Nordea Private Banking Investment Review

Earnings growth surprisingly brisk despite tariffs

The second quarter earnings performance was substantially better than expected, even though President Trump's tariffs cast a long shadow of uncertainty over the earnings season. Overall, trade uncertainty has had surprisingly little impact and, based on comments, does not significantly overshadow future outlooks either. There are, of course, industries and companies that suffer significantly from tariffs, but the effect on overall earnings seems to be more moderate than feared.

Currently, it appears that corporate earnings internationally would grow at a fairly normal pace this year. Considering the uncertainties, this performance is excellent. Fairly brisk growth is still predicted for next year as well, although earnings forecasts will likely be trimmed down slightly as they normally are. The strongest earnings growth has once again been seen in technology sectors, and these sectors are expected to continue to lead growth. AI investments and tax changes will continue to support the growth prospects of these sectors.

Rumors of a technology bubble are greatly exaggerated

The strong growth prospects in technology sectors is actually the main reason why stock market valuation multiples as a whole appear high. Expectations of rapid growth go hand in hand with higher valuation multiples. Improved profitability and growth prospects have raised the valuation multiples of technology sectors somewhat and their weight in the entire stock market considerably. Valuation multiples for other sectors, on the other hand, are largely at their historical average. Market concentration and high multiples will certainly accelerate the market decline eventually when the earnings outlook for major sectors begins to weaken. So far, however, there are very few signs of this.

Despite elevated valuation multiples, more comprehensive measures of return prospects still point to good, albeit slightly below-average, medium-term returns from the stock market. As interest rates have risen in recent years, the return prospects for bonds have improved somewhat. As a result, the expected return difference between stocks and bonds is smaller than during the previous 10 years on average, but still clearly in favour of stocks. In an environment where the economy and earnings remain on path, it is likely that equity investments will outperform fixed income investments. Therefore, we recommend overweighting equity investments. At the same time, however, one should note that the return prospects for bond investments are also better than they have been for a long time. Thus, it remains appropriate for investors to ensure that their portfolio also includes bond investments at approximately the weight corresponding to their investment plan.

Uncertainty abates

The markets concluded that a bad deal is better than no deal, when the EU, Japan and Korea, among others, reached trade deals with the US at the end of the summer. Companies like shipping giant Mærsk expect lower uncertainty to facilitate decision-making and boost global trade after a challenging spring. In August, Mærsk revised its view of global container volume growth, now expecting it to be in the range of 2% to 4%. 

Tariffs will undoubtedly have an impact on business profitability, with the US government collecting 10% to 50% of the import value of imported goods, depending on the product. Pricing power will determine how costs are distributed in the production chain. For the most part, the effects of tariffs will remain moderate, but the highest rates will put an end to some trade relations, forcing countries to search for new partners. The leaders of the largest emerging countries have already decided to strengthen their mutual trade relations due to the high tariffs and unpredictable policies introduced by the US, while the EU aims to strengthen its internal market.

The 15% import tariff imposed by the US on the EU is a fairly moderate rate, which didn’t weaken the EU’s competitiveness relative to other exporting countries. However, the appreciation of the euro adds another challenge for export companies. Despite these challenges, Europe’s recovery has continued, and economic growth is expected to pick up markedly next year, driven by lower interest rates and sizeable investment. We therefore recommend overweighting European equities due to their moderate valuations and improving earnings growth.

Stocks rally in China

The trade negotiations between China and the US were extended again in August, but the continued uncertainty has not been reflected in the Chinese stock market, which saw a strong rise in the summer. The Shanghai Stock Exchange, which is dominated by local investors, rose to its highest value in 10 years at the end of August. Share prices also saw a steep rise on the Hong Kong Stock Exchange, where it is easier for foreign investors to invest than in mainland China. Chinese households have accumulated significant savings, but investments have been scarce recently due to the weak housing market and low interest rates. As a result, households have begun to channel their savings into equities, which also seems to be the goal of the country’s political leaders. Favourable developments in the stock market make it easier for technology companies to list and raise funding. The promotion of technological self-sufficiency and innovation is now the number one priority for China. 

A year ago, there was a lot of speculation in the markets about whether China is still fit for investment but this talk seems to have since died down. In the summer, the US investment bank Goldman Sachs introduced a list of Chinese companies poised for growth, calling it the ‘Prominent 10’ in the same vein as the ‘Magnificent 7’ US tech companies. The ‘Prominent 10’ includes China’s largest tech companies Tencent, Alibaba and Xiaomi, among others.

Technology and finance are the top gainers

The US stock market rally has been driven by large tech companies again this year, but the share prices of manufacturing companies and companies providing public goods have also risen strongly. The healthcare sector has performed the weakest out of all major sectors, suffering from the Trump administration’s cuts to Medicaid and research funding, as well as demands to lower drug prices. In Europe, the rise in share prices has been driven by banks, public goods and the defence sector. The weakest performance has come from the consumer sector, including car companies suffering from tariffs and luxury goods companies weighed down by lower demand. 

We continue to have confidence in the financial sector and are keeping it overweight, as loan volumes have started to grow, investment banking has picked up and de-regulation is at least being considered. Intriguing opportunities may also open up in the materials sector, where a significant turnaround in earnings is expected next year, or in health care, provided that the political pressure on the sector eases. Valuations in the health care sector relative to long-term earnings growth are now clearly lower than in the past 20 years.

Economic growth slightly below forecast

Finland’s economic growth fell slightly short of forecasts in the first half of the year, and the economic recovery has not accelerated as expected, despite significantly lower interest rates. According to preliminary data, Finland’s GDP in the second quarter remained at the same level as in the previous quarter, but grew by 0.5% year-on-year.

Weak consumer confidence has kept domestic consumption subdued and increased household savings, even though real wages have started to grow. The threat of tariffs imposed by the US has contributed to weaker business confidence and postponed investment decisions. The trade deal reached between the EU and the US may therefore help boost the economy as the year goes on, and the accommodative monetary policy is also expected to support the economy towards the end of the year. 

Both Europe and the US are seeing signs of recovery in the outlook for manufacturing, a key sector on the Helsinki Stock Exchange. Earnings forecasts have been slashed due to prolonged uncertainty, but the share prices on the Helsinki Stock Exchange have nevertheless been on a strong upward trajectory. As a result, the bar is lower for companies to meet their forecast earnings. On the other hand, valuation multiples have already risen above their historical average on the Helsinki Stock Exchange. As a whole, the outlook for manufacturing is more important than the outlook for the service sectors to the cyclically sensitive Helsinki Stock Exchange. 

Among the large caps, Outokumpu, Nokian Tyres and UPM saw the biggest cuts to earnings forecasts over the past three months. The weakest year-to-date earnings were recorded by Qt Group and Nokia, which issued profit warnings in the second quarter, as well as Huhtamäki. Meanwhile, the best year-to-date returns were generated by a very diverse group of companies, including Orion, Wärtsilä and Mandatum. 

Uncertainty over trade policy reflected in earnings season reports

The second-quarter earnings season began with anticipation on the Helsinki Stock Exchange, as earnings forecasts had clearly declined due to uncertainty over trade policy. But despite the revised forecasts, the outcome ended up being rather modest in terms of reported figures. Engineering companies were a bright spot during the earnings season with strong earnings reports and order books. The forest sector, on the other hand, performed even weaker than expected.

Helsinki Stock Exchange achieves above-average valuation after rally 

The valuation level of the Helsinki Stock Exchange is above its historical average following the forecast cuts issued after the earnings season and the strong rise in share prices. However, the anticipated recovery of the economy and especially manufacturing in Europe is set to underpin earnings growth prospects, which makes the higher valuation level justifiable.

Uncertainty over trade policy muffles messages from the earnings season

In Finland, the earnings season for the first quarter of the year began with anticipation, as earnings forecasts had clearly declined since the fourth-quarter earnings season last year. In the end, the first-quarter earnings season beat expectations slightly in terms of reported figures. Forecasting the rest of the year will be challenging due to the uncertainty created by import tariffs and trade policy. 

Valuation of Helsinki Stock Exchange is now above average after early-year rally 

The valuation level of the Helsinki Stock Exchange is slightly above its historical average following the forecast cuts issued after the earnings season and the strong rise in share prices since the start of the year. This has corrected some of the drop in valuations which occurred last year. Many companies continue to offer rather attractive dividend yields even at the current share prices.

Eurozone interest rates rose during the summer

Eurozone government bond yields rose slightly during the summer as the economic outlook stabilized. Since the beginning of June, the German 10-year bond yield has risen by 0.2 percentage points to 2.7 percent. As a result, the yield on government bonds has been modest at -0.7 percent. Eurozone corporate bond performance has been positive this summer, thanks to narrowing risk margins. Investment grade bonds have returned 0.9 percent and high yield bonds 1.5 percent.

In the United States, interest rates have fallen slightly during the summer. The calming of the markets following tariff concerns and budget deficit discussions has prompted investors to buy bonds again, and the US long-term interest rate is 0.1 percentage point lower at 4.2 percent. Nordea expects eurozone government bond yields to rise closer to three percent by the end of the year. The US long-term interest rate is expected to rise closer to five percent.

Fed's actions under close scrutiny

Among central banks, the market's attention is currently focused on the US Federal Reserve, which is expected to continue its rate cuts at its September meeting. The Fed cut rates last fall, but has been on hold for more than six months. US inflation has remained quite stubbornly above the central bank's two percent inflation target. The tariff hike announced last spring further increased the risk of inflation accelerating. The Fed currently estimates that the risks of a cooling US labor market have increased, and on the other hand, the highest estimates of inflation acceleration do not seem to be materializing, so this opens the door for the Fed to ease monetary policy. The Fed's key interest rate is currently in the range of 4.25–4.50 percent. The market is pricing in two 0.25 percentage point rate cuts by the Fed during the rest of the year.

The European Central Bank (ECB) is on the watch regarding its key interest rate. Eurozone inflation has fallen to 2% and the ECB has eased monetary policy considerably. The ECB's deposit rate for banks has fallen to 2.0% from a peak of 4.0%. Euribor rates are currently around 2%. Investors do not expect the ECB to make any changes to its monetary policy in the coming months.

Corporate credit spreads very low

Corporate credit spreads have tightened over the summer. In the spring, margins saw a spike as higher tariffs announced by the United States created nervousness in the markets. However, the situation has calmed down over the summer as the United States has reached preliminary trade agreements with several of its major trading partners. Credit spreads have fallen back to historical lows. Many spreads are practically close to their lowest levels since the 2008-2009 financial crisis. In the current, moderate economic growth environment, corporate creditworthiness is expected to remain stable, and margins are not expected to widen significantly without a downturn in the economy. The number of defaults on high-yield corporate bonds is currently low, and the rate is expected to remain moderate in the future.

Bond yields attractive for investors

Bond yields currently offer good investment opportunities. Euribor rates have fallen lower, but longer-term government bond yields are at quite high levels compared to history. Therefore, investors should focus their attention on the bond market when investing in fixed income. In Nordea's House view, we recommend reducing euro area investment grade corporate bonds from overweight to neutral and increasing government bonds from underweight to neutral. Corporate bond risk margins have fallen very low, so we believe that in this environment it is worth seeking interest income evenly across different bond categories. 

The yield on euro area government bonds is 3.3 percent and the yield on euro area corporate bonds is also 3.3 percent.

Asset classes

Bond markets

Equity markets

Returns by asset class

Asset class returns for the past 12 months: Global equities 12,4 %, Eurozone high yield bonds 6,4 %, Eurozone corporate bonds 4,5 %, Eurozone government bonds 1,1 %.

Asset class returns for the past 12 months: North America 13,2 %, Europe 9,4 %, Japan 8,6 %, Emerging markets 12,7 %, Finland 12,2 %.

Responsible editor
Antti Saari, Wealth Management, Nordea Bank Abp
antti.saari@nordea.com

Content production
Hertta Alava, Ville Korhonen, Antti Saari, Teemu Mäkelä

Registered address and domicile
Satamaradankatu 5, Helsinki FI-00020 NORDEA
Business ID 2858394-9

E-mail
Opens new window

Disclaimer