Brutality on the stock market

Stock markets have fallen brutally in recent days. Active investment tweeter and Head of IR at Sampo, Mirko Hurmerinta, pointed out laconically that Nasdaq Helsinki is in negative territory for the 8th month in a row. The general index has already seen figures below 9,000 points. 

A small cause for oh-so-Finnish schadenfreude is that the recent decline has spread to stock markets around the world. For example, the balanced version of the S&P 500 index has already fallen for a few months, close to the lows of last fall. It is mainly the mega-sized monoliths such as Apple and Amazon that continue to hold the main index together.

The gloomy mood of the Finnish retail investor is well illustrated by Nasdaq Helsinki's small cap index, which is already down 50% from its fall 2021 peak. If rampant inflation is taken into account, the purchasing power of an investor in small companies has already been destroyed by more than 60%. Quite some figures.

In this post, we talk about how the earnings season has been developing. Spoiler alert - it hasn’t been pretty to watch. Before that, we look at the hot US economy and rising interest rates, and the welcome pick-up in China's economic growth, which is also critical for China-dependent European companies like KONE. However, the market was not yet convinced by this growth.

Again, due to the earnings season buzz, this post will unfortunately be the only one this week.

Fierce labor market in the US 

The jobless claims data released last week continued the story of a strong US economy. There were less than 200,000 new jobless claims per week and the trend has been downwards since the summer, although this data is fluctuating wildly. At the same time, however, the total number of applications for unemployment benefits has risen slightly to 1.7 million, which may indicate that the unemployed are finding it more difficult to look for new jobs. As I have mentioned before, there may be big corrections to this data and employment may develop well for a long time, but so far, the economy looks enormously strong in this area.

Interest rates are also expected to give the economy a real squeeze soon. The world's economic gravitational force, the US 10-year bond rate, has already risen to 5%. That level was last seen in the summer of 2007, before the financial crisis. Money is starting to have a real price, although valuations, especially in US stocks, don't seem to care so far. Fed Chief Jerome Powell commented last week that the rise in long-term interest rates is working in the Fed's favor as they tighten monetary conditions. The market expects the Fed's current 5.5% policy rate to remain at the peak of the interest rate cycle for the time being. However, the expectations suggest that it will take a while for the interest rates to come down.

China's economic recovery is critical for Europe

The Chinese economy grew faster than expected by 4.9% year-on-year in the third quarter. This is if the country's official economic figures - which are constantly being tampered with - are to be trusted. In my latest post, I was talking about how the Communist Party is going to lash the country's 5% GDP growth target over the bar by forcibly swinging the debt whip. Now, this really seems to be the case. At the same time, real estate investment in the country fell by 9% year-on-year.

The good news for economic growth was the recovery in domestic consumption. Since the pandemic, household consumption has outpaced industrial growth. As I have often argued in these posts, the key to taking China's investment-led economic growth model to the next level is to boost domestic consumption.

China's stock market is not spectacularly enthusiastic about the pick-up in growth and is competing with Nasdaq Helsinki for the title of the world's best flatliner. Both China's main index and Nasdaq Helsinki have fallen below last fall's lows.



The slow digestion of what is reportedly the biggest real estate bubble in the country's history is weighing on sentiment. 

A recovery or at least a stabilization of the Chinese economy would also be encouraging for European equities. According to Bloomberg calculations, €460 billion of the turnover of companies in the Eurostoxx 600 index came from China last year. On average, as much as a fifth of sales in different sectors come from China. For 80 companies, more than 5% of turnover comes from China. At the top of the list of European companies' dependencies on China is KONE, the Helsinki-listed elevator technology company, with more than 30% of its turnover coming from China. Atlas Copco, another Nordic engineering giant, gets 23% of its turnover from there.



Among industries, British banks in particular, the automotive sector led by Germany's Volkswagen, Mercedes and BMW, the mining sector and French luxury companies such as LVMH and Hermes have built up a dependency on China that is no longer as cool as previously thought. China is becoming a concern for European companies in the same way that dependence on Russia was for many Finnish companies venturing there in the 2010s.

China ties are also reportedly part of the reason why the valuation gap between European stock markets and American companies with more domestic market protection has widened. European stocks are trading at 12 times and American stocks at 18 times their forecast earnings.

Although China is now the black horse of the global economy, a recovery in its economic growth and not invading Taiwan could make China ties a source of growth again in the future. However, the country's population of 1.4 billion people will certainly want to continue to increase their level of economic prosperity and the market is too big to leave to others. The country's GDP per capita is at $13,000, a level where premium products are beginning to attract consumers and a level where there is still much room for improvement.

Unfortunately, the future plans of dictatorships are rarely predictable, let alone sensible in terms of overall well-being. 

However, if the Chinese economy doesn’t recover and industrial capacity is otherwise unused, Chinese companies could face fierce price competition from Western industrial companies as they look for more sales. That's another threat to bear in mind. For example, Wärtsilä has commented on Chinese companies selling at firesale prices in the energy storage sector.

Earnings season mood: Reality check

Let’s take a look at the results of the biggest companies that have reported their results.

The Nordic banking sector seems to be doing well so far, despite the macroeconomic challenges. Nordea, the most owned company among Finnish investors, reported another record result. Return on equity is an excellent 18% and loan loss provisions are €33 million, which is practically nothing compared to a loan portfolio of €350 billion. Of the major Nordic banks, Nordea's exposure to the notorious commercial real estate sector is fortunately the lowest. 

Handelsbanken, which is historically speaking the safest and most profitable major bank in the Nordic countries, also swept the floor with analysts' forecasts. Interest yields are soaring. The bank's large exposure to the rotting Nordic commercial real estate sector doesn’t seem to be a problem either, as loan losses amounted to 0% of the loan portfolio. The bank's return on equity rose to 17%, although its solvency ratio is at an exaggerated level of 19%. Known for its decentralized decision-making and conservative risk-taking culture, the bank has emerged from the financial crisis and the recession of the 1990s with drier feet than its big-bank peers that stumbled through crises.

 Nordic banks are priced at around seven times the earnings of the next few years. Earnings are not expected to improve, but on the other hand investors are being cheered by massive dividends and share buyback programs. The market clearly does not believe in the sustainability of banks' performance. From the shareholder's point of view, the situation can unfold in two ways. Either the Nordic banks will hold up and the bad debt won’t go boom, leaving the investor with excess returns as valuations are corrected and dividends roll in. Or the market skepticism will be right and banks' profit levels will fall significantly. Nordea has so far been one of the few bright spots in the earnings season.

Nokia, the cult Finnish stock, once again gave investors a stark reminder about what it’s like to run a good business market that isn't growing.

Listed companies have been spitting out profit warnings like no tomorrow. Clearly, customers have gone into a savings mode. Of the 122 companies in the HEX index, only 13 have published their results, of which just 3 have exceeded analysts' expectations and on average both results and turnover have fallen more than expected.

In previous posts, I have liked to emphasize the cheapness of Nasdaq Helsinki, but if the results nosedive this cheapness is just an illusion. This week and next week will see the lion's share of Nasdaq Helsinki results, so we will soon be wiser about the direction of the results.

In the US, Netflix and Tesla reported their results. Netflix subscriptions are growing rapidly again as the company attacks password sharing with vigor. In total, there are already almost 250 million subscribers around the world. Unlike its competitors, Netflix has proven that streaming can be a profitable business despite billions invested in content. However, the stock is still far from its 2021 bubbly peaks.

Tesla, always presenting the best aspects for investors in investment discussions, is reporting weak figures. Car sales grew by only 5% year-on-year. The company's sales suffered from the price cuts; or should I say despite the price cuts. Profitability is ratcheting back towards the profitability of a normal car company. Despite the sale of emission allowances, the profit margin fell to less than 18%. It will be interesting to see whether Tesla can permanently break out of the structurally weak profitability of the automotive sector or whether this disruptor will eventually become a typical flatliner. Technoking Elon Musk is reportedly paranoid about the economy. High interest rates make consumers cautious, as credit is usually used to buy cars.

 

Overall, 74% of the less than 100 S&P500 companies that have reported so far have exceeded earnings expectations. Average earnings have been 6% ahead of expectations, but the share price reaction has still been negative, suggesting that the results were not good enough for investors.

All in all, the earnings season with a slew of profit warnings has not been pretty to look at for the most part.

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