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private banking - investment strategy
December 2010 Speeding up the tempo
Investment Strategy

Portfolio strategy..................................................................................................................8
Theme: Speeding up the tempo...................................................................................... 11
Theme: Emerging markets lead the pack...................................................................... 15
Theme: Low government bond yields - new portfolio thinking.................................. 18
Theme: What will happen to the stock market in a stable financial climate?........... 20
Macro summary................................................................................................................. 23

Equities............................................................................................................................... 25
Fixed income...................................................................................................................... 28
Hedge funds....................................................................................................................... 30
Real estate.......................................................................................................................... 32
Private equity..................................................................................................................... 34
Commodities...................................................................................................................... 36
Currencies........................................................................................................................... 38

Investment Outlook - december 2010 3

Investment Strategy

This report was published on November 30, 2010.

Its contents are based on information and analysis available before November 22, 2010.

Hans Peterson Lars Drougge

Global Head of Investment Strategy Portfolio Manager
+ 46 8 763 69 21 + 46 8 763 69 34

Lars Gunnar Aspman Helene Cronqvist

Global Head of Macro Strategy Portfolio Manager
+ 46 8 763 69 75 + 46 8 788 62 52

Rickard Lundquist Carl Barnekow

Portfolio Strategist Global Head of Advisory Team
+ 46 8 763 69 27 + 46 8 763 69 38

Victor de Oliveira Reine Kase

Portfolio Manager and Head of IS Luxembourg Economist
+ 352 26 23 62 37 +352 26 23 63 50

Johan Hagbarth Cecilia Kohonen

Investment Strategist Global Head of Communication Team
+ 46 8 763 69 58 +46 8 763 6995

Peter Eklöf Liza Braaw

Portfolio Manager Communicator and Editor
+ 46 8 763 69 55 +46 8 763 6909

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4 Investment Outlook - december 2010


Following the upward trends

Signs of accelerating growth are discernible Meanwhile we are striving to maintain a predetermined risk
level in our portfolios. This creates an equation to solve.
in many parts of the global economy, despite
mixed messages from macroeconomic data. The role of government bonds as risk-offsetters may be past,
It is time for the economic cycle to shift into and if their yields start trending upward, such bonds will not
third gear, speeding up the tempo. Demand is provide the returns that portfolio managers have become
accustomed to during the past 25 years or so. This means
being driven mainly by portions of the emerg- that the focus is increasingly shifting towards alternative
ing markets, whose new role on the world eco- investments and active strategies of various kinds. This is no
nomic stage already seems self-evident. problem in itself, but it places new demands on investment
processes, and the search for capable managers will become
Risks are always an element of the investment climate, and at even more important.
the moment lots of them are generating newspaper headlines
in the financial field around the world. Industrialised coun-
Favourable market climate
tries have sizeable overcapacity and low employment, which Financial market conditions are gradually improving, and the
together are limiting their expansion. There are sovereign risk of a double dip recession − which spoiled the mood of
debt problems, especially in southern Europe, and people are many investors late in the summer − can essentially be written
discussing a currency war. Meanwhile risk assets, led by equi- off. Valuations of most asset classes are reasonable. Overall,
ties, are continuing to rise gradually in value, a trend explained this creates a climate that is relatively favourable for most risk
primarily by relatively strong global economic growth. investments.

Forecasts of global GDP above the long-term trend during Continued low interest rates and commitments from central
the next few years give us reason to ponder what attitude banks to prop up weak growth in the industrialised countries
we should have as investors towards risks and risky assets. It will create good market conditions, especially for risk assets.
may very well be that the sources of risk now attracting lots of
attention will lose their importance to the market when real Importantly, our view of emerging markets and their role in
economic performance is so good. the world economy is changing. In these markets, the trend
towards rapid economic growth and greater financial clout will
Trends for the future intensify and continue. The same is true of the trend towards
This issue of Investment Outlook includes reflections on what high demand from emerging markets, which Swedish compa-
today’s trends will mean for the future. One question we have nies have noticed, as have others. The income statements of
asked ourselves is: What will happen in stock markets if the many companies already reflect a clear increase in the propor-
economy continues to perform well, and if profit growth as tion of their exports going to these markets.
well as valuations remain at normal levels?
For many Swedish industrial companies, sales to the United
Another question is what will happen with government bonds States nowadays account for 10-20 per cent of their revenue.
− the natural risk buffer in many portfolio strategies − if the Sales to emerging markets are growing even larger, and we
long-term trend towards falling yields for such bonds turns expect this shift to continue. Emerging markets are no longer
around and they begin to rise, and what impact this will have a risk investment; they are a reliable source of growth.
on portfolio management.
Hans Peterson
Because of economic conditions, we are gradually allocating CIO Private Banking and Global Head of
more and more capital to equities and other risk investments. Investment Strategy

Investment Outlook - december 2010 5


Expected 1-2 years

(annual averages)
return risk Reasoning
PositivE. The sideways trend will soon have a chance to be replaced by a better trend. Most markets
seem to be gaining firmer ground to stand on, thanks to continued economic recovery, further monetary
Equities 10% 17% stimulus measures in the OECD countries, low equity valuations and good corporate profit figures.
negativE towards government securities, positive towards High Yield. The macro map still indicates continued
low key interest rates in Western countries, making government securities unattractive. From a risk/return
standpoint High Yield (HY) is now the most attractive, with a continued decline in bankruptcies among HY
companies. Emerging market (EM) debt and EM corporate debt also remain appealing due to high yields and
Fixed income 5%* 6% possible exchange rate appreciation.
PositivE. Large global imbalances and tensions between asset classes are continued arguments for Global
Market and CTA strategies, while Event Driven is likely to benefit from increased merger and acquisition
(M&A) activity. There are also good yield and price arbitrage opportunities for Fixed Income R/V and Credit
Hedge funds 7.5% 6% L/S strategies.
neutral/positivE. Early signs that the driving forces of the recovery will soon shift from speculation to
the real economy, together with a stabilising banking sector, still favour this asset class, but the real estate
Real estate 4.5% 3% market will recover slowly.
Private pOSITIVe. This asset class took a beating when the market was choppy, but it still offers a 30-40 per cent
equity 15% 22% discount on already conservative net asset values. Secondaries remain attractive.
neutral/POSITIVE. Global recovery is a general argument for commodities, since strong economic growth
in the EM sphere will be especially favourable for industrial metals. Looking ahead, growing risk appetite
Commodities 8% 18% may push down gold prices.
neutral/NEGATIVE**. Currency issues are increasingly important, and countries are thinking in terms of
depreciation contests to strengthen their export opportunities. We expect high interest rate (EM) currencies
Currencies 3% 3% to strengthen against low interest rate currencies in developed markets (DM) as risk appetite returns.
* Expected risk and return on corporate bonds that are weighted about 1/3 Investment Grade and 2/3 High Yield.
** This opinion refers to the alpha-generating capacity of a foreign exchange trading manager.

16% 14%
Private equity 12%
14% 10%
12% 6%
Equities 4%
Expected return

Hedge funds Commodities -2%
6% -4%
Real estate








Fixed income*
Equities Fixed income* Hedge funds Real estate
Private equity Currencies Commodities
0% 5% 10% 15% 20% 25% 30%
(NOVEMBER 30, 2000 TO OCTOBER 31, 2010)
(NOVEMBER 30, 2000 TO OCTOBER 31, 2010)
Fixed income

Hedge funds

Real estate



Fixed Income Commodities


Hedge funds
Real estate Equities 1.00
Historical return


Fixed income -0.48 1.00
-4% Hedge funds 0.44 -0.20 1.00
Private equity
Real estate -0.17 0.11 -0.04 1.00

-10% Private equity 0.86 -0.36 0.53 -0.18 1.00

0% 5% 10% 15% 20% 25% 30%
Historical volatility Commodities 0.20 -0.14 0.62 -0.09 0.33 1.00
Historical values are based on the following indices: Equities = MSCI AC World. Fixed
Currencies -0.19 0.17 0.19 -0.08 -0.08 0.02 1.00
income = JP Morgan Global GBI Hedge. Hedge funds = HFRX Global Hedge Fund. Real
estate = SEB PB Real Estate. Private Equity = LPX50. Commodities = DJ UBS Com-
modities TR. Currencies = BarclayHedge Currency Trader.

6 Investment Outlook - december 2010



0% 40%
Equities Equities

81.5% 20%
Fixed income Fixed income

9.5% 23.5%
Hedge funds Hedge funds

2% 0%
Real estate Real estate

0% 10.5%
Private equity Private equity

0% 5%
Commodities Commodities

Currencies 5% Currencies

Cash 2% 1.0%

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 0.0% 10.0% 20.0% 30.0% 40.0% 50.0%

Previous Current Previous Current


Equities 29% 1

Fixed income
Hedge funds 0.4
2.5% 0.2
Real estate

3% 0
Private equity
Commodities 5%
Currencies -0.6

3% -0.8
2002 2003 2004 2005 2006 2007 2008 2009 2010
0% 10% 20% 30% 40%
Fixed income Hedge Real estate
Previous Current Private equity Commodities Currencies

Speeding up the tempo: Large global imbalances, coupled with stimulus measures, are creating great possibilities but also tensions

Emerging markets lead the pack: Continued large capital inflows to the EM sphere, with rising asset prices as a consequence

Low government bond yields - new portfolio thinking: In a climate of rising yields, the role of bonds in a portfolio needs to be re-examined

What will happen with the stock market in a stable financial climate? Two out of three valuation parameters signal favourable
long-term conditions

65 65 45%
60 60 40%
55 55 Source: FactSet, MSCIbarra, SEB
50 50
45 45 20%

40 40 15%
35 35
30 30
2004 2005 2006 2007 2008 2009 2010 0%



Index service sector Index manufacturing sector

Source: Reuters EcoWin

Progress in the emerging market (EM) sphere is noticeable on many

After large gains, the J.P. Morgan global purchasing managers’ in-
fronts. The political influence of these countries is increasing as
dex for both the manufacturing and service sectors peaked in April
their economies grow. EM stock exchanges have also accounted for
2010, followed by a downturn during the summer and early autumn.
a fast-rising percentage of global stock market capitalisation in the
In October, both indices rose again, which promises better global
past decade. If the same pace continues, EM exchanges will account
economic performance.
for 25 per cent of a world index as early as 2020.

Investment Outlook - december 2010 7

Portfolio strategy

Portfolios for better times

Lower and lower yields this autumn have persuaded investors to seek out risk, causing both equities
and High Yield bonds to rise. In our portfolios, we are now positioning ourselves for a long, slow eco-
nomic recovery, with a focus on sound growth conditions.

MODERN Protection In recent weeks, the foreign exchange market has become
The third quarter was dominated by discussions about the more turbulent. The largest movements have mainly involved
probability of a double dip recession and fears of an abrupt the EUR-USD exchange rate, but the SEK has also moved a
deceleration in the world economy. Subsequent months have bit. The changes in fund managers we made worked relatively
had a more positive tone, since most market players have well, and our currency exposure is now significantly more de-
more or less abandoned thoughts of a double dip. fensive. Of course, lower risk also implies reduced opportuni-
ties for high returns, but until we find alternatives that further
In the corporate bond sector, High Yield bonds have been reduce the correlation in the portfolio, we are satisfied with
the best performers by far in the portfolio. SEB Modern the return profile we have right now.
Protection’s primary task is capital preservation, and for rea-
sons of risk our High Yield allocation is fairly limited. Its con- We have already seen a positive outcome from the changes
tribution to portfolio returns has nevertheless been clear. We we made in the hedge fund portfolio. The character of the
are keeping our exposure intact, although we have marginally flow of returns has improved. Risk has increased somewhat,
lowered our expected return for the segment. but correlations have diminished. Our earlier overweighting
of Market Neutral holdings did not produce sufficiently good
The shortest-term market interest rates have showed a clear earnings. We now feel that our holdings better match our view
rising trend in recent months. Since June 30, the three-month as to which hedge funds have the best potential for generat-
Euribor has risen from 0.75 to 1.0 per cent, which benefits our ing returns during the next cyclical phase.
least risky investments. Yields on longer-term government
securities fell sharply in August and then began a rising trend The real estate market has continued to be a positive element
in September. The announcement of the American monetary of the portfolio. We have not changed our expectations, and
stimulus package affected markets and yields in slightly differ- our holding remains a complement to our fixed income invest-
ent stages. At first, long-term yields were pushed down both ments.
in the US and Europe, but they began an upward path in con-
2% 5%
junction with Chinese economic policy tightening measures 2%
aimed at curbing inflation and a new wave of sovereign debt 9.5%
worries in the EU (read: Portugal and Ireland). These move-
ments have not had any major impact on our portfolio, how-
ever, since we have no long-duration strategic exposure. But Cash
our Total Return and Cash Plus holdings benefited from these Currencies
movements. The fact that we increased the percentage of Real estate
Hedge funds
the Fund that was invested in these holdings, at the expense 81.5% Fixed income
of short-term fixed income holdings, further contributed to
already strong positive growth.

8 Investment Outlook - DECEMBER 2010

Portfolio strategy

MODERN Growth As the spread between High Yield bonds and risk-free yields
The increased emerging market element in Modern Growth narrows, expected return will become somewhat lower. We
contributed to the positive trend in the portfolio during the have thus marginally adjusted our forecasts downward, but
autumn, both in absolute and relative terms. Investments in we believe that the effective yield is sufficiently attractive to
mature markets also performed better than comparable indi- keep its percentage of the portfolio unchanged. However, we
ces. It is very satisfying when both the choice of manager and have chosen to reduce our holdings in the Investment Grade
the allocation between markets make a positive contribution. segment and increase the percentage of the portfolio consist-
We have boosted the percentage of equities in the total port- ing of equities (see above). We believe that the potential for
folio, reflecting our strategic view that the equities asset class excess returns in Investment Grade is virtually non-existent.
has sometime higher potential in the next 1-2 years. These
holdings are fairly evenly allocated among both mature mar- In recent weeks, the foreign exchange market has become
kets and emerging markets, taking total risk level into account. more turbulent. The largest movements have mainly involved
the EUR-USD exchange rate, but the SEK has also moved a
After their strong performance during the autumn, private bit. The changes in fund managers we made worked relatively
equity and commodities have recovered most of the down- well, and our currency exposure is now significantly more de-
turns they experienced during the spring. Commodities have fensive. Of course lower risk also implies reduced opportuni-
been the best performing asset class in SEB Modern Growth ties for high returns, but until we find alternatives that further
since June 30, closely followed by private equity. Our attitude reduce the correlation in the portfolio, we are satisfied with
towards commodities has become rather more positive. We the return profile we have right now.
believe that certain base metals have the largest potential, but
we regard precious metals as currently somewhat overvalued The task of changing our hedge fund sub-portfolio has con-
at present. As for oil prices, our view is that the coming year tinued throughout the past quarter and has not yet been
will fit well into OPEC’s goal: relatively stable prices in the USD completed. We have identified the funds we want and have
70-90/barrel range. At this writing, prices were about USD 82/ performed a portfolio analysis. Implementation has begun and
barrel. is determined by the liquidity cycle of each respective fund.
The emphasis will be on CTA (Systematic Diversified − where
The fixed income portion of SEB Modern Growth made the the manager designs computer models that in turn generate
largest contribution to the portfolio’s positive return this transactions), Global Macro and Fixed Income. We are also
autumn. The size of the sub-portfolio − about 30 per cent adding two new funds with an Event Driven strategy, aside
of Modern Growth − combined with the sharp upturn in our from the Multistrategy holdings we already have. The strategy
dominant holding in the High Yield segment generated better for the hedge fund sub-portfolio is diversification compared
returns than our already ambitious expectations. Among the to the equities sub-portfolio, and this is important in order to
holdings that stood out was Emerging Market Debt, which has maintain the overall risk level we want.
climbed by more than 10 per cent since June 30.

29% 3%
2.5% Currencies
Private equity
28.5% Real estate
Hedge funds
Fixed income
25% Equities

Investment Outlook - DECEMBER 2010 9

Portfolio strategy

MODERN Aggressive In the fixed income sub-portfolio, we are choosing to sell con-
The aim of Modern Aggressive is to capture the potential in vertible bonds in order to increase the percentage of equities
the main themes we foresee in the capital market ahead. This in the portfolio. Convertible bonds have provided a stable con-
implies that the portfolio has larger exposure towards our tribution to the portfolio, but we view the equities component
assumption about the economic upswing than the other two as more attractive for SEB Modern Aggressive. Nowadays the
portfolios. fixed income sub-portfolio consists only of the corporate High
Yield and Emerging Market Debt segments. We still foresee a
Since our ambition is to be a little more daring in SEB Modern favourable risk-adjusted potential for these holdings, which
Aggressive, we have a sizeable share of the portfolio invested will meanwhile provide high effective yields that help to
in emerging market (EM) assets. Emerging markets comprise smooth the volatility in the stock markets. Looking ahead, we
nearly 40 per cent of the portfolio’s equity holdings. Otherwise also consider it likely that this segment will provide a signifi-
we work with developed markets and by making careful cant contribution to the performance of the portfolio.
choices, which we have recently done in a satisfactory way.
Both our EM and developed market holdings have surpassed The task of changing our hedge fund sub-portfolio is under
their benchmark indices. way. The emphasis will be on CTA, Global Macro, Fixed Income
and nowadays also Event Driven strategies when we add a
In line with our higher expected return from the equities asset new fund to the portfolio. We are also investing in a Credit
class during the coming one to two years, we are now increas- Long/Short fund with a somewhat more liquid and trading-
ing the percentage of the SEB Modern Aggressive portfolio in- oriented strategy. We expect this holding to reduce the port-
vested in equities from 35 to 40. However, we are keeping the folio’s correlation with stock markets. The Modern Aggressive
same allocation within the asset class as previously. Equities hedge fund sub-portfolio focuses on the main hedge fund
are the asset class that weighs heaviest in SEB Modern management trends that we foresee as having potential. Here
Aggressive and thus accounted for the largest contribution to we are also diversifying towards cyclically driven assets, but
the portfolio’s positive return during the period. beyond that we are emphasising managers who accept a high
risk level in their funds. Since our hedge fund sub-portfolio
After their strong performance during the autumn, private eq- contains different types of strategies, we still have a good di-
uity and commodities have recovered most of the downturns versification effect and high expected returns.
they experienced during the spring. Commodities have been
the best performing asset class in SEB Modern Aggressive
since June 30, closely followed by private equity.


Private equity
Hedge funds
Fixed income
20% Equities

10 Investment Outlook - december 2010

Speeding up
the tempo

The cycle shifts into third gear

• Faster growth rates and the Fed’s QE2 will were characterised by market fluctuations. These were influ-
benefit risk assets... enced by lowered GDP forecasts in the wake of slower growth
rates in the OECD countries, budget tightening in southern
• ...and capital is flowing into the emerging Europe, reassuring stress tests of European banks, fears of a
market sphere... double dip recession in the US and budding expectations that
the Federal Reserve (Fed) would resume large-scale bond pur-
• ...generating major opportunities but also chases − “quantitative easing” to stimulate the economy.
global tensions
Time for third gear
After about a year of range trading, it now seems to be time
After the worst economic and financial crisis in living memory, for the cycle to shift into third gear. This is due to signs of re-
March 2009 saw a shift into first gear in the recovery process newed acceleration in growth rates in many parts of the global
for equities and other risk assets − a new bull market. Like so economy, further quantitative easing by monetary policy mak-
many times before, the initial rally phase was characterised by ers in key OECD industrialised countries (developed markets,
a broad-based increase in asset values: a “beta market”. DM) and sustained strong economic growth in the emerging
markets (EM) sphere − coupled with low core inflation, as well
In keeping with history, the economy stabilised rather soon as prospects of continued profit improvements and strong
after the stock market rebounded. The United States and balance sheets in companies worldwide.
many other countries began their recovery around the middle
of 2009. The global cyclical upswing was then confirmed by INDICATIONS OF FASTER GLOBAL GROWTH
macroeconomic statistics late in 2009. Together with signifi-
65 65
cant cost savings, this caused corporate profits to rise, while
interest rates in most industrialised countries remained very 60 60
low. A combination of rapid economic expansion, upward revi- 55 55
sions in growth forecasts, higher profits and low interest rates
50 50
then provided a very favourable environment for risk assets.
45 45
Second gear 40 40
Late in 2009, the recovery cycle shifted to second gear, as 35 35
financial markets began to be more and more affected by both
30 30
positive and negative forces. Stock markets thus showed more 2004 2005 2006 2007 2008 2009 2010
of a sideways price trend − “range trading” − and there was a Index service sector Index manufacturing sector
greater focus on the quality of investments: an “alpha market”. Source: Reuters EcoWin

After large gains, the J.P. Morgan global purchasing manag-

Soon after New Year 2010 the spotlight turned to the financial ers’ index for both the manufacturing and service sectors
problems of the Greek government, and China took its first peaked in April 2010, followed by a downturn during the
steps towards tightening its economic policies. On the other summer and early autumn. In October, both indices rose
hand, during the spring companies presented surprisingly again, which promises better global economic performance.
good earnings reports, and at the same time GDP forecasts
were raised further. But during the second quarter, the
European sovereign debt crisis exploded, resulting in sizeable
price declines for risk assets. The summer and early autumn

Investment Outlook - december 2010 11

Theme: Speeding up the tempo

The downturn in growth rates (mainly in the DM countries) But if economic observers − unexpectedly − should become
which began early in the second quarter of 2010 ended this substantially more upbeat, expectations concerning monetary
autumn, judging from various leading economic indicators. In policy in influential DM countries would probably soon shift
October, both manufacturing and service activity accelerated in a tightening direction, which in itself would have a negative
for the first time in six months, according to the JP Morgan impact on stock markets. This happened, for example, in the
global purchasing managers’ index. Behind this were higher US during October 1993.
production, order bookings and employment. The countries
and regions that reported the largest total improvements in Growing replacement need
the manufacturing and service sectors included the US, the The cyclical improvement that is now noticeable is based,
United Kingdom, China, Hong Kong, India and Russia. among other things, on events during 2009, when companies
− especially in the DM countries − sharply decreased their
In the manufacturing sector of many countries, the order/in- fixed investments and many households abstained from buy-
ventory ratio − a “leading-leading indicator” − rose in October. ing capital goods. This has now resulted in a growing need to
If, for example, order bookings rise quickly at the same time as replace worn-out machine tools, cars, refrigerators, washing
companies are reducing inventories − which is now the case in machines etc. Unusually low interest rates in the wake of ultra-
large swaths of American business − this promises growing ac- loose monetary policies in major DM countries are another
tivity ahead once companies boost production, both to meet factor that benefits the economic cycle. A third is the new
greater demand and to rebuild their inventories. quantitative stimulus measures by central banks.

Higher US car sales In early October, the Bank of Japan announced a programme
Among other macroeconomic measures that conveyed equivalent to USD 60 billion to purchase various assets: gov-
the same positive economic message during October was ernment bonds, commercial paper, exchange-traded funds
America’s National Federation of Independent Business (NFIB) (ETFs) and real estate investment trusts (REITs). But the Fed’s
index − the small business equivalent of the ISM purchasing new round of US quantitative easing (QE2) − buying USD 600
managers’ index − which reported its largest upturn in six billion worth of government bonds by mid-2011 − will be more
months. Meanwhile US car sales surged. important. This will swell the Fed’s balance sheet to nearly
USD 2.9 trillion, compared to about USD 800 billion in the
The world economic acceleration signalled by leading indica- summer of 2007, before the financial crisis.
tors seems to be happening a little earlier than foreseen in
many forecasts (the second quarter of 2011). It thus cannot be It is worth adding that the Fed will also continue reinvesting
ruled out that GDP forecasts will be revised upward in the win- interest proceeds and principal on maturing government
ter. If history repeats itself, this would contribute to rising stock and mortgage bonds in new government bonds. As a result,
markets. During the past decade, an increase of approximately its total purchases of such bonds by June 30, 2011 will total
one per cent in the consensus forecast for one-year global about USD 875 billion (about 6 per cent of GDP). According to
GDP growth has resulted in a global stock market upturn of Fed calculations, USD 100 billion in new bond purchases are
about 10 per cent, all else being equal. At the level of individ- roughly equivalent to a 0.1 per cent cut in the federal funds
ual countries, the correlation between revised forecasts and rate, its key interest rate.
stock market reactions has been especially large in the US.

2.50 2.50

2.25 2.25

2.00 2.00
1.75 1.75
Immediately after Lehman Brothers went
1.50 1.50 bankrupt in mid-September 2008, the Federal
USD trillion
USD trillion

Reserve launched a massive quantitative

1.25 1.25
easing programme, which was reflected in the
1.00 1.00 growth of its balance sheet from roughly USD
800 billion to about USD 2.25 trillion. It has
0.75 0.75 remained at approximately this level so far
during 2010, but new Treasury bond purchases
0.50 0.50 will swell the balance sheet by USD 600 billion
2002 2004 2005 2006 2007 2008 2009 2010
from this autumn until mid-2011.
Source: Reuters EcoWin

12 Investment Outlook - december 2010

Theme: Speeding up the tempo

According to the “transmission mechanism”, QE2 will favour- valuation pressure on their currencies. The result is a powerful
ably affect the US economy, in theory via three channels. The monetary stimulus which − in the event of high price and cost
first is via lower real bond yields as inflation expectations pressure − needs to be offset by fiscal austerity measures.
rise, benefiting interest rate-sensitive demand for housing,
consumer capital goods, construction and corporate capital These macro events in the wake of QE2 are thus harmful to
spending. The second is via rising risk asset prices, which many companies in the EM countries that compete interna-
strengthen household balance sheets − and thus willingness tionally. China is among the exceptions, because the yuan
to consume − while boosting corporate investments due to has only risen marginally against the dollar since the summer.
lower risk capital costs. Thirdly, a lower dollar exchange rate Meanwhile domestic economic activities, such as private con-
stimulates US companies that export or compete with imports, sumption and construction, are benefiting from cheaper im-
which will become more expensive. The overall effects via ports and record-low real interest rates. Coupled with higher
these channels may boost GDP growth in 2011 by nearly 0.5 economic growth, this means a good stock market environ-
percentage points, and by a bit more in 2012. ment in many EM countries.

However, it is unlikely that QE2 will have any major positive There are also threats
impact on the economy via the banking system and the credit The global macro and market picture that has emerged so far
multiplier. In order for this to happen, banks must be ready is upbeat in many respects. But there are also threats, among
for a large-scale expansion of their balance sheets through them substantial imbalances in the public sector finances and
increased lending, which is probably not in the cards when current account balances of some countries. This generally
banks must take into account the requirements specified by requires a difficult balancing act when countries carry out their
the new Basel III capital adequacy rules. monetary and fiscal policies, and it is likely to trigger major
currency-related tensions.
Other countries are also affected by QE2
Some of the financial effects attributable to QE2 have already In some places, there have been insistent demands for budget
been noticeable, both in the US and internationally, because tightening, especially by the PIGS countries (Portugal, Ireland,
expectations of renewed bond purchases by the Fed have Greece and Spain). Portugal, Greece and Spain have respond-
existed in the market since the summer. This is reflected, for ed by unveiling tough fiscal austerity programmes, and Ireland
example, in the decline of the dollar and accompanying ap- will do so in early December − one of the requirements for its
preciation of many currencies in the EM sphere. Especially via financial aid package from the European Union (EU) and the
the foreign exchange market and its large capital flows, other International Monetary Fund (IMF). The Irish government’s tar-
countries are thus also significantly impacted by QE2. get is to reduce its budget deficit to 3 per cent of GDP by 2014.
After the recent rescue package for Ireland, many observers
The decline in US Treasury yields − at this writing (November expect that Portugal is next in line to utilise the European
22) the two-year yield is just below 0.50 per cent − in response Financial Stability Facility (EFSF), which was launched by the
to QE2 has caused many investors to seek higher returns in EU and the IMF during the summer.
the corporate bond market’s High Yield segment and in other
countries, primarily the EM sphere, which offers substantially SEARCH FOR RETURNS IS BENEFITING
better yields on both government and corporate bonds. This CORPORATE AND EM BONDS
“search for returns” has greatly contributed to the rapid appre- 10 10
ciation of many EM currencies, which in turn has brought the 9 9
concept of “currency war” and the risk of trade barriers into 8 8
7 7
the financial news headlines. 6 6
Per cent

5 5
Foreign exchange market interventions 4 4
The international competitiveness of EM countries with 3 3
2 2
floating exchange rates has weakened. A number of these
1 1
countries have reacted by intervening in the foreign exchange 0 0
market to limit currency rate increases, introducing taxes and 2004 2005 2006 2007 2008 2009 2010
restrictions on foreign portfolio investments in bonds and eq- India, Government Benchmarks, Bid, 2 Year, Close, INR
United States, Government Benchmarks, Bid, 2 Year, Close, USD
uities, as well slowing the pace of monetary tightening (since United States, Corporate Benchmarks, BBB Rated, 2 Years, USD
Source: Reuters EcoWin
strong currencies of course also have a tightening effect).
The Federal Reserve’s zero interest rate policy and quantita-
tive easing have led to record-low US Treasury bond yields.
But EM economies that have pegged their currencies to the
Investors seeking higher returns are finding them in the cor-
US dollar, for example Hong Kong, are forced to adjust their
porate bond market and emerging market debt (EMD).
monetary policies to those of the Fed in order to prevent re-

Investment Outlook - december 2010 13

Theme: Speeding up the tempo

EXPENSIVE TO INSURE PIGS SOVEREIGN BONDS Among major DM countries, the situation and trends affecting
public finances vary. Germany appears set to bring its budget
1100 1100
1000 1000 deficit below the 3 per cent of GDP criterion as early as next
900 900 year. In the UK, Chancellor of the Exchequer George Osborne
800 800 has presented a tough GBP 83 billion target for total budget
700 700
Basis points

tightening by 2015. In the US, the new Republican majority in

600 600
500 500
the House of Representatives after the November 2 election
400 400 will lead to political gridlock and the risk of passivity in fiscal
300 300 policy. The tax cuts that were enacted by President George
200 200 W. Bush may possibly be extended. But offsetting this is that
100 100
many of President Obama’s 2009 stimulus measures are now
0 0
Aug Nov Feb May Aug Nov Feb May Aug Nov expiring, and US fiscal policy will thus tighten automatically.
2008 2009 2010
Spain Portugal Greece Ireland Source: Reuters EcoWin
In Japan − which “internally finances” most of its public sector
After minor sovereign debt worries about the PIGS countries deficit − new fiscal stimulus measures totalling the equivalent
(Portugal, Ireland, Greece and Spain) late in the summer, of USD 55 billion are expected soon, aimed at propping up
more recent concerns about Ireland in particular have spread regional economies and small businesses.
to the others. This has led to skyrocketing costs for insuring
their 5-year government bonds using Credit Default Swaps
Focus on imbalances and tensions
(CDSs). Global imbalances − especially the US current account deficit
and China’s surplus − and the currency tensions generated by
Lingering worries about public finances in the PIGS countries, these imbalances as well as America’s QE2 programme were a
along with Germany’s demands that private lenders should major focus of the G20 summit in Seoul on November 11-12.
eventually also share the losses if a euro zone country cannot
pay the interest and principal on its loans, has caused credit The communiqué following the meeting contained clear dec-
default swap (CDS) premiums and government bond yields in larations with a bearing on current economic and financial
the PIGS countries to soar in November. imbalances in the world, but without binding formulations. In
spite of this, it represented a success of sorts that the 20 coun-
The fiscal crisis in southern Europe and Ireland is thus still tries were able to reach agreement on the final document.
clearly reflected in the markets. But when EU finance minis-
ters announced that their plans for a new emergency fund, But the bottom line is that there is no reason to expect any of
including greater liability for private lenders, would not include these countries to change its economic policies as a result of
already outstanding government bonds in the union and that the meeting.
the new rules would not take effect until after mid-2013, this
calmed the markets temporarily.

150 150
100 100

0 0 The US current account deficit totals nearly

USD 125 billion per quarter, while China’s
USD billion

-50 -50 quarterly surplus is about USD 75 billion. Many

USD billion

-100 -100 observers maintain that a major decline in

the US dollar (USD) exchange rate against the
-150 -150 Chinese yuan (CNY) is essential in reducing
-200 -200 this financial imbalance. In the summer, China
resumed CNY appreciation against the USD,
-250 -250 but so far the pace has been very modest.
1985 1990 1995 2000 2005 2010
China US
Source: Reuters EcoWin

14 Investment Outlook - december 2010

Emerging markets
lead the pack

Continued growth trend in emerging markets

• EM now a natural part of a portfolio In the climate we foresee, investors will also be prepared to
gradually take more risk. Fear of a double dip recession has
• Large capital flows to the EM sphere will eased, companies are delivering rising profits, interest rates
continue will remain low for an extended period and stock market valu-
ations are attractive in a historical perspective. Greater risk
• We foresee good potential for EM assets appetite traditionally favours assets connected to emerging
Since share prices bottomed out in early March 2009, emerg-
ing markets (EM) have been a big favourite among both ana-
Expansionary interest rates
lysts and investors. This is reflected in a massive capital inflow As a result of the deep financial and economic crisis, the
to these countries, resulting in sharply rising share prices, cur- world’s most influential central banks lowered their key inter-
rency rates and bond prices. est rates to record-low levels. Due to today’s free capital flows,
low key rates in Western countries have also pushed down
The higher returns generated by investments in emerging global interest rates. An ultra-loose monetary policy suits the
markets compared to developed markets (DM) have been G7 countries but is too expansionary for the EM sphere. For
well-justified, since the picture of a two-speed world seems example, short-term nominal interest rates in emerging mar-
increasingly clear. Although the global economy suffered kets average around 5 per cent, while GDP growth in nominal
through its worst cyclical slump since the Great Depression of terms has surpassed 11 per cent during the past 12 months.
the 1930s, the EM sphere has steamed along with nearly un- As a rule, a large gap between borrowing cost and growth
interrupted strength. In contrast, OECD countries face major leads to increased economic activity, rising asset prices and,
challenges in the form of gigantic financial deficits, high un- eventually, inflation. But as long is inflation is kept at moderate
employment and slow growth. This dualism is the reason why levels, there are good prospects for continued price increases.
we − and many others − have elevated the EM sphere to a first
choice position in our global equity allocation.
It is not the world’s best-kept secret that the EM sphere has
80 EM bonds
weathered the challenges of the financial crisis with flying
60 EM equities
colours. The arguments for the long-term potential of EM
countries are also widely known, and there are few analysts
who fail to sing the praises of the EM sphere. But when the
same theme is on the lips of every man and woman, the warn- 0

ing bells begin to ring. Who or what will drive asset prices to -20

new heights, when the investor community has already over- -40

weighted the EM sphere in its portfolios? -60

2007 2008 2009 2010 YTD
Source: EPFR
Yet despite the recent rally and the like-minded consensus
view, our assessment is that EM assets have more to give. So The inflow into EM funds has been massive, increasing the
far this year, global investors have sought out quality invest- risk of large outflows if risk appetite falls, but we believe risk
ments. As world economic recovery gains traction, their focus appetite will remain high and that EM assets have more to
will move towards assets that generate growth. This is why give.
investors are likely to continue demanding EM assets.

Investment Outlook - december 2010 15

Theme: Emerging markets lead the pack

In recent years, one clear trend is that exports from emerging concept was launched − there have been only a few upgrades
markets to the OECD countries have declined. Instead, an from developing to developed country. Aside from Israel and
increasing percentage of trade occurs within the EM sphere. South Korea, which were recently reclassified as developed
This shift in trade flows is likely to benefit EM countries. Their countries, only Portugal and Greece have advanced to the
dependence on Western demand is decreasing, and it is thus developed category, according to the indices. But today these
less important if this demand falters. Instead sales are aimed two euro zone countries face enormous financial problems
at domestic consumers, who are in a position to increase their and their path to solvency will be long, tortuous and difficult.
purchases. Unemployment in the EM sphere is comparatively As a result, several credit rating agencies have put Greece and
low, while debt is also low and the savings ratio is high. Portugal on their watch lists for further downgrading.

NEW EM TRADE FLOWS However, a number of countries have been downgraded from
% developing countries to “frontier markets” (usually countries
60 with markets that are more difficult for an international inves-
tor to gain access to). For example, Standard & Poor’s has
Source: SEB downgraded Argentina, Jordan, Nigeria, Pakistan, Sri Lanka,
Venezuela and Colombia. Consequently most such economies
have failed to develop at the pace once hoped for. There are
abundant historical explanations for these shortcomings.
Among the most common are dictatorships, wars and civil
wars, corruption, hyper-inflation and communism.
1998 2000 2002 2004 2006 2008 But the past decade has witnessed major upheavals, both
EM to DM Intra EM
political and economic. Most developing countries have imple-
mented far-reaching structural reforms, among other things
Trade within the EM sphere is accelerating and the percen- aimed at improving the efficiency of their economies, giving
tage of EM exports going to developed countries is falling. central banks more independence, deregulating financial mar-
This trend is beneficial to EM countries, since they are less kets, embracing responsible budget policies and overcoming
dependent on debt-burdened “Western” consumers. corruption. As a result, the EM sphere now stands on consider-
ably more stable ground than previously.
If − contrary to expectations − new storm clouds loom ahead,
the EM countries have the economic policy tools to deal with Historically, a negative puff of wind in the global economy has
this. Their key interest rates are relatively high, and in many usually developed into a full-scale storm in the EM sphere. On
cases their government treasuries are full to bursting. The EM occasions when a developing country’s economy has been
countries are thus in a position to pursue expansionary fiscal mismanaged, it has traditionally ended up being insolvent.
and monetary policies as needed. In most Western countries, But this time around, the roles are reversed. The established
however, governments are out of cash and the key interest economic powers seem to be the weakest link in the chain.
rate has already been slashed to around zero. However, there are still a number of EM countries that are
characterised by widespread corruption, erratic political lead-
A paradigm shift ers and economies on the brink of ruin. But these countries
In a longer-term perspective, emerging market coun- are becoming fewer.
tries increasingly look like the investment of the future.
Developments over the past decade indicate that a paradigm A sphere worth watching
shift is under way. During this period, growth has been 4 The EM sphere accounts for about 47 per cent of world GDP
percentage points higher in the EM sphere than in the OECD (adjusted for purchasing power), and its share is growing rap-
countries. As a whole, returns in EM stock markets have been idly. China is expected to surpass the US as the world’s largest
10 per cent higher than the world index, and their risk (meas- economy by 2020, and India is expected to surpass the US by
ured as volatility) has gradually fallen to the same levels as in 2050. This expansion in national economies is also reflected in
OECD stock markets. the companies that are based in the EM sphere. On the Forbes
400 list of the world’s largest companies, three of the five larg-
The expansion in emerging markets has primarily occurred af- est are in the EM sphere. Of the 100 largest companies, 11 are
ter the turn of the millennium. Before that, “developing coun- in China, a number that only the US beats. It is clear that a new
tries” did not live up to their label. For the financial market, in world order is materialising and that this is occurring at a rapid
practice it is major index suppliers (MSCI, FTSE and S&P) that pace.
define what is a developing or a developed country, respec-
tively. During the past 30 years − since the “emerging markets”

16 Investment Outlook - december 2010

Theme: Emerging markets lead the pack

A decade ago, emerging markets accounted for only 4 per cent EM sphere is the stronger card in the deck − a discount is not
of global stock market capitalisation. Since then, the figure equally justified.
has steadily grown and now stands at about 14 per cent, but
this is still very low considering the economic size of the EM As a rule, the foreign exchange market is controlled by risk
sphere. One explanation is that most EM countries still have appetite, the fundamental underlying values in countries
restrictions on what equities foreign investors may own. In ad- and currencies and interest rate or yield spreads (with inves-
dition, many large EM companies make only a small percent- tors borrowing where interest rates are low and putting their
age of their shares available to private investors. money into places where interest rates or yields are high). All
these factors point towards stronger EM currencies compared
As economic and financial markets in these countries evolve to the OECD (see also the “Currencies” section of this report).
and their openness to the global economy increases, EM equi- One attractive way of gaining currency exposure is to buy
ties are likely to boost their share of the global equities index. bonds issued by EM countries. Aside from the expected posi-
If this occurs at the same pace as during the past decade, tive returns on currency movements, investors can also take
emerging markets will account for 25 per cent of the global in- advantage of the higher yields prevailing in the EM sphere.
dex in 2020 and 40 per cent in 2030. An overweighting in EM In addition, from a risk standpoint it is beneficial to diversify
equities today is thus likely to be regarded as an underweight- a fixed income portfolio into a larger number of assets that
ing within the relatively near future. can generate returns. In terms of risks and opportunities, an
investment in EM bonds mainly provides currency exposure.
Exposure to the EM sphere Based on historic price fluctuations (volatility), currency move-
We see good prospects for EM-related assets, regardless of ments account for about two thirds and yield movements
whether they are equities, currencies, fixed income securities about one third of price fluctuations.
or commodities.
Industrial metals are closely connected to EM expansion. Our
For equities, we are continuing to suggest overweighting EM assessment is that prices of industrial metals will continue to
shares in global equity portfolios. The countries that we be- climb at the same rate as world economic recovery, which is
lieve have the greatest potential in the EM sphere are Russia, being driven by the EM sphere. One important piece of the
Poland and Turkey. Despite sharply rising share prices, valu- puzzle in price formation is the situation in the commodities-
ations do not appear exaggerated on EM stock exchanges. hungry Chinese economy. After a downturn in manufacturing
The P/E ratio is below 12, or at about the same level as during activity during the summer, industrial data are now pointing
the 2000s. During the 1990s, the average P/E ratio in the EM towards acceleration. In addition, the inventory draw-down
sphere was 15. EM shares are traditionally traded at a discount that took place in China during the first half of 2010 seems
compared to the world index, but because of the stock market to be over, and metal imports are rising once again. In our as-
rally in recent months this discount has narrowed from 15 to sessment, copper and aluminium have the greatest potential
5 per cent, which in itself is alarming. But given the two-speed among industrial metals (see the “Commodities” section of
economic situation now prevailing in the world − where the this report).

35% EMERGING MARKETS account for

20% Progress in the emerging market (EM) sphere

is noticeable on many fronts. The political in-
15% fluence of these countries is increasing as their
10% economies grow. EM stock exchanges have
also accounted for a fast-rising percentage
5% of global stock market capitalisation in the
0% past decade. If the same pace continues, EM
exchanges will account for 25 per cent of a






world index as early as 2020.

Source: FactSet, MSCIbarra, SEB

Investment Outlook - december 2010 17

Low government
bond yields −
new portfolio

Do government bonds still belong in a

• Government bond yields have been falling for This has meant that government bonds have been a good
a long time investment during the same period. The return on a bond is a
combination of the interest rate at which a bond is issued and
• What will be the next low-risk investment? continuous market valuation. The value of bonds increases
when interest rates fall, since these bonds were issued at high-
• The traditional role of bonds in a portfolio er interest rates. For example, if a bond is issued when market
needs to be re-examined interest rate is 10 per cent and market interest rate falls to 8
per cent, the value of the bond rises. As a consequence, over
the past 30 years bonds have been a very good investment −
Markets always give us the potential to generate returns, but
better than equities during many periods. In other words, risk-
sometimes we may be misled into believing that the impor-
taking has not paid off.
tant investment decisions are being made minute by minute.
Images of young women and men sitting in front of stock
The flip side of the above-mentioned favourable trend is that
market monitors talking on their telephones have created a
if government bond yields now rebound − a conceivable sce-
distorted perception of how portfolio management works.
nario − such bonds will generate very low returns. The direct
consequence of this is that government bonds as an asset
In reality, most markets change their direction once or twice a
class will not provide the self-evident returns than people are
year; the key is identifying these shifts. As for the bond market,
accustomed to.
it is important to have an even more long-term perspective.
Right now this market seems to be changing direction after 25
Portfolio managers often use government bonds to lower the
years, a shift that will have major consequences for portfolio
risk in a portfolio. Combinations of equities and bonds have
management in general.
historically been, and in many cases remain, a tool for adjust-
Yields trending downward ing the risk level of a portfolio to an investor’s desired risk
For a very long time (since the early 1980s) the world has been
watching bond yields trend downward. This has been a conse- Risk of very low, even negative returns
quence of several factors: ever-lower inflation in the wake of
Many private investors have also chosen traditional mixed
inflation-fighting monetary policy, increased global competi-
funds that apply similar philosophies. Today there is a danger
tion, lower commodity prices and − for the past decade or
that many such strategies will generate very low or even nega-
so − a large quantity of new production capacity in developing
tive returns, depending on how the fund managers handle
countries, which has meant falling prices for many goods.
risk. The risk will become reality, provided that bond yields
rise. This risk should not be exaggerated today, but viewed in
Before this, bond yields had been rising essentially since the
a longer perspective it exists. Above all, we should not view
1950s, first as a result of rapid economic growth and accom-
bonds as a self-evident risk reducer and a source of returns in
panying competition for savings and then mainly due to rising
the future.
inflation, among other things caused by two oil price shocks
and growing budget deficits in key countries such as the US.
Today government bond yields are very low. In some countries
they are even touching 1950s levels. In Sweden they have
Bond yields peaked in the early 1980s, especially after the
gradually begun to rise, but they remain low. The yearly re-
second oil price shock had driven up inflation to double-digit
turn on 10-year government bonds is around 2.5 per cent in
levels in many industrialised countries. Since then bond yields
Sweden, elsewhere in Europe and the US.
have fallen sharply, and today they are historically low.

18 Investment Outlook - december 2010

Theme: Low government bond yields − new portfolio thinking

Today we have a world economy that is gradually improving. The spread between High Yield bonds and equivalent govern-
Meanwhile capital markets are being helped by an expanded ment bonds, for example, is still wide and is more than the
quantitative easing programme in the US, designed to push historical average. Government bonds are employed as risk
down bond yields. Globally, this will help feed liquidity into the reducers in portfolios, but also as a tool for earning current
financial system and keep bond yields down for a period. We coupon income. Here even the stock market may serve as an
cannot rule out the risk that at some point, yields will gradually alternative investment when yields have fallen as much as
move upward. This movement cannot be so large, since infla- they have. Although equities will never have the features that
tion pressure in the West is very low. investors demand from bonds, bond yields have nevertheless
fallen so low that the yield on equities has become an alterna-
Two possible scenarios tive from an income standpoint.
There are actually two conceivable scenarios: government
bond yields will stand still, in which case today’s return levels Equity yields are increasingly attractive
will continue. The other is that yields will rise as a conse- One observation we can make is that one of the world’s lead-
quence of strong economic growth, in which case we can ing bond managers, Pacific Investment Management Co.
expect negative returns. (Pimco), has started equity funds. If we assume that stock
markets are reasonably valued and the global economic re-
So how will investors behave? In the future, they will still want covery will continue at a relatively healthy pace, equities with
to have multiple sources of returns and investments, aimed at yields of 3-4 per cent will appear more and more attractive to
offsetting the risk that pure equity holdings create. This means a portfolio manager.
that asset managers are likely to search for other methods to
achieve this balance. Fixed income and bond investment man- Portfolio managers and investors will thus need to seek new
agement with free mandates − not tied to a benchmark (for paths of diversification and find new sources of returns. Other
example a government bond index) − will be in demand. management styles, hedge funds and stock markets may then
become a focus for a growing number of investors.
Even today, we are seeing a growing number of freely man-
aged fixed income investments. They are almost like hedge
funds with low risk mandates that focus on bond investments,
a category that will be of growing importance in the future.
Some capital will find its way into corporate bonds, a trend
that has been under way for some time and that will continue.


Source: Dimson et al, EcoWin, SEB Swedish government bond yields bottomed
-10% out in the late 1940s and then peaked in 1985.
During the 25-year period from 1945 to 1969,
the return on the government bond market av-
1 3 5 7 9 11 13 15 17 19 21 23 eraged a modest 2.2 per cent annually in real
Year terms, while the corresponding figure during
the period of falling yields was 10.6 per cent.
Real return 1945-1969 Real return 1985-2009

Investment Outlook - december 2010 19

What will happen
with the stock market
in a stable
financial climate?

How a stable economy will affect the stock

• Looking ahead two years, the consequences of been reduced by 20 per cent. Expectations would continue
stable economic growth look promising… to fall gradually until the final outcome was unveiled early in
2009 in the form of annual financial statements. The actual
• …but the question is whether there is upside level was about SEK 390 billion. Expectations for the next
potential left couple of years, meaning 2009 and 2010, had also fallen and
would later be lowered further by analysts. Earnings expecta-
• Considering profit estimates, the answer is tions bottomed out at the end of August 2009: “only” SEK 270
probably yes, despite a mixed macro situation billion for the full year 2009 and SEK 340 billion in 2010 (in
other words, below the profit level reported for 2008). After
On November 21, 2008 the situation in the Swedish stock that, expectations began to move upward.
market, like of its peers around the world, was desperate. The
financial crisis, which had begun with the sub-prime crisis It may seem paradoxical that the OMX Nordic Exchange
a year and a half earlier, had entered a frantic phase. The Stockholm had “already” bottomed out by late November
Swedish money market closed, and the US central bank − the 2008, even though profit estimates continued to undergo dra-
Federal Reserve − issued a bond with a negative yield. Bear matic downward adjustments until the following summer. Why
Stearns had been saved early in 2008, but on September 15 buy equities if the returns will be worse in the future? Even
that year the end came for another major investment bank, though this is history, the question is worth asking in order to
Lehman Brothers. This bankruptcy had repercussions all over understand market mechanisms.
the world, especially in the fixed income market. The Swedish
stock market had been falling since the summer of 2007, and The chart below illustrates this trend. It shows the price/earn-
on this day the SIX Return Index reached its lowest point. ings (P/E) ratio in Stockholm, with moving 12-month forecasts.
At the end of November 2008, it hit a low of 8.1. Then the P/E
New conditions ratio rose to a peak of 19.4 at the end of September 2009. This
trend unfolded quickly, since share prices were rising while
Now, two years later, the situation has changed. The aftermath
profit estimates were being lowered; the numerator of the ra-
of the financial crisis has been quite noticeable to many peo-
tio increased while the denominator decreased.
ple in North America and much of Europe, but with few excep-
tions the OMX Nordic Exchange Stockholm and other Swedish ATTRACTIVE P/E RATIOS
stock exchanges have celebrated triumphs. The SIX Return 30.0
Index has risen by 110 per cent, and the big question now is 25.0
whether there are further price increases to come, or whether
the world’s stock markets will take a break or perhaps even
turn downward. Considering analysts’ profit forecasts for the 15.0

next few years, it should be easy to answer this question in the 10.0
affirmative, but it is not really that simple. 5.0
Source: SEB
In the long term, all financial markets are driven by expecta- 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
tions of future returns, but taking risk level into account. At
the end of November 2008, expectations for the most heavily P/E ratios, OMX Nordic Exchange Stockholm

traded companies on the Stockholm exchange were for a total P/E ratios in Stockholm, based on expected profits 12
profit of SEK 440 billion during that year. At the beginning months ahead, bottomed out at 8.1 in late November 2008.
of 2008, expectations had been SEK 560 billion, so they had After that it has risen, but it remains relatively low. (Chart 1)

20 Investment Outlook - december 2010

Theme: What will happen with the stock market in a stable financial climate?

Inverting the P/E ratio gives us a measure of the expected This leads back to the question of how the market will per-
returns on the stock exchange. It is useful to compare this to form in the future. Let us examine how the current situation
bond yields, for example. In the summer of 2008, the worst of looks. Forecasts for 2011 are 12 per cent above the profit
the financial crisis seemed to be over, and at the end of July projected for this year, and forecasts for 2012 are another
a Swedish 10-year government bond was being quoted at 11 per cent higher than for 2011. These forecasts have been
4.5 per cent, about the same level as a year earlier when the adjusted upward too, just like those for 2010. Although the SIX
sub-prime crisis had exploded. When the crisis flared up again, Return Index has climbed nearly 30 per cent since the end of
this yield rapidly fell. The chart below illustrates stock market September, the P/E ratio for the coming twelve months has
returns (based on the inverted P/E ratio) and 10-year govern- fallen from 19.4 to 13.0, as shown in Chart 1; in other words,
ment bond yield. the forecasts have risen faster than the stock exchange index.
The return on the Stockholm exchange stands at 7.8 per cent
The differential (or spread) between stock market returns and and the 10-year government bond yield is 2.75 per cent, which
bond yields may be regarded as a risk premium, the “extra means a spread of more than 5 per cent, as shown in Charts 2
return” that the stock market demands in order to hold equi- and 3. Chart 3 also indicates that the current risk premium is
ties instead of fixed income securities. This is illustrated in the unusually high.
chart on the next page. At the end of June 2007, in other words
precisely when the sub-prime crisis broke out, this spread Falling risk premium in the long run
reached a low of 2.3 percentage points. Then the risk premium Given a less uncertain financial world, it “should” be pos-
increased to an extreme level at the end of November 2008, sible for the risk premium to fall to more “normal” levels,
more than 8.8 percentage points, which illustrates the crisis approximately 2-4 per cent. Assuming more forecasts and an
situation well. unchanged 10-year government bond yield, a risk premium
of 3 per cent − in the middle of the range − would justify a
Although profit expectations continued to fall during the fol- long-term P/E ratio of 17.4, implying a stock market upturn of
lowing six months or so (lowering stock market returns, due nearly 35 per cent. “If only macro problem X is solved,” many
to a higher P/E ratio), the abnormally high risk premium was investors say, “the risk premium will decrease and the stock
reduced by the stock market upturn, and this gained “extra” market will rise.” But what is worrisome is that “macro problem
power because of falling 10-year government bond yields. X” tends to be followed by “macro problem Y” and so on.
At the end of September 2009, the risk premium reached a
new low of 1.8 percentage points. As mentioned earlier, profit Like most other stock exchanges, the Swedish exchange
expectations began to be adjusted upward just before that, seems to be happy about the Federal Reserve’s QE2 round (for
helping drive down the P/E ratio (and thereby increase the risk explanations, see page 12), which will solve the problem of
premium). The final outcome for 2009 was that profits for the sagging American economic growth, at least temporarily. But
most traded companies reached SEK 300 billion, or about 10 before that, stock markets were worried that the weak finan-
per cent higher than forecasted. At present, forecasts for 2010 cial position of the Portuguese and Irish governments would
profits stand at SEK 430 billion, or 25 per cent higher than just threaten the euro and eventually the European Union. Before
over a year ago. that, there was Greece. Considering the huge financial imbal-
ances that have built up around the world over many years, it

4% Inverting the P/E ratio gives us the return on
2% the stock exchange, which shows an unusually
Source: SEB
0% high risk premium in relation to the 10-year
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 bond yield. The latter fell below 3 per cent
during the financial crisis and has also been
Return on stock exchange Swedish 10-year yield below 3 per cent since April 2010. (Chart 2)

Investment Outlook - december 2010 21

Theme: What will happen with the stock market in a stable financial climate?

seems unlikely that the risk premium will decrease soon, but Looking ahead, we can thus say that at least two out of three
perhaps in the long run. In fact, it has already decreased by valuation parameters will probably move in a favourable direc-
nearly one percentage point in only two months. tion. A period similar to the years 2005 until mid-2007, with a
total doubling of share prices, appears likely. During this pe-
With regard to profit forecasts, 2012 forecasts are higher riod, the moving P/E ratio varied from 13 to just over 15 (share
than 2011 ones, which in turn are higher than forecasts for prices changed at about the same pace as profit estimates
this year. This means that these estimates are higher over were being adjusted upward) and the risk premium varied be-
time. If all parameters remain unchanged for one whole year, tween 2 and 4 per cent. Starting in early May 2006, however,
this means that the stock exchange’s P/E ratio will fall from the stock market lost 20 per cent in about one month. In other
13.0 to 11.7. But more important are the initial indications words, even during this “idyllic” period, short-term volatility
of forecast adjustments that Swedish analysts are currently could be high. Given the major imbalances in the world econ-
making as a consequence of corporate nine month reports, omy, it is likely that both the OMX Nordic Exchange Stockholm
which are solidly upbeat − up about 5 per cent for this year’s and other stock exchanges will suffer from temporary “macro
profit level (and similar or nearly the same for 2011 and 2012). shocks”, but based on valuation parameters, the long-term
Unfortunately, this also echoes the macroeconomic environ- outlook seems positive.
ment. American quantitative easing may be cheered by the
world’s stock market players, but meanwhile the Swedish ex-
port industry is being threatened by a stronger krona, perhaps
offsetting some of the upward adjustments in the forecasts.

Finally, the question is whether bond yields can go any other

way but up in the long term. Even though the financial crisis
began nearly two and a half years ago, Swedish ten-year gov-
ernment bond yields have not fallen below the three per cent
level other than occasionally, except since April 2010. Even if
yields start rising, it will be from a very low level.


2% The spread between 10-year bond rates and

stock market returns may be regarded as a risk
0% premium, which at present is unusually high.
Source: SEB
-2% Considering the financial imbalances that
have built up in the world for many years, it
-4% seems unlikely that the risk premium will shrink
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 drastically. (Chart 3)

Risk premium

22 Investment Outlook - december 2010

Macro summary

Global economic prospects a bit brighter

• Conditions for world growth have improved a Overall, the global economy has the potential to grow a bit
faster in 2011-2012 than analysts forecasted late in the sum-
bit... mer. The deflation risk in parts of the industrialised countries
• ...and downside economic risks have (OECD) remains larger than the risk of faster inflation. But in
some emerging market (EM) countries, there are tendencies
diminished somewhat towards undesirably high inflation.
• Deflation remains a greater danger than
US growth will sputter for another while but will strengthen
inflation in parts of the OECD substantially in the course of 2011. The Federal Reserve’s
quantitative easing measures will improve the outlook via low
This past summer there was increased uncertainty about the real interest rates, rising asset values and a weak dollar. This
world economic recovery, and the outlook worsened. One of will help spur private consumption, corporate capital spending
the main worries was a slowdown in the American economy, and an export recovery. Somewhat tighter public budgets will
especially the danger of a double dip recession. Yet the United slow the growth rate, however. Unemployment will fall slightly
States noted decent GDP growth during the third quarter, and in 2011, but inflation will remain low. A new wave of home
recently various US indicators have pointed upward. The dan- price declines is the biggest economic risk. Our assessment is
ger of recession has thus faded, especially after the Federal that GDP will increase by more than 2.5 per cent this year, a bit
Reserve launched its QE2 programme (see page 12). On the less than 2.5 per cent in 2011 and close to 3.5 per cent in 2012.
whole, downside risks in the global economy appear to have
diminished somewhat in recent months, although the financial ECB will prop up southern Europe
situation of governments in southern Europe is a continued Euro zone GDP looks set to grow a bit faster than 1.5 per cent
source of concern and international tensions have increased in this year − far above the consensus view this past summer −
the currency and trade policy fields. but the differences within the zone have widened. Germany is
benefiting from a strong export and investment surge, while
various other euro zone members, especially the PIIGS coun-
10.0 10.0 tries (Portugal, Ireland, Italy, Greece and Spain) are burdened
7.5 7.5 by competitiveness problems and fiscal austerity meas-
Per cent quarter on quarter

5.0 5.0 ures. This two-speed euro zone will continue in 2011-2012.
Financial aid measures at the European level, combined with
2.5 2.5

national cost-cutting, have eased the acute crisis symptoms

0.0 0.0 in the PIIGS countries, but their problems are far from solved.
-2.5 -2.5 Euro zone GDP will increase by more than 1.5 per cent in 2011
-5.0 -5.0 and 2012. Low inflation will enable the European Central Bank
Source: EcoWin (ECB) to keep its refi rate low for a long time in order to sup-
-7.5 -7.5
2000 2002 2004 2006 2008 2010 port economic recovery in southern Europe.

During the past six months, the British economy has per-
This winter, American GDP growth will lumber along at a formed better than many had forecasted. For example, GDP
slower pace than usual during a recovery, but in the course rose twice as fast as expected in the third quarter, and the
of next year the economy will accelerate, fuelled by the Fed’s purchasing managers’ indices in both manufacturing and the
monetary stimulus, as the deeply depressed housing and service sector are pointing upward. Major fiscal austerity −
consumer capital goods sectors recuperate from the crisis. GBP 83 billion by 2015/16 − will hamper economic activity, but

Investment Outlook - december 2010 23

Macro summary

without interrupting the recovery. Further monetary stimulus this year. In an international comparison, the 2011 outlook for
is unlikely in light of stubbornly high British inflation. the region’s public finances is strong − with budget deficits
equivalent to about 2.5 per cent of GDP and debt 35 per cent
In the first half of 2010, Swedish growth surpassed all expec- − while the overall current account deficit will be rather small.
tations. The outlook for the next few years is also very good.
Public finances are exceptionally strong in an international Smaller fiscal deficits in Eastern Europe
perspective. The budget is moving towards a surplus and The export-led recovery of the past year in Eastern Europe is
public debt towards record-low levels. GDP increases are not continuing. GDP growth will accelerate further in most of the
equally high in the other Nordic countries, but the region’s region during 2011-2012. While it is true that the export-led
growth rate is still well above the OECD average. The Nordic upturn in the manufacturing sector seems about to slow, there
countries as a whole are also characterised by current account is good potential for domestic demand to assume a larger
surpluses and relatively good public finances. role as a growth engine. The region’s earlier problems with
large current account deficits have eased greatly, and budget
Fragile Japanese recovery deficits are now gradually shrinking. Inflation will be low but
After a strong start in 2010, Japanese growth decelerated gradually rise. Key interest rate hikes will thus begin during the
sharply − mainly due to the record-strong yen. Recent indica- first half of 2011, beginning in Poland and the Czech Republic.
tors are showing the fragility of the recovery. The purchasing
managers’ index in manufacturing has fallen from nearly 55 The Baltic economies have left behind their deep cyclical de-
to about 47 in October. Deflation is maintaining its grip, and clines − Estonia, Latvia and Lithuania all showed positive GDP
we expect 2011 inflation to be close to zero. Economic stimu- growth in the past two quarters − mainly as a result of their
lus measures are now being unveiled on a broad front. The competitive exports. Capital spending and private consump-
government is launching an extra budget equivalent to USD tion are gradually beginning to recuperate, sustained by low
55 billion, while the Bank of Japan has lowered its key interest interest rates and some improvement in household purchas-
rate and launched a new round of quantitative easing. This ing power. Meanwhile there are large remaining imbalances
year’s GDP growth of nearly 3 per cent will be followed by in the form of structural labour market problems and sizeable
growth of about 1.5 per cent in both 2011 and 2012. public budget deficits in Latvia and Lithuania.

Asia’s resilience during the economic and financial crisis has Above-trend global growth
further increased the importance of that region in the world: To summarise: We predict that GDP in the entire EM sphere −
Since 1990, its share of global GDP has grown from just above which accounts for nearly 50 per cent of the world economy
10 per cent to nearly 25 per cent. This past summer, the GDP (adjusted for purchasing power) − will increase by about 7 per
growth rate in Asian emerging countries decelerated due to cent this year and 6.5 per cent in both 2011 and 2012. As a re-
slower expansion in manufacturing and exports, but growth sult of this high expansion rate and the unusually loose mon-
will remain higher than the average for the EM sphere. We pre- etary policies of many OECD countries, the world economy
dict that China’s GDP will increase by more than 10 per cent can grow by 4-4.5 per cent a year in 2010-2012, compared to
this year, 9 per cent in 2011 and 8 per cent in 2012. The corre- an average of less than 3.5 per cent since 1990.
sponding figures for India are 8.5, 8 and 7 per cent.
So far the strong performance of the Asian economies has not 17.5 17.5
led to any broad inflation pressure, although rising food prices 15.0 15.0
are pushing up consumer prices in China, India and elsewhere.
In response, the central banks of these countries have raised 12.5 12.5
Per cent
Per cent

key interest rates and reserve requirements for banks, and 10.0 10.0
more such tightening measures can be expected soon. The 7.5 7.5
main economic risks in Asia are connected to massive capital
inflows, which lead to appreciation pressure on currencies as 5.0 5.0

well as rising prices for equities, real estate and fixed income 2.5 2.5
securities, with the accompanying danger of asset bubbles. 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
China, RR2 reserve requirement for small Chinese banks, CNY
India, repo rate, INR
Latin American growth above world average China lending rate, CNY
Source: Reuters EcoWin

After this year’s strong upswing, GDP growth in Latin America The central banks in China and India have hiked their key
will slow in 2011 but still end up above the world aver- rates due to inflation. China has also raised its reserve
age. Inflation does not represent a major problem, though requirements for banks. These tightening measures seem
Argentine consumer prices will climb more than 10 per cent well-justified.

24 Investment Outlook - december 2010

Asset class:

A favourable situation for the stock market

• Attractive valuations and stable profit During the period September 1-October 31, the world stock
outlook… market (measured as the MSCI World Index in local currencies)
rose by 9.7 per cent. Practically the entire upturn occurred
• …combined with a gradually improving from early September to mid-October. Since then, the market
economic picture… has moved sideways. This time around the American stock
market led the way, with a gain of more than 12 per cent (in
• …are making us more positive towards the local currency) after having lagged behind earlier in the year.
stock market Share prices on the technology-heavy NASDAQ exchange
gained a full 18 per cent, but US small-cap companies also
performed very well. This trend also applied at the global level;
When we published the last issue of Investment Outlook in technology companies and smaller companies performed
September, global stock markets were characterised by low much better than the world index.
risk appetite. Share prices fell on a broad front during August
as markets reacted to repeated negative American macroeco- Other stock markets that performed strongly during this pe-
nomic statistics and the seemingly imminent risk of a double riod were Hong Kong, China and Mexico, followed by Russia
dip recession in the US. and India. In all, stock market indices in the emerging market
sphere rose somewhat faster than the world index, while
These worries were toned down during September as more European stock markets performed somewhat worse. Once
positive figures appeared, both in the flow of US statistics again, the bottom-ranking stock market in the world was
and from China, in the form of better production growth. The Japan, whose index even fell marginally in local currency.
world’s stock markets have generally shown positive growth
since then. Third quarter corporate reports started appearing
in early October, further fuelling the market’s good mood and
increased willingness to take risks.

Stock exchanges in emerging markets and
105 Sweden have performed better than those in
the US and Europe since October 2009, mainly
thanks to continued high economic growth
95 and a good profit outlook. This autumn, US
Source: Bloomberg
90 exchanges climbed as better macro data
have been presented. Meanwhile European
2009-Oct 2010-Jan 2010-Apr 2010-Jul 2010-Oct
exchanges have lagged behind, with concerns
about sovereign debt and banks still hanging
S&P 500 TR MSCI EM Net MSCI Europe Net OMXS TR over the markets.

Investment Outlook - december 2010 25

Asset class: Equities

Persuasive fundamentals Demand is driven by a growing middle class

The corporate profit outlook is fairly stable and is continuing Our investment focus is on regions and sectors that are show-
to persuade market players. In the US and Europe, companies ing the best growth, combined with attractive valuations. We
are predicting profit increases of between 12 and 14 per cent find what we are searching for in China, India, Brazil and vari-
in 2011, while profits in the emerging market sphere are ex- ous smaller countries in the emerging market sphere, where
pected to increase somewhat more. Countries like China and growth is being driven by a rapidly growing middle class that is
Brazil will show significantly higher profit growth, however increasingly demanding cars, luxury items and capital goods.
(more than 20 per cent). Valuations must still be regarded as Domestic companies are benefiting from this trend, along
attractive, with European equities trading at price-earnings with Western companies that have large exposure to these
(P/E) ratios just above 10 times next year’s forecasted prof- countries. In such sectors as technology, telecommunications
its. The P/E ratio for emerging markets has risen somewhat and white goods emerging market companies are also mak-
since August and now stands at 12, just below Japan and the ing strong advances. They are conquering the world at a rapid
US, where shares are trading at P/E ratios of about 13. These pace, leaving behind their Western competitors by offering
comparatively low valuations, combined with stable profit high quality and low prices for their goods and services. In a
forecasts, allow room for higher share prices. global equities portfolio, we are thus attaching great impor-
tance to the EM sphere. We do not want to miss the emerging
A global recovery market train, whose journey has only just begun.
In addition, the economic picture is gradually improving, which
also justifies greater optimism about the future performance Mixed performance on Nordic exchanges
of the world’s stock markets. On the whole, US macro data As for the Nordic stock exchanges, their performance has
have been stronger than expected this autumn. Global eco- been positive but mixed. The big winner this autumn is the
nomic indicators also rose in October, with the OECD and Asia Oslo Stock Exchange, which gained more than 17 per cent
showing improvement, whereas Japanese indices fell sharply. between September 1 and November 12, or almost twice as
We are at the beginning of a global recovery, and it looks as much as the world index. Helsinki also performed well dur-
if we have several years of good growth ahead. If macro sta- ing this period, with an upturn of nearly 12 per cent, while in
tistics continue to provide upside surprises, company profit Copenhagen the index rose by “only” 8.5 per cent. With an
forecasts will probably rise, which may help boost share prices upturn of just above 9 per cent, the OMX Nordic Exchange
in stock markets that have low valuations. Stockholm was close to the world average for the period.

Economic sectors with low cyclical sensitivity such as telecom- Except for Sweden, however, the Nordic indices all have one
munications, food and pharmaceuticals performed well during large company or one large sector that strongly impacts the
the summer. This autumn, we have seen signs that more cycli- performance of the respective country’s stock market by
cal sectors have revived, for example industrial and technol- virtue of its weight in the exchange’s index. In Finland, for
ogy shares. During the current phase, we believe it is worth example, Nokia accounts for nearly 20 per cent of the Helsinki
focusing on industrials with stable profits that are a bit later exchange, which also includes a number of companies that
in the cycle. We also prefer companies with high exposure to are strongly dependent on how Nokia performs. Denmark
fast-growing countries in Asia and Latin America. has Novo Nordisk, which accounts for more than 30 per cent
of the weight of the Copenhagen index. In Norway, oil price
trends have a powerful effect on the Oslo Exchange index,

120 This autumn there has been growing interest in
115 cyclical shares, due to the gradual improve-
110 ment in the economic picture. Global indica-
105 tors rose in October, and we probably have
several years of good growth ahead of us. On
Source: Bloomberg
90 US exchanges, the industrial and materials sec-
2009-Oct 2010-Jan 2010-Apr 2010-Jul 2010-Oct tors have performed strongly in recent months,
while health care and consumer staples have
S&P 500 Consumer Discr. TR S&P 500 Industrials TR
S&P 500 Materials TR S&P 500 Consumer Staples TR lagged behind.
S&P 500 Health Care TR

26 Investment Outlook - december 2010

Asset class: Equities

since a full 50 per cent of the exchange is connected to that krona has admittedly lowered earnings growth for exporters,
sector. Statoil alone accounts for more than 20 per cent of the but not yet by as much as many observers had feared.
Oslo share price index. Thus it is not always certain that the
stock markets indices in these countries actually describe how As share prices have continued upward, valuations have natu-
most shares have performed. rally also risen. At present, the 30 companies in Stockholm’s
OMXS30 index are trading at a P/E ratio of 12.6 based on
In that respect, Sweden is more diversified. Although we have expected 2011 profits. This is low in a historical perspective.
quite a few large companies that weight heavily in the index, During the past 10 years, the P/E ratio has averaged 15.7
no single company accounts for more than slightly above 8 based on expected profits 12 months ahead. And if we look at
per cent (H&M) of the index. The largest companies are also the median value, which eliminates some of the high valua-
spread across a number of sectors. For example, the five com- tions of the early 2000s and the low valuations when the stock
panies with the highest market capitalisation in Stockholm − market plunged during the credit crisis, the 10-year figure is
H&M, Nordea, TeliaSonera, Ericsson and Volvo − all represent still as high as 15.0.
different sectors.
Continued potential in the stock market
Impressive company report season But although the Swedish stock market has already performed
But one major basis for this autumn’s upturn in share prices is well this year, it has more potential. We are still in a relatively
the third quarter company report period, which has generally early phase of the economic cycle, and as the economy con-
provided upside surprises, especially in terms of earnings. So tinues to gain strength, demand will increase. So far, a large
far, no fewer than two thirds of these reports have come in proportion of earnings improvements in the manufacturing
above or in line with analysts’ expectations. Companies have sector, for example, have been due to cost-saving and effi-
also shown significantly higher profits than during the corre- ciency-raising measures, rather than improved sales. Looking
sponding quarters of 2009. ahead, however, we can expect profits to be increasingly
based on increased demand and resulting higher sales. Many
Because so many companies surpassed the estimates made of the major engineering companies that have already pub-
by analysts before the publication of their reports − in some lished their third quarter results have reported sharply higher
cases by as much as 10-20 per cent − the market has revised order bookings compared to the third quarter of last year,
its profit forecasts for 2010 upward by 2.5 per cent and for which promises good sales performance ahead.
2011 by 2.2 per cent. Profit growth for the full year 2010 is now
expected to be 48 per cent, the highest such figure in 15 years. In addition, we should not be so concerned that the improved
margins that industrial companies achieved during the credit
PROFITS SET TO REACH RECORD LEVELS crisis will fade away as the economy and sales figures improve.
Many industrial companies estimate that more than 50 per
cent of the cost savings achieved during the credit crisis are
100 of a structural nature. In other words, they will not be reversed
when demand recovers. We should thus be able to look for-
ward with confidence to continued profit growth over the next
60 several years.
During 2011 and 2012, we expect corporate profits to continue
increasing by 18 and 12 per cent, respectively. As early as next
0 year, net profits are expected to exceed those of the peak year
2000 2002 2004 2006 2008 2010 2012 2007. But in spite of this, combined with low interest rates
Source: Bloomberg and lower valuations than the historical average, the OMXS30
index is still nearly 20 per cent below its 2007 peak.
This year, total profits of companies on the OMX Nordic
Exchange Stockholm are expected to increase by 48 per
There are thus many indications that within the near future,
cent, and in 2011 by another 12 per cent, yet the exchange
the stock market may break out of the “range trading” that has
index is still nearly 20 per cent below its 2010 peak.
prevailed for some time. In a slightly longer perspective, it may
begin to climb towards new record levels. This does not mean
This year’s profit growth has largely come from improved that the process will be painless; we should count on recurring
margins, mainly at industrial companies, as well as lower loan profit-taking declines of 5-10 per cent during the same period.
losses at banks. Cyclical companies, especially in the engineer- There are still storm clouds hovering above the stock market,
ing sector, have benefited from the economic recovery. This and at regular intervals these worries will gain the upper hand
has resulted in a major profit surge for the sector. The strong in an otherwise positive equity investment climate.

Investment Outlook - december 2010 27

Asset class:
Fixed income

High yield and EM debt the winners

• Record-low OECD key interest rates and the remain at 1 per cent until the spring of 2012. This means that
Fed’s QE2... ECB’s monetary policy will thus be tailored largely to the needs
of southern Europe.
• ...are making assets that provide better yields
look attractive... The Bank of England (BoE) will decide its monetary policies
against the backdrop of relatively slow economic growth, im-
• ...especially High Yield (HY) and emerging minent budget-tightening, undesirably high inflation and ris-
market (EM) bonds ing inflation expectations among households. Assuming that
British GDP nevertheless shows decent growth in the near
term and that the inflation rate meanwhile slows somewhat,
Economic growth in major OECD countries will be fairly slow we predict that the bank’s first repo rate hike will come late in
during the next couple of years, and deflationary forces − 2011. The BoE is unlikely to deliver further QE measures.
downward pressure on prices − will predominate. Influential
central banks thus have strong reasons to continue their ultra- Mediocre outlook in Japan
loose key interest rate policies for a long time and, in some October, the Bank of Japan lowered its call money rate from
cases, also launch quantitative easing (QE) programmes. 0.1 to 0-0.1 per cent and also unveiled a new QE programme
equivalent to USD 62 billion. Because of the mediocre eco-
The Federal Reserve (Fed) − which foresees downside risks nomic outlook in Japan and the prevailing deflation, the key
for both the American economy and inflation − intends to buy interest rate is likely to remain close to zero until autumn 2012.
about USD 875 billion worth of US Treasury bonds between Further QE programmes cannot be ruled out.
this autumn and next summer, a programme popularly known
as QE2 (see also page 12). As for the federal funds rate, our Central banks in such commodity-exporting countries as
forecast is that it will remain at 0-0.25 per cent until mid-2012. Canada, Australia and New Zealand − as well as Norges Bank
Due to low inflation, an uncertain economic outlook, major in Norway and the Riksbank in Sweden − are in a different
budget and growth problems in the PIIGS countries (Portugal, situation. Stronger economic performance, some inflation
Ireland, Italy, Greece and Spain) and a strong euro, we believe risks, a number of rather overheated real estate markets and
that the European Central Bank (ECB) will allow its refi rate to undesirably rapid increases in household debt are giving these

7 7
6 6
5 5 Slow growth, deflation risks and fiscal tight-
Per cent

4 4 ening are important reasons why major

3 3 OECD central banks appear likely to let their
2 2
key interest rates remain historically low for
1 1
an extended period. Sweden’s Riksbank has
-1 -1
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 a different scenario for its decisions and is
among central banks that have begun to
UK, repo rate
Germany, refi rate
US, federal funds rate
raise their key rates step by step.
Sweden, repo rate
Japan, call money rate
Source: Reuters EcoWin

28 Investment Outlook - december 2010

Asset class: Fixed income

central banks reasons to gradually ratchet up their key interest One of the purposes behind the Fed’s programme is to pave
rates further. At least in the case of Sweden and Norway, how- the way for higher private consumption and more invest-
ever, these rate hikes will probably occur at a somewhat slower ments via rising asset values for households and businesses,
pace than reflected in forecasts a few months ago. which among other things will benefit the HY market. This is
especially true because the institutions that sell American gov-
Sovereign bond yields in the OECD countries will rise in 2011- ernment bonds to the Fed can be expected to invest sizeable
2012, mainly due to large public sector borrowing require- sums in fixed income securities with higher yields than gov-
ments and decent risk appetite, which are unfavourable to ernment securities − the search for returns − mainly HY bonds
government securities. These yield increases will be relatively and EMD (see below).
gentle, however, since inflation will remain very low, economic
growth will be comparatively slow and major central banks On both sides of the Atlantic, the share of HY companies that
will keep their key interest rates at record lows for a lengthy went bankrupt culminated during 2009 at 12-14 per cent
period. But if growth in major OECD countries during 2011 (12-month figures). Since then, such bankruptcies have fallen
should turn out to be well above what a majority of forecasters steeply. During the first nine months of 2010, for example,
and the Fed are expecting today, there is an obvious risk that only 10 American HY companies went bankrupt. Our forecast
government bond yields will climb more forcefully. is that these bankruptcies will decline to 2-3 per cent by early
2011. The average for next year may be even lower.
Growing risk appetite
Market appetite for risky investments rebounded in Assuming a bankruptcy level of about 1.5 per cent during
September. October and the first half of November were 2011, American HY bonds are still attractively priced. Today’s
also characterised by good risk appetite. Among the reasons yield spread against US Treasury securities is around 6.5
were that concerns about a possible double dip recession in percentage points − well above the historical average of 5.3
the US had faded and that macroeconomic statistics from points − which is compatible with a bankruptcy figure of more
various parts of the world were unexpectedly strong. These than 6 per cent. A calculation based on a forecast of a 1.5 per
trends favoured corporate bonds, especially the High Yield cent bankruptcy rate instead justifies a yield spread of less
(HY) segment, as well as emerging market debt (EMD). High than 4 percentage points. In other words, the yield spread on
Yield, in particular, benefited from persistently strong earnings HY bonds might shrink by more than 2.5 points.
figures from companies, which in many parts of the world also
showed increasingly solid balance sheets. Attractive EM yields
In terms of yield spreads, sovereign bond yields in the emerg-
Assuming that market instability in mid-November − mainly ing markets (EM) sphere are still well above their OECD
because of Ireland’s financial problems − will fade, the outlook equivalents. Effective yields in the EM sphere are thus signifi-
for the HY segment of the corporate bond market is bright. cantly more attractive. It is true that sovereign bond yields
This is due to a surprisingly fast economic upturn, the zero in- in EM countries may rise somewhat when they tighten their
terest rate policies of central banks, the Fed’s Q2 programme, monetary policies due to rapid growth and certain overheat-
the search for returns, attractive valuations and a shrinking ing risks, but these interest rate hikes are likely to be relatively
percentage of bankruptcies among HY debt-issuing compa- moderate because many EM currencies have risen sharply
nies in both the US and Europe. The latter reflects the growing since the summer. The price risks on EM bonds must therefore
financial strength of these companies. In the US there are be regarded as fairly small, especially since such bonds are
1,500 HY companies, which as a group boosted their profits also benefiting from the Fed’s Q2 programme.
by nearly 10 per cent from the second to the third quarter this
year. The number of HY companies in Europe is about 250. The prospect of stronger EM currencies make the EMD asset
class especially attractive for investors with currencies like the
US dollar, euro or Swedish krona as their base currency.

Source: JPMorgan


10-year Treasury bonds 8.00 7.60
Compared to both Treasury bonds and equities
Investment grade bonds 8.60 5.50 in large (S&P 500) and smaller companies
9.40 8.40 (Russell 2000), US corporate bonds have
High Yield bonds
offered an attractive combination of risks and
S&P 500 share index 9.70 15.80 returns over the past 25 years. (Average annual
Russell 2000 share index 8.30 19.90 returns and volatility since 1985.)

Investment Outlook - december 2010 29

Asset class:
Hedge funds

Global imbalances will benefit hedge funds

• Tensions between emerging and developed give hedge funds good opportunities to position themselves
markets… and earn money, obviously on the condition that the analysis
they have made is correct.
• well as between asset classes...
The market situation is thus favourable for hedge funds that
• ...will create good potential for hedge funds can employ several different asset classes to generate value.
Global Macro managers do precisely this. They can earn
The performance of different hedge funds has varied during money by correctly analysing interest rate curves and cyclical
2010. The difficulty for hedge funds has been to find the right movements. They can take positions in asset classes such as
risk level and thereby create the conditions for generating fixed income securities, currencies, equities and commodities.
returns. As of mid-November, hedge funds as a whole were up At present, we note that Global Macro managers are mainly
about 3.5 per cent for the year, a figure well below the histori- using currencies and fixed income securities to generate value.
cal average, but still an acceptable level if we assume that this We also see that they have begun to take more risks than they
is one of the weaker years for this asset class. did during the first half of 2010, when uncertainty about the
economy was greater. The Global Macro holdings we have in
The potential for hedge funds during the rest of the year looks our strategies have generated returns of a few percent since
good. The financial market is offering a climate favourable to January 1, while Global Macro on an aggregate basis is down
hedge funds, with a number of themes that managers could about one per cent during the same period.
take advantage of in order to generate value. We have a world
that is divided between emerging economies, on the one CONTRIBUTING STABILITY
hand, and “old” developed industrial countries, on the other. 500
We are also seeing also tensions in the economies of the old
developed countries, with divergent opinions on what needs
to be done to get the economy to take off. The United States is 300
flooding the economy with quantitative easing, while Europe 200
seems to be belt-tightening. In the global arena, the G20 has
100 Source: Bloomberg
been holding meetings where it has seemed difficult to reach
a consensus on one view and one set of actions. The world is 0
more many-facetted today, with more participating players. 1993 1998 2003 2008
The US no longer rules the roost. These tensions provide fuel
Dow Jones Credit Suisse Hedge
for hedge funds and a chance to generate value. S&P 500 Total Return
JPMorgan Hedged USD GBI Global
Emerging market countries are grappling with other worries.
The fact that growth must not occur too fast is a factor to take Although hedge funds as a group fell about 25 per cent from
into account. Another is the question of how the capital being October 2007 to February 2009, in a portfolio context they
earned from large exports should be used − questions such as have contributed to stability over time. According to the DJ
what is the proper interest rate, how the flows between differ- Credit Suisse hedge index, hedge fund managers have recov-
ent countries and asset classes look, and what impact politics ered their losses from the financial crisis, while equities have
will have on events. All of these are factors and questions that some way to go before reaching their previous peaks.

30 Investment Outlook - december 2010

Asset class: Hedge funds

Trend-following systematic CTA (Commodity Trading Advisors) year, while Distressed strategies have performed well, with a
hedge funds work in a way similar to Global Macro, but they return of more than 7 per cent.
use computer algorithms to determine what transactions
should be made. Their expertise is in analysing markets, then At present, Fixed Income Relative Value has good potential to
creating computer models capable of predicting future market generate fine returns, thanks to a number of factors. American
movements, regardless of asset class. quantitative easing is one factor that having an impact, as
are European austerity measures. Managers can take long or
At the index level, during 2010 CTA hedge funds have gained short positions in different maturities along the yield curve,
about 7 per cent, while several of the funds we have selected thereby efficiently taking advantage of the curvature of the
are up 15-20 per cent − figures that show that it is important yield curve. Good opportunities in the High Yield segment also
to find the “right” hedge funds that can deliver results that lead to good opportunities for Fixed Income Relative Value
beat the index over time. Quality and the ability to continu- and for Credit Long/Short, which we also like. The outlook for
ously adjust models to changed circumstances are vital. CTA Convertible Arbitrage and Volatility looks worse, and we prefer
is a strategy that we use in most of our mandates, not only for to stay away from them. We see continued good opportunities
its ability to generate good returns over time, but also because for ordinary High Yield funds. If we add the ability of hedge
generally speaking, it is fully rational. It can thus generate funds to structure their transactions using derivatives to pro-
returns even in crisis-ridden markets, provided that there is a tect their capital or boost their returns, this gives us attractive
long-term trend. Being able to identify this trend is more im- qualities that we are happy to invest in. So far this year, the
portant than what direction it is moving in. Relative Value index has returned about 6.5 per cent.

We also analyse how these CTA funds fit into the risk levels We are more sceptical about Equity Long/Short. The opportu-
that our various investment mandates have as their prefer- nities that we consider good for the above strategies instead
ence. Hedge fund management employing the Event Driven become difficulties for Equity L/S managers, with the result
strategy, which analyses corporate events of various kinds, that we have mainly chosen to give them a pass and instead
has been fuelled by the recovery phase following the deep focus on more absolute-return strategies.
2007-2009 recession. Examples of “corporate events” include
mergers, merger rumours, hostile take-overs or company Having said this, we can still note that the Equity L/S index
restructuring. In our assessment, the number of corporate has gained more than 4 per cent this year, but we believe this
events will continue to increase. For this reason, we consider outcome is largely a matter of beta (market) returns and not
the Event Driven strategy very useful today. This applies so much alpha (skill-related) returns. For hedge funds, it is all
especially to broad Event Driven and Merger Arbitrage strate- about being able to generate alpha, as uncorrelated to other
gies. In contrast, we foresee diminishing opportunities for asset classes as possible. Those of us who continuously follow
Distressed strategies, and our advice is to start being cautious up our investments prefer to buy ordinary equity funds if we
about them. For those who want to invest in this type of hedge want stock market exposure. On the whole, we regard the po-
funds, we prefer broader Event Driven or Merger Arbitrage tential for hedge funds as good, and we believe that this asset
funds. As a whole, Event Driven is up about 1.5 per cent this class is highly useful in portfolio-building.

Source: 2010 Hedge Fund Research, Inc

INDEX YTD* 2009 2008

HFRX Global Hedge Fund Index 3.73 13.40 -23.25
HFRX Equity Hedge Index 4.57 13.14 -25.45 As the table indicates, different hedge fund
strategies have different inherent risk and re-
HFRX Equity Market Neutral Index 2.24 -5.56 -1.16
turn characteristics. After a strong 2009, Rela-
HFRX Event Driven Index 1.50 16.59 -22.11 tive Value strategies have continued to per-
HFRX Distressed Securities Index 7.57 -5.60 -30.69 form well this year too, while strategies more
HFRX Merger Arbitrage Index 4.77 8.14 3.69 closely connected to the stock market, such as
HFRX Macro Index -1.34 -8.78 5.61 Equity Market Neutral and Equity Hedge, are
lagging a bit behind. This year Event Driven
HFRX Systematic Diversified Index 7.89 -9.04 31.55
has only gained 1.5 per cent, but this strategy
HFRX Relative Value Arbitrage Index 7.06 38.47 -37.60 along with Merger Arbitrage should benefit
HFRX Convertible Arbitrage Index 8.62 42.46 -58.37 from the prevailing environment. Also worth
noting is that Merger Arbitrage is the only
HFRX RVA: Multi-Strategy Index 9.71 42.05 -15.60
strategy that has provided consistently positive
HFRX Total Emerging Market Index - -25.09 19.30 returns during this period.
* Until November 11, 2010

Investment Outlook - december 2010 31

Asset class:
Real estate

Beyond the first phase

• The initially investor-led recovery… volumes during the past year for Europe, the Middle East and
Africa (EMEA) as well as North America and Asia. They have
• …will be increasingly driven by forces in the concluded that if we aggregate the five cities in each region
real economy that have had the largest transaction volumes, they total more
than half of the global transaction volume − very concentrat-
• Early signs that the real estate market may ed, in other words. London has had the largest volume, even
soon recuperate though the British economy is still ailing. The British govern-
ment is launching major fiscal austerity measures in order to
address the government debt situation and the budget deficit,
The world economic recovery is continuing, benefiting all
yet the turnover of properties has been large. Among the rea-
kinds of real estate investments. Although there may be sig-
sons for this are an improved situation for the banking world
nificant differences between markets and types of properties,
combined with interest from financial investors.
we have still seen a clear improvement, which has yielded
good returns to real estate investors. If we match up markets
Quality − in the sense of how properties are used and their
and types of properties with their various risk levels, we can
locations − still plays a major role for investors. Few investors
summarise total return over the past year as being around 8
have dared to take the step into secondary areas, even though
per cent, which is not bad.
the levels of return are clearly higher there but also clearly
more uncertain. The returns may be dependent on a single
Yet given all the lingering uncertainties during the recovery
tenant, and if that tenant should move out, it may be difficult
phase, as financial investors we have focused on more con-
to replace with another. In such a situation, only costs remain.
servative and liquid real estate investments. In this type of
We need to enter phase two if the situation is to change sig-
investments, the level of returns has been around 4 per cent.
Compared to low-yielding government fixed-income securities
(normally an alternative to real estate investments), this return The second phase
must be considered good.
Given the depth of the financial crisis, the recovery will take
time. We are probably talking about several years before we
An improved credit market and large stimulus packages from
have moved through the second phase, but there are encour-
public authorities around the world have made a positive con-
aging signs that we do not have so far to go before entering
tribution to the performance of real estate investments. In the
the second phase.
short term, we expect many of these positive effects to fade.
As a consequence, the pace of improvement will probably fall
One sign is American commercial real estate prices which,
during 2011 and then regain speed during 2012.
with some hesitation, appear to have bottomed out at the
same price levels that prevailed in 2003 and have now begun
For some time, we have maintained that the first phase of real
to climb again. Considering that commercial real estate prices
estate market recovery is investor-led and that the next − and
often lag behind the real economy, this is a positive indication
more sustained − phase will kick in when the real economy
that we are on the right path (see also the chart on the next
has clearly improved. Signs that indicate such an improvement
page). Due to last spring’s crisis in financial markets, together
are higher consumption and a stronger labour market.
with the expiration of US tax credits, the price increase took
The first phase a break during the summer. Statistics lag a little behind, but
we see a clear shift towards a healthy price trend, meaning
There are many indications that we are still in the first phase
upward. We expect the statistics that appear in the coming
of recovery, Real Capital Analytics has examined transaction
months to confirm this.

32 Investment Outlook - december 2010

Asset class: Real estate

If we examine the figures in somewhat more detail, we im- are historically low, which is helpful to the real estate industry.
mediately see that home prices in such places as Florida Low borrowing costs increase the probability of good returns.
and southern California have begun to move upward, while Even at relatively low rent levels, it is possible to earn good re-
industrial properties and retail properties are having a tougher turns on assets. Obviously banks and other suppliers of capital
time. The positive trend needs to become more broad-based have noted this, and this is one of the reasons why we are
for us to be in phase two. seeing higher loan-to-value ratios in real estate investments.
There is a good chance of borrowing 60-70 per cent or more
of the purchase price today. This serves as a lubricant in the
200 real estate industry and will enable it to continue normalising.
Better and better day by day
The financial crisis and the Great Recession of 2007-2009
140 still play a major role in the consciousness and behaviour of
120 investors. Turbulence during the first half of 2010, including
the government financial crisis in southern Europe and bubble
Source: MIT/CRE
tendencies in China, are clear indications that not everything
80 is normal yet, and we must deal with that. We stayed away
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 from real estate when the crisis was raging at its worst, and we
avoided the asset class even in the beginning of the recovery.
Moody’s/REAL CPPI National All Properties A while ago, however, we began investing in real estate via
Prices of US commercial properties fell again in the third good managers of this asset class. This has begun to yield
quarter, even though transaction volume increased during results in our strategies.
the same period. Prices and volume traditionally go hand
in hand, and the data reflect investors’ search for quality Transaction volumes confirm the same picture we just de-
properties rather than secondary areas. The gap between scribed (see chart below). The recovery made a solid break-
purchase and sale offers shrank during the third quarter, through during the second half of 2009, especially during the
which indicates better liquidity. fourth quarter, when financial investors felt more comfort-
able with the real estate market and thus began investing.
There is an expectation among investors that the labour However, there has been obvious nervousness throughout the
market situation will improve, which might trigger higher recovery phase. We became aware of this during the first quar-
consumption. In the past month, the American labour market ter of 2010, when transaction volumes fell in North America
has shown stronger figures than expected. The number of new and EMEA. In the second quarter this year the curve rebound-
unemployment benefit claims during the week of November ed in North America and EMEA, while Asia slowed down.
1 (and the average for the previous month) was clearly better
than forecasted. We interpret these statistics as indicating that Looking ahead, this trend will continue. Asia will calm down
the second phase is not so far away. somewhat, while North America and EMEA have the potential
to continue increasing their volumes. Overall, there is every
Better access to credit and to good terms indication that time is doing its job and that things will actually
One of the most important factors for the real estate industry get better and better day by day in the real estate industry.
has been good access to credit on good terms. Interest rates

60 Source: Real Capital Analytics PURCHASES
20 Chinese land purchases account for more than
0 half of transaction volume in Asia. Adjusted for
2007 Q1
2007 Q2
2007 Q3
2007 Q4
2008 Q1
2008 Q2
2008 Q3
2008 Q4
2009 Q1
2009 Q2
2009 Q3
2009 Q4
2010 Q1
2010 Q2

these, volume seems to be recovering at a slow

pace in Asia as well as Europe, the Middle East
and Africa (EMEA) and America.
Americas EMEA Asia Pac. (ex China)

Investment Outlook - december 2010 33

Asset class:
Private equity

Winner in a brighter scenario

• More stable growth is driving values in private There have been a number of driving forces.
equity companies
• The economic picture has brightened somewhat
• Good business opportunities and large • Company earnings reports have been strong
discounts are attractive • Risk appetite has generally increased
• Activity in the private equity market has been high
• Continued financial uncertainty will mean a • Worries about tax effects have been exaggerated
bumpy road ahead • The financing market has stabilised

The first two points above are of a more general nature and
This autumn has been a strong period for private equity (PE), do not apply exclusively to private equity. They are described
from several perspectives. In our judgement, conditions will elsewhere in Investment Outlook − but we can briefly note that
remain good in the long term. We are sticking to our positive developments in recent months have been consistent with our
view of this asset class. A favourable position in the economic view that the world is moving towards decent growth over the
cycle, gradually improving fundamentals and attractive valu- next couple of years and that financial markets are gradually
ations are arguments for PE, while the risks mainly consist of daring to discount this. It is worth pointing out, however, that
renewed economic uncertainty and any new financial instabil- strong company reports also include signals about PE compa-
ity. We expect a continued positive trend, but with large fluc- nies’ target companies. Combined with continued low interest
tuations along the way. rates and otherwise expansionary monetary policies, the first
two points lead to rising risk appetite, which in turn opens the
Put simply, this past year has included three phases for private way for higher private equity activity. Meanwhile, a number
equity companies. The first four months consisted of a nor- of market players have realised that the tax proposals that
malisation of markets in terms of risk appetite, stock market have been introduced will not have as dramatic an impact as
performance and financing. This led to increased activity in feared, if they are implemented at all.
the PE market and rising share prices for listed PE companies.
The latter (measured by the European LPX 50 Index) rose by Financing in place
more than 20 per cent by April 30. As for financing, we can state that at present, all sources of
financing are again operating rather normally. Bank lending to
In late spring, the southern European debt crisis dealt a heavy private equity companies is again in full swing. But the condi-
blow to the private equity market, due to risk aversion and tions for granting loans and not withdrawing them (loan “cov-
uncertainty about the financing situation. Such events harm enants”) are still somewhat stricter than before the financial
the private equity industry in several ways. It becomes tougher crash a couple of years ago. At that time, of course, a financial
for buyers to finance their acquisitions, initial public offer- bubble had been created, and the then-prevailing standards
ings (IPOs) become more difficult − and occasionally impos- were probably not healthy in the long term. The corporate
sible − to carry out, and the flow of capital into the PE sector bond market is also functioning smoothly nowadays, and
decreases. In the midst of this crisis came news of proposals a number of PE companies have arranged financing in that
for heavier taxation of certain types of PE companies in the way. It is worth noting that final investors have also begun to
United States. As a result, the index of listed companies fell by return. A number of new PE funds have been started, although
nearly 15 per cent from late April to early July. After bottoming volume is substantially lower than during the boom.
out in early July, the same index has risen by 23 per cent.
Some of the reasons behind the recent upturn will also lay the
groundwork for the future. Decent and improving economic

34 Investment Outlook - december 2010

Asset class : Private equity

perspectives, prospects of good corporate profit increases listed companies, we have a positive view of the situation.
(generally and with regard to PE portfolio companies) and low During the recession, most PE companies were very active in
OECD interest rates will have positive effects ahead. In addi- working with their portfolio companies, and we are entering
tion, there is a valuation argument which in many respects is the phase of the economic cycle where the best PE companies
about discounts to net asset value (NAV). normally score their biggest successes.

We have previously pointed out the unusually large discounts Risks in a weak economy and financial market
prevailing in the private equity industry. A discount can be But there is naturally plenty of risks. In the short term, fluctua-
described in simple terms as the ratio between the share price tions in market sentiment affect value via risk appetite. They
of a listed PE company and its carrying amount or book value also affect the ability of PE companies to sell their holdings
(which largely consists of the value of the companies it owns via the stock market − an important alternative, since few
− its portfolio companies). Such discounts were at historically, industrial purchasers have reawakened yet. Renewed concerns
if not hysterically, high levels during the 2008-2009 financial about global demand as well as further negative news from
crash: around 70 per cent. Since then, they have shrunk. the financial sector may also generate setbacks for the PE sec-
During most of 2010 they have been around 30 per cent. This tor and for the share prices of listed PE companies.
is the same as at the bottom of the 2002 recession and is well
above the historical average of around 10 per cent. At this writing, the climate is good and many IPOs and divest-
ments are being planned. This is promising for future develop-
During the autumn, these discounts have shrunk further and ments, but the process is likely to be far from free of pitfalls.
are now about 22 per cent. This is largely explained by gener- There is still great uncertainty about many fundamental fac-
ally increasing risk appetite and by the fact that the private tors.
equity transactions that have taken place have demonstrated
that book values have not been too high as some had feared, Numerous observers have pointed out that there is a great
but instead have actually been too conservative. In many need to sell companies and clean up balance sheets, especial-
cases, companies have been sold at 30-40 per cent above ly among banks. On the other hand, a certain amount of capi-
book value, making the actual discount unjustifiably large. tal is again flowing in from final investors, and the PE funds
In addition, a relative good economic outlook indicates that and portfolios that have been created since 2007 have large
book values should be able to rise in the near future, which amounts left to invest. In a number of cases, the investments
is an argument for continued reductions in discounts. Net periods specified by the funds are beginning to expire.
asset values are in the midst of a positive trend, for example
as evidenced by SVG Capital, a private equity company that With a reasonable liquidity situation, good long-term fun-
reported a 20 per cent increase in book value during the third damentals but short-term sources of concern, we foresee a
quarter. Generally speaking, we believe that net asset values positive trend characterised by high volatility. Despite sizeable
have risen by more than 5 per cent. recent upturns for private equity, we anticipate good potential
for those who can tolerate uncertainty. Given their large dis-
Largest discount on listed companies counts to NAV, we believe that listed private equity companies
One interesting trend is that discounts now vary somewhat have an advantage over secondaries, for example.
between market segments. While listed companies as a group
are being traded at a discount of more than 20 per cent, exist- BACK TO A POSITIVE TREND
ing PE obligations (“secondaries”) are now being sold at dis- 300
counts of around 5-10 per cent. Together with the potential to
divest portfolio companies at above book value, this opens up
business opportunities for some PE companies. As an exam-
ple, Apollo Alternative Assets (AAA) has sold assets and used 150
the proceeds to buy back its own shares at a higher discount. 100
This boosts net asset value for the remaining shareholders,
and the company’s shares have performed very well recently. Source: Bloomberg
Other companies, such as HarbourVest and Princess, have
2003 2004 2005 2006 2007 2008 2009 2010
also recently carried out repurchases.
LPX50 Total Return MSCI AC World Net EUR
Although the decline in discounts and skilful use of the market
situation (for example through share repurchases) may con- After a few years dominated by boom, bust and recovery,
tribute to a positive trend ahead, changes in the value of port- private equity still has a long way to go before reaching its
folio companies are still what will determine the future success previous peaks. We expect a continued positive trend, but
of the private equity industry. In line with the conditions for with major fluctuations.

Investment Outlook - december 2010 35

Asset class:

Increased demand for industrial metals

• Heavy demand for industrial metals from bring about lower real interest rates (since inflation expecta-
emerging markets tions will rise), rising asset prices (since the price of capital will
fall) and a weaker US dollar (since the quantity of dollars in the
• Oil service sector still has good potential system will increase).

• Not always gold that glitters Aside from stimulating American GDP growth, these effects
also put upward pressure on commodity prices. Rising infla-
A number of factors drove commodity prices to new heights tion expectations increase the demand for real assets such as
during the past quarter. Commodity prices largely follow glo- commodities. Low interest rates fuel risk appetite, which ben-
bal economic performance, and the storm clouds surrounding efits risk assets. Since commodities are traded in dollars, there
this have largely dissipated. Today the risk of a double dip re- is also a strong association between the dollar and commodity
cession in the American economy seems almost marginalised. prices. When the dollar is weak, producers demand higher
Worries about a hard landing in the Chinese economy no long- payment for their commodities in dollar terms, resulting in ris-
er seem justified, since recent industrial data actually indicate ing commodity prices.
an acceleration. The spotlight has also moved away from debt-
burdened southern Europe; instead, the market is focused its The Federal Reserve (Fed) recently approved a new round of
attention on quantitative easing in the United States. quantitative easing. Although this large monetary stimulus
programme lies mainly ahead of us, much of its impact has
THE RECOVERY HAS LIFTED COMMODITY PRICES already been priced in by market players. In order for com-
modity prices to rise from today’s levels, fundamental demand
500 500
for commodities will also have to increase.
450 450
400 400
Upside economic surprises
350 350
Recent economic data indicate that an acceleration in global
300 300
250 250
growth may take place somewhat earlier than most observers
200 200
had anticipated. This is likely to support commodity prices,
150 150
since there has been a high correlation between upwardly
100 100
revised GDP forecasts and rising risk asset prices in the past
50 50
decade (see the Theme article on page 12).
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Agricultural Industrial Energy For commodity prices, the level of GDP growth is usually more
Source: HWWI
important than changes in the growth rate (if such a change is
Commodity prices are closely connected to economic already part of forecasts). In other words, it is more important
expansion. We foresee above-trend global growth in 2011 that the global economy is steaming along − so that demand
as well as 2012, which is likely to increase the demand for for commodities is kept at a high level − than that the econo-
commodities. my is accelerating. Despite relatively weak GDP growth in the
OECD countries, our assessment is that the global economy
By means of large-scale purchases of government securi- will move forward at a pace of about 4-4.5 per cent annually
ties, the American central bank is trying to get the economic during 2010-2012 (since 1990, world GDP growth has aver-
wheels spinning. The aim of these liquidity injections is to aged a bit below 3.5 per cent yearly). We expect the emerging
market (EM) sphere as a whole to continue providing the larg-

36 Investment Outlook - december 2010

Asset class: Commodities

est contribution to global growth − about 7 per cent annually We have previously highlighted oil service as an attractive sec-
during the next two years. tor, and recent events have reinforced this view. With oil prices
at around USD 90/barrel, along with the lifting of the deep wa-
Hot industrial metals ter drilling moratorium in the Gulf of Mexico and oil companies
Industrial metals are the commodities that correlate the very beginning to increase their investment budget, oil services are
best with economic fluctuations. Our assessment is that re- likely to remain in demand.
cent price increases will continue as the world economy recov-
ers. One important piece of the puzzle in the industrial metals Not always gold that glitters
price trend is the situation in the industrial metals-hungry Gold is the big winner of the escalating “currency war” and the
Chinese economy. After a downturn in manufacturing activity market focus on quantitative easing by the Federal Reserve.
during the summer, industrial statistics are now pointing to- This precious metal is often regarded as an alternative curren-
wards acceleration. In addition, the inventory draw-down that cy, and when countries compete in weakening their respective
took place in China in the first half of 2010 seems to be over, currencies, demand for gold increases.
and metal imports are rising once again.
During the first six months or so of 2010, gold was in heavy de-
In our assessment, copper and aluminium have the greatest mand due to fluctuating risk appetite in markets. At the peak
potential among industrial metals. For copper we anticipate of the volatility, it was largely only gold and American govern-
rising demand and reduced supply after 2013 − due to declin- ment securities that investors wanted to trade. At this writing,
ing metal content in copper ore, few new mining projects and the price of gold had climbed by 25 per cent during 2010.
long lead times for production in new mines. For aluminium,
we also foresee potentially rising prices, since production cost There is usually a “best before” date on themes that market
is at the level of today’s prices and there will be room to add players pay attention to. For example, the debt crisis in south-
profit margins. In addition, the Chinese authorities will choose ern Europe is as acute now as last spring, but the market’s fo-
to shut down inefficient aluminium production as part of their cus has moved to quantitative easing. As a result, the euro has
efforts to improve their country’s energy efficiency, thereby risen sharply in value. Our assessment is that worries about a
reducing supply. currency war will subside (see the “Currencies” section), and
the spotlight will probably also eventually shift away from the
Advantage: Oil service Fed’s monetary injections. These themes have already had a
A brighter economic outlook and a weaker dollar have caused significant impact on asset prices, but it is difficult to deter-
oil prices to approach USD 90 per barrel, but it still appears mine when market interest will cool. But when this happens,
to be the Organisation of Petroleum Exporting Countries there is a risk that gold prices will fall from today’s peak levels,
(OPEC) that decides where oil prices end up. Large production especially in light of our assessment that we are approaching
reserves − especially in Saudi Arabia − provide the muscle to an investment climate where market players will be prepared
control prices, by adjusting supply. According to OPEC’s explic- to take more risks. Gold has simply risen too much in too short
it pricing strategy, the organisation aims at keeping oil prices a time, and there is a risk that this “bubble” will burst.
in the USD 70-90/barrel range. So far this year, prices have av-
eraged around USD 80/barrel. Considering that OPEC recently
adjusted its oil demand forecast for 2011 upward, we believe
that oil prices will gravitate to the upper part of this range.


1200 1200
140 140
USD/Ounce (troy)

1000 1000
120 120
800 800
100 100

600 600
80 80
400 400
60 60
200 200
40 40 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

20 20 Source: Reuters EcoWin

2004 2005 2006 2007 2008 2009 2010
Gold prices have risen by more than 400 per cent in the
Source: Reuters EcoWin
past decade. In a market climate with stronger global
In our assessment, crude oil will continue to be traded in the growth and continued high risk appetite, when the “cur-
upper part of the USD 70-90/barrel range. Oil service is one rency war” theme has disappeared from the spotlight there
sector that will benefit if oil prices remain at these levels. is a risk that the gold bubble will burst.

Investment Outlook - december 2010 37

Asset class:

The world will avoid a currency war

• Growth and interest rate differentials are
Weak trend for major currencies
driving exchange rates
Assuming a relatively small risk of a new recession, at the
• Major currencies will be losers... same time as we expect risk appetite to continue, exchange
rates are likely to be driven by growth and interest rate differ-
• ...while EM and commodity- exporter entials. In this currency climate, the US dollar, the euro, the yen
currencies will appreciate and the British pound will be losers. Within this group, the USD
is likely to be weighed down by the Federal Reserve’s quan-
titative easing programme for some time to come, but the
In recent issues of Investment Outlook we have predicted
Fed’s future operations are well known in the market, so their
that fundamental strengths of countries/currencies and how
impact is already reflected in today’s dollar exchange rates. In
market players take advantage of interest rate differentials
our assessment, the USD is relatively close to bottoming out.
(spreads) will be the most influential driving forces in the for-
We expect the dollar to reach its lowest value − about USD
eign exchange market. Developments in the past six months
1.40 per euro − at the end of 2010. After that, stronger US eco-
or so have been consistent with this forecast, and at present
nomic growth combined with lingering debt problems in the
we see no reason why these trends should cease.
PIIGS countries are likely to cause the dollar to rise towards
USD 1.30 per euro by the end of 2011.
Although the global economy has suffered a correction, the
picture of a divided world is becoming increasingly clear.
The crisis has had the most impact on countries with highly
indebted households, meagre government cash reserves 8% GDP growth, EM
and inflated home prices. On the other side of the divide are GDP growth, OECD
countries that have weathered the crisis relatively unscathed 6%

and have recovered quickly. Investors’ search for quality and

returns has led to large capital inflows to “healthy” economies,
whose currencies have risen in value. Put simply, money has 2%
flowed from debt-burdened OECD countries towards emerg-
ing markets and commodity-producing countries.
Source: SEB
The large interest rate differential between these two group-
ings is another driving force behind prevailing currency -4%
2009 2010 2011
movements. Debt-burdened OECD countries are pursuing
ultra-loose monetary policies, while interest rates especially in
Asian emerging market countries and commodity-producing The EM sphere continues to show significantly higher eco-
countries are far higher. A large interest rate gap creates incen- nomic growth than the OECD countries, and this is likely to
tives for the “carry trade” − investors borrow where interest be the case in 2011 as well. Rapidly growing economies with
rates are low and invest where interest rates are high. The sound finances are likely to continue attracting investors,
result is downward pressure on the currencies of countries and EM currencies will thus rise in value.
with low interest rates, while currencies in countries with high
interest rates become stronger. Investors generally choose to
take advantage of interest rate differentials when risk appetite
is high and volatility is low.

38 Investment Outlook - december 2010

Asset class: Currencies

Sweden’s Riksbank chose to lower its forecasted key interest Imbalances are the heart of the problem
rate path in October. This helped end the upward trend for Fundamentally, the infected currency issue is not a matter of
the krona, but we expect the krona to remain strong because exchange rates, but of how countries should save and spend
the Riksbank will be delivering further rate hikes in December in order to rebalance economic growth. Today’s indebted
and February. Good export performance and low valuation will countries − led by the United States − have historically been
cause the krona to strengthen to SEK 8.75 per euro by the end the perfect consumer, and this has led to record-sized trade
of 2011. This will result in a USD/SEK exchange rate of around deficits. In contrast, developing countries − led by China −
6.70 at the end of next year. have played the role of the perfect producer, resulting in size-
able trade surpluses.
With currency as a weapon
For most developing countries, the large capital inflow of the One prerequisite for a full rebalancing to occur is that China
past year is unwanted, since a stronger currency weakens their should abandon its “managed float”, in which the yuan is only
competitiveness. During the past decade, these countries allowed extremely limited room to fluctuate against the dollar.
have relied on exports as a growth engine. When appreciation China’s currency policy has been controversial for many years.
pressure in export-dependent countries has been perceived as So far, the Chinese have been unwilling to bend to the pres-
too high, they have resorted to currency interventions. In re- sures from other countries. One consequence of China’s cur-
cent months, various countries have also used financial regu- rency policy is that a number of other Asian central banks are
lation, tariffs and taxes to stem the inflow of foreign capital. also continuously intervening in the foreign exchange market
in order to remain competitive in relation to China.
Meanwhile debt-burdened economies attach greater hopes
to export-driven growth, since domestic demand is conspicu- In order to solve the problems of global imbalances, a global
ously absent. A weak currency may also help increase inflation currency policy agreement is needed, since there is no domes-
pressure in these economies. Central banks thus abstain from tic political solution to a global problem. In the short term, cur-
normalising interest rates to the extent that domestic factors rency weakening may benefit a single country, but in the long
would justify. Currency intervention is also being used in some term it will lead to lower global growth because protectionism
of these countries for the purpose of weakening exchange will increase, hurting global productivity.
The latest G20 summit in South Korea (in mid-November) was
There are thus not many countries that want to see their cur- something of a disappointment, since it did not approve any
rency appreciate. This has created political tensions, and there concrete commitments in the currency field. Although it will be
are growing concerns that a currency war might break out. a while before changes in global currency policy materialise, it
In recent months there have been loud, emotional discus- is difficult to imagine countries actually carrying out the radi-
sions around the world, with countries accusing each other cal trade restrictions that some have threatened. The cost of
of protectionism and nationalism. The problem of currency such an escalation would be too great for all parties involved,
manipulation has thus ended up at the top of the international due to the mutual economic dependence that has been built
political agenda. up in recent decades. Meanwhile there is no quick solution
' that will eliminate the world’s imbalances. It will take time and
will require a large measure of persistence.

Return in local currencies, year to date
Currency rate change in relation to SEK, YTD
Source: EcoWin
0% A large proportion of returns on foreign equi-
-5% ties is dependent on exchange rate move-
-10% ments. For example, the strength of the Swed-
ish krona during the past year has adversely
affected returns on a global portfolio for a
Hong Kong









Swedish investor. Although European stock

exchanges have gained nearly 10 per cent,
returns measured in SEK were ±0 per cent.

Investment Outlook - december 2010 39




2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010




Equities Fixed income Hedge Real estate

Private equity Commodities Currencies

- Return in 2010 is until October 31.

- Historical values are based on the following indices: Equities = MSCI AC World. Fixed income = JP Morgan Global GBI Hedge.
Hedge funds = HFRX Global Hedge Fund. Real estate = SEB PB Real Estate. Private equity = LPX50. Commodities = DJ UBS Commodities TR. Currencies = BarclayHedge Currency
SEB is a North European financial group serving 400,000 corporate customers and institutions and
more than five million private individuals. One area with strong traditions in the SEB Group is private
banking. From its founding in 1856, SEB offered financial services to wealthy private individuals.
Today the Group has a leading position in Sweden and a strong presence in the other Nordic coun-
tries and elsewhere in Europe.

SEB Private Banking has a broad client base that includes corporate executives, business owners and
private individuals of varying means, each with different levels of interest in economic issues. To SEB,
private banking is all about offering a broad range of high-quality services in the financial field − tai-
lored to the unique personal needs of each client and backed by the Group’s collective knowledge.

SEB Private Banking has some 350 employees working in Sweden, Denmark, Finland and Norway.
Outside of Sweden, we take care of our clients via offices in Estonia, Geneva, Latvia, Lithuania,
Luxembourg and Singapore as well as a branch in London. On September 30, 2010, our managed as-
sets totalled SEK 257 billion.