markets about lifting rates
regardless of the macro outlook in order to soft pressure Europe’s government
to do more and create a better “policy mix” using ECB president Lagarde’s own words.

When we
look across the economic landscape it’s clear that the UK and Europe have the
most room for maneuvering on the fiscal side with especially Europe running too
tight budgets relative to the current trajectory of the global economy. But
here lies also the upside potential for next year. European equity markets
could be the big surprise next year if both the UK and EU loosens the purse string
as it could drive stronger currency and ultimately demand.
If the ECB in
addition indicates a shift in its monetary policy then banks would
significantly add to performance. Also note today’s decision by the Japanese government to launch a $121bn stimulus programme to revive growth. It’s already starting.

Semiconductors
stocks have done very well despite challenging trade environment as demand has
remained robust and some frontloading by China has likely taken place. We like
to use South Korea and semiconductors as leading indicators on the economy. Numbers
out of South Korea are still worsening and the trade uncertainty is holding
back investments among many companies. The hesitation to do investments are
beginning to feed through to the semiconductor industry with operating earnings
showing the biggest drawdown since 2012.
Semiconductor earnings doubled
from late 2016 to late 2018 which has fueled strong sentiment. Our view is that
a lot of the hype around AI will cool down significantly in 2020 and with it
demand for semiconductors.

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website is not intended to and does not change or expand on this. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
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Peter Garnry
Head of Equity Strategy
Saxo Bank
Topics: Equities Central Banks Sweden United States China

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