Nordea Private Banking Investment Review

Strong support from earnings

The strongest support for equity markets comes from companies’ exceptionally healthy earnings. Part of the boost in first-quarter results came from one-off items at a few technology groups. Even stripping those out, however, profit growth was still more than twice the normal pace. At present, analysts expect profits to rise by more than 25 per cent globally this year, more than three times the usual rate. Notably, those expectations have improved markedly even while the Strait of Hormuz has remained closed.

Technology companies are in a league of their own, driven by heavy investment in artificial intelligence. But fairly strong earnings improvements are also expected across many other sectors. The pace of growth expected this year is unusual, and it is also a strong sign that this is likely to be a fairly good year for equity markets.

Equities offer the most attractive outlook

Compared to the earnings outlook, equity valuations have fallen this year because share prices have not kept up with steadily improving profit expectations. Better profitability also strengthens the longer-term growth outlook for companies, which in turn supports the case for equities. At the level of individual companies, shares do not look especially expensive, either. That said, with overall market valuations above their long-term average, investors should also be prepared for the possibility that returns over the next several years may be somewhat lower than they have grown used to. Even so, the return outlook still clearly favours equities. Bond return prospects are also good compared with their own history, but they are nowhere near as compelling as those for equities.

Investor sentiment has swung with the stock market during the year. For now, these indicators are roughly back to normal: some point to a fairly positive outlook, but most suggest a more balanced picture. There is no sign of either excessive enthusiasm or deep anxiety, so sentiment is offering neither a clear tailwind nor a clear headwind. After such a strong rise in share prices, investors should also be ready for occasional pull-backs. Over the longer term, however, strong earnings growth and decent economic growth should continue to push stock markets to fresh highs. That is why we continue to recommend an overweight position in equities.

We expect strong earnings growth to keep supporting equity markets in the period ahead, which is why we maintain an overweight recommendation for equities. Among Nordea’s funds, one example of a broadly diversified way to invest in international equity markets is Nordea Global Enhanced*.

The AI boom continues

The rapid pace of AI investments has increased bottlenecks in the semiconductor industry, boosting companies’ pricing power. Among the standout performers so far this year are the leading memory chip manufacturers, which dominate the fast-growing market for high bandwidth memory (HBM). During May, the key HBM chipmakers – Samsung, Micron and SK Hynix – reached the symbolic milestone of a trillion-dollar market capitalisation. 

One trillion, or one thousand billion dollars, is roughly equivalent to Finland’s GDP over three years. Apple was the first company to cross the trillion-dollar threshold in 2018, and its market capitalisation has since risen to approximately 4.5 trillion dollars. Since then, several major technology companies have joined the trillion-dollar club. The club is likely to gain at least one new member soon, as space technology company SpaceX prepares to list on the Nasdaq. This is expected to be followed by listings from AI companies OpenAI and Anthropic, both of which should reach – or at least come close to – a trillion-dollar market capitalisation. 

These three IPOs aim to raise a total of around 200 billion dollars from institutional and private investors to fund the companies’ AI investments. This is a substantial sum and could create short-term selling pressure in other technology shares. That said, it is also possible that investors will be willing to further increase their positions in technology, encouraged by the strong market momentum. 

Funding AI investments will require increasing contributions from investors going forward. Not even the cash flows of the largest US technology companies are any longer sufficient to finance annual investments of hundreds of billions of dollars, and companies are increasingly turning to the bond markets for funding. Will investors continue to be willing to provide financing to these companies if annual AI investments double from this year’s 765 billion dollars by 2030, as investment bank Goldman Sachs estimates?

Forecasting several years ahead is notoriously difficult, but in the short term the AI boom is undoubtedly set to continue, and we’re keeping the technology sector overweight. We consider emerging market technology companies particularly attractive, as their valuations remain relatively moderate compared with their growth potential. In regional recommendations, we are therefore overweighting the emerging markets. Among Nordea’s funds, Nordea Emerging Market Equities* provides a broadly diversified way to gain exposure to global equity markets.

European growth forecasts revised down

Rising energy prices and expected interest rate hikes have weighed on consumer and corporate confidence in Europe. As a result, forecasts for economic growth have been revised down since the start of the year. Nordea’s economists expect the eurozone GDP to grow by 1.0% this year, compared with an earlier forecast of 1.5% at the beginning of the year.

Despite subdued growth prospects, European stock markets rallied in the first months of the year even though returns lagged those in the US and emerging markets. The first-quarter earnings season exceeded expectations, as earnings increased by 11.5%, compared with forecasts of only a couple of per cent. So there is no need for excessive pessimism, but we’re keeping Europe underweight in our regional recommendations due to particularly strong earnings growth in other regions. In Europe, growth prospects remained solid in the defence, technology and energy sectors, but consumer demand may continue to be subdued.

Robust growth in US

Economic growth in the US was very strong in the first months of the year. Record-high tax refunds to households boosted consumer demand and offset the impact of rising fuel prices. The main risk is inflation, which could accelerate significantly in the coming months.

In the US, reported earnings growth for the first quarter reached an impressive 29%, although one-off items at large technology companies enhanced growth figures by several percentage points. Nevertheless, earnings growth was fairly broad-based, with the median growth rate across sectors at around 15%. We maintain a neutral weight in the US, as strong earnings growth is offset by higher equity valuations compared with other regions. 

The Finnish economy has finally returned to broad-based growth, driven by private consumption and industry. However, rising energy prices and interest rates caused by the Middle East conflict will slow economic growth for the rest of the year. Orders and output in the export sector have been on a nice upward trend since last autumn. In particular, orders have grown strongly in the engineering, shipbuilding and defence industries, which signals growth in goods exports. 

The growth in consumption is reflected in the retail sector, which had been declining for four years but has now turned to growth. However, higher fuel prices and higher interest rates due to the war in Iran are likely to slow growth in purchasing power. Consumer confidence has indeed deteriorated. Based on card payment data for March and April, private consumption has nonetheless remained strong, despite the negative news.

Nordea’s latest economic forecast now balances between the strong development at the start of the year and, on the other hand, the negative shocks brought by the Middle East conflict. If the situation in the energy markets calms down in the near term, we may see substantially stronger-than-expected growth in the forecast period as the economy’s positive cycle gains momentum. On the other hand, a possible escalation of the oil crisis and a prolonged increase in fuel prices and interest rates could again push purchasing power downward and significantly weaken the growth outlook.

Despite the conflict in the Middle East, the outlook for manufacturing, a key sector on the Helsinki Stock Exchange, has continued to improve in both Europe and the US. Signs of a pick-up in the economy have led to strong price performance in the first months of this year. In particular, equities related to the defence, energy and artificial intelligence themes have performed strongly. Despite mixed messages during the first-quarter earnings season and moderate guidance, stock prices have continued on an upward trajectory.

Among the large caps, Neste, Outokumpu and Nokia have seen the biggest upward revisions to their earnings forecasts over the past three months. Measured year-to-date, the weakest returns have been recorded for Lumo, which is suffering from rising interest rates, and Qt Group, which is perceived as a loser in the AI revolution. On the other hand, the best year-to-date returns have come from Nokia, Neste and SSAB, which are boosted by the energy and AI themes.

Mixed earnings reports

During the first-quarter earnings season, investors focused on companies’ messages regarding the impact of the Middle East conflict on their outlook this year. When all was said and done, the figures reported in the earnings season were almost as anticipated, yet some companies diverged from the rest. There were slight downward revisions in companies’ earnings growth outlooks during the earnings season, but this hasn’t slowed the stock market rally led by Nokia and Neste over the past three months. 

Valuation of Helsinki Stock Exchange close to its all-time high 

The valuation of the Helsinki Stock Exchange is close to its all-time high after the recent rise in stock prices. Traditionally, a high valuation alone is not enough to trigger a correction. The anticipated recovery of the economy and especially the manufacturing sector in Europe is set to underpin earnings growth prospects on the Helsinki Stock Exchange. But as valuations rise, investors should adopt a more selective approach in their stock picks.

US yields rising, euro area more stable

The euro area bond market has remained more stable than its US counterpart. The yield on the German 10-year government bond has hovered around 3 per cent, whereas in the United States the equivalent yield rose moderately in May to approximately 4.5 per cent. Rising yields in the US have weighed in particular on the performance of corporate bonds, as bond prices move inversely to yields.

In contrast, the euro area has offered a more supportive environment. Yields have remained more contained, resulting in positive returns for both government bonds and investment-grade credit. In May, European government bonds returned 0.9 per cent, while investment-grade corporate bonds gained 0.8 per cent.

Returns driven by effective yield currently

In the current market environment, bond returns are primarily driven by effective yield. Government bond yields in the euro area are at relatively elevated levels, meaning that a sizeable portion of corporate bond yields is attributable to the underlying sovereign rate. Credit spreads, meanwhile, are historically tight around 0.85 to 1.0 percentage points in the investment-grade segment. This implies that investors should not expect additional returns from further spread compression at present. That said, the credit spread paid by the issuer on top of the government bond yield still contributes positively to total returns, even though it is at low levels.

In high-yield markets, yields remain reasonably attractive, at around 6.5–7 per cent globally. However, the scope for price appreciation is limited without a clear decline in government bond yields. In May, global high-yield bonds delivered a marginally positive return despite rising US government bond yields, as a slight tightening in spreads was sufficient to offset the negative impact.

Tight credit spreads reflect strong earnings growth among companies and continued investor confidence in corporate balance sheets. Economic growth remains firm enough to keep default rates at moderate levels. However, risks in credit markets could increase if energy prices continue to rise, potentially eroding profitability in industrial sectors and contributing to tighter financial conditions through higher interest rates.

Yield levels in bond markets: Government bonds, euro area 3.5%, corporate bonds, euro area 3.7%, high yield bonds, global 6.8%

Central banks focused on inflation

The European Central Bank has held its deposit rate at 2 per cent for nearly two years, but inflationary pressures stemming from the recent energy shock could prompt a shift towards rate increases. Economic growth in the euro area remains subdued, yet inflation risks—particularly linked to rising energy prices—have led the ECB to consider further tightening. Markets are currently pricing in a rate hike at the June meeting and another increase later in the year.

In the United States, the Federal Reserve has also tilted towards a more restrictive stance. The policy rate currently stands at 3.50–3.75 per cent, and expectations have shifted from earlier projections of rate cuts to the possibility of rate hike by year-end. Persistent inflation and resilient economic activity suggest that rates are likely to remain elevated. Central banks’ cautious stance implies that interest rate levels will remain broadly unchanged in the coming months or may edge slightly higher. This limits the potential for capital gains in fixed income, but at the same time supports effective yield.

Attractive yield available

While the bond market is unlikely to deliver rapid price gains in the current environment, its role in portfolio construction remains important. At prevailing yield levels, investors can achieve a reasonably attractive and stable income stream. We recommend maintaining a neutral allocation across fixed income sectors. A well-diversified bond portfolio offers access to yields of around 4 per cent, which is clearly more attractive than current money market rates of just over 2 per cent. Among Nordea’s funds, Savings Fixed Income* provides diversified exposure to fixed income markets. We remain underweight money market investments in our asset allocation.

Asset classes

Bond markets

Equity markets

Returns by asset class

Asset class returns for the past 12 months: Global equities 26.7%, Global high yield bonds 5.2%, Eurozone corporate bonds 2.4%, Eurozone government bonds 0.7%.

Equity market returns for the past 12 months: North America 25.9%, Europe 17.2%, Japan 28.3%, Emerging markets 47.4%, Finland 34.9%.

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

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

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Investment services are provided by Nordea Bank Abp. The issuer of the products described in this message is Nordea Funds Oy. The information provided in this message is intended as general product information only. This information is not an exhaustive description of the products or the risks related to them and does not constitute investment advice or recommendations. Remember that investing always involves risks. The return on your investment may fluctuate, and you may lose some or all of your capital. Past performance is not a guarantee of future results. Before making any investment decisions, you should read the relevant prospectus and key investor information documents for more details about the investment product.

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