The forgotten Nordic Small Caps

Underperformance

The Nordic region has lagged the European and American markets this year by a clear margin. Large caps are barely with their head above water, the exception in the large cap space is Denmark, driven by Novo Nordisk alone, which today has become Europe’s second largest company measured by market cap after successful development in treating diabetes, obesity, and heart diseases. The Nordic Small Cap market has developed clearly weaker than large caps, with the characteristics being – the smaller the company, the weaker the performance. This has now been the trend for the last two years.

MSCI Europe has risen by appr 3 % during the last 24 months, whereas MSCI Nordic is down 6 %, MSCI Nordic Small Caps have dived -30 % and the MSCI Nordic Micro Cap index has lost 39 %. The gap has become enormous looking at the regions and company size. The usually outperforming Nordic region has turned into a laggard, and one could question why. There are a couple of reasons to consider. One factor is the Nordic consumers’ interest rate sensitivity, as mortgages are usually tied to short reference rates which have risen considerably from around zero to 4 %. Thereby the health of the consumer has been questioned. Another explanation is the Swedish real estate sector which is very dependent on bond financing – appr 40bn euros needs to be refinanced during the coming years. Additionally, there are a couple of investor groups in real estate who have run into trouble due to high debt levels. Looking at the Nordic banks, none of them report losses from real estate and loan losses in general are low. It would be reasonable to assume that the uncertainties around the consumer and the real estate sector have been the main constraints for the Nordic markets in the past 24 months. As a result of the uncertainties, foreign ownership has dropped on the Swedish stock exchange by appr 3 % -points to 37 % during the last 18 months. A similar trend has been seen in Finland to a slightly smaller extent. Outflows from the Swedish and Finnish stock market exceed 40bn euros, which obviously has influenced the stock markets in a significant way.

The development has also led to an unusual situation with a valuation discount for Nordic small caps that is as high as levels seen in the financial crisis, or around 20% compared to large caps. Normally small caps trade at a premium. The weakening of the Swedish and Norwegian krona – the SEK is down appr 15 % and NOK 11 % during the last two years – has been a major drag for the euro investor. The currencies are also on multiyear lows vs the euro. The currency behavior and small cap discounts are similar to developments during the financial crisis. Micro caps are showing almost as weak share price development as in the financial crisis, this time close to 40% down vs appr -50 % in the financial crisis.

What will turn the tide?

The underperformance for Nordic small caps has continued during the summer. US and European markets have fared quite well, whereas the Swedish and Finnish markets have stalled, also looking at the large caps. Forest related companies like Stora Enso and UPM have issued profit warnings and have underperformed this year. Inflation is still on the high side in the Nordics, which means that the central bank in Sweden is still in a tightening mode despite inflation showing signs of falling. Given that inflation settles, and the outlook of interest rates being at peak, a turning point is approaching.

Consumer confidence is still depressed in Sweden but has started to increase slightly from rock bottom. Also, flat prices have stabilized. The setup for the investor is unique looking at Nordic small caps: strong underperformance, record high discount and the SEK and NOK at all-time low.

Markus Larsson
Portfolio Manager