investment outlook september 2019 · 2019-09-11 · investment outlook: september 2019 2 02....

1Investment Outlook: September 2019

Investment Outlook

September 2019


02 Contents

03 IntroductionDecreased risk exposure due to uncertain outlook

04 Summary by asset class

05 Risk exposure & allocation We are now underweighted in equities

06 Macro and other market drivers Increased risks will slow down growth

09 Fixed income investments Central banks preparing for new stimulus measures

11 Global equities Trade war is dictating stock market mood

15 Nordic equitiesFrom upbeat to downbeat and back again

18 Theme: Energy storage – Lifting sun and wind to the next level

23 Theme: Impact investing – Doing good while making money

27 Contact information

Contents


• We are underweighted in equities for the first time since 2016

• We do not expect any recession in 2020-2021, but theescalation of the trade war is making our forecast a lot moreuncertain

• Energy storage – for sustainable long-term energy production

• Impact investing – an increasingly common way of workingtowards a sustainable world

Introduction

This past spring, we reduced the risk level in our portfolios to a neutral weighting. Early in August, we took a further step and underweighted equities for the first time since 2016. Now, as then, there are signs of weakness in global growth. They are due to a very prolonged economic expansion combined with the US-Chinese trade war. In the near term, the risk situation is especially dim because an autumn of Brexit is also approaching. Aside from the risk situation, market performance so far in 2019 has also been very strong. All this led to our assessment that a decrease in risk exposure was appropriate.

As a result of this decision, we reduced our proportion of equities – which, in spite of everything, have good long-term potential – and invested in fixed income securities, which at present include very low-yielding government bonds. The logic of this decision was, and is, very much a matter of different time perspectives, where the near-term risk situation is especially hard to forecast. How we view these complex associations and varying time perspectives is reported from many angles in this issue of Investment Outlook. We also hope we can guide you, our readers, in this unusually difficult investment

terrain – where growth prospects, monetary and fiscal policy measures (that is, decisions by central banks and governments), valuations and investor positioning are among the positive and negative drivers behind the future performance of financial assets.

In this issue, we are adding to our series of analyses about various sustainability themes. First we provide an in-depth look at energy storage – a very important piece of the puzzle in boosting the efficiency of past and present energy investments, while phasing in more sustainable energy solutions. Our second theme article examines the evolution of sustainability efforts, which increasingly include “impact investing” and supportive regulation in addition to earlier methods that often focused more on exclusion of sectors and companies from portfolios.

Wishing you enjoyable reading, Fredrik Öberg Chief Investment Officer Investment Strategy


Nordic equities

• The escalating trade war will have a negative impact on risk appetite and the economy.

• Financial markets are being thrown between hope and despair by Trump’s tweets.

• The economy is slowing down, but how quickly?• Hopes of central bank stimulus measures are saving the

stock market.• The most dramatic sector rotation in the stock market

since 2008.

Return expectations, %, next 12 months (SEK)

Equities Return RiskGlobal equities 7.3% 14.9%

Emerging market equities (local currencies)

8.0% 14.0%

Swedish equities 8.7% 14.8%

Fixed income investments Return Risk

Government bonds -1.1% 1.1%

Corporate bonds, investment grade (Europe IG)

-0.1% 3.0%

Corporate bonds, high yield (Europe/ US 50/50, HY)

2.5% 4.2%

Emerging market debt (local currencies)

3.1% 8.1%

Alternative investments Return Risk

Hedge funds 3.5% 6.0%

Source: SEB, forecasts Aug 2019

Fixed income investments

• More and more interest rates and yields are negative.• Increased central bank stimulus measures will entrench

the low interest rate environment.• We predict that Sweden’s Riksbank will hold off on rate

hikes in 2019 and 2020.• The search for returns will boost demand for higher-risk

corporate credits.

Alternative investments

• Clear trends in fixed income and foreign exchange marketsare supporting trend-following hedge fund strategies.

• Stock market volatility is creating opportunities for equi-ty long/short hedge fund strategies.

• The central bank U-turn means certain difficulties for macro fund managers.

• Most fund managers are generating absolute returns, though in varying degrees.

In the May issue of Investment Outlook we said we had reduced our risk level to a neutral position and that positive potential would arise if the economy – more specifically inter-national trade and the manufacturing sector – stabilised and regained their momentum. This has definitely not happened. Instead, these elements of the economy have continued to weaken, and the prolonged trade war between China and the United States is helping to fuel market worries. This has persuaded the US Federal Reserve (Fed) to shift its policy direction, shelve planned key interest rate hikes and instead begin to cut its key rate. Government leaders are under ever-increasing pressure to deploy fiscal stimulus. Investors have moved their portfolios a step further towards more de-fensive positioning, since the above sources of concern have been accompanied by stagnating corporate earnings.

Because of worries about the economy, bond yields have plunged and the gap between government and corporate bonds has widened. Meanwhile the US stock market delivered an all-time high this summer, which may seem paradoxical.

Global equities

• Falling interest rates and bond yields have propped up global stock markets, as growth and earnings have gradually slowed.

• Growth stocks have performed substantially better than value stocks, with record-high differences in price trends and valuations.

• This year global earnings growth forecasts have been lowered by more than 6 percentage points, but we expectstabilisation at current levels of around 1 per cent.

• We expect a marginal upturn in 2019 earnings, while esti-mates for 2020 are still too high. This should put a damperon the stock market mood for the rest of this year.

Summary by asset class

The reason is that central banks have driven down yields while helping support the stock market. Also worth mention-ing is that within the stock market, money has poured into defensive sectors and fast-growing, non-cyclical companies.

We are in the late phase of the economic cycle. Combined with the ongoing trade war, we are thus receiving signals that make us somewhat sceptical of the growth rate and earnings-generating ability of the corporate sector, but this is offset by hopes of more stimulus measures by central banks and political leaders via lower key interest rates and higher government investments. In addition, investors’ risk appetite and positioning are already cautious. We thus keep empha-sising that volatility will persist and that long-term factors must also be factored in when looking at how defensive we might consider making our portfolios, for example by compar-ing government bond yields – which are very low – with the long-term dividend-paying capacity of the stock market. The difference has rarely been bigger than today.


During 2019 a balanced portfolio consisting of equities, fixed income investments and alternative investments has shown strong but volatile returns. This has occurred at the same time as worrying headlines have filled the front pages of newspa-pers. We have also learned that investors in financial assets normally discount increased risks of impending bad times. For example, in one chart below we see that the US stock market has climbed this year while US 10-year Treasury yields have fallen very rapidly. The latter is supposed to be a function of growth and inflation expectations and is thus likely to signal bad times. This should be reflected in stock market valuations, which are supposed to discount future US corporate earnings.

One obvious conclusion is that not everything is the way it usually is. The main difference is the highly aggressive mon-etary policies being pursued by central banks. Last year we experienced a brief period of normalisation in the form of key interest rate hikes, but due to this year’s weak economic performance – which is also being threatened by a prolonged trade war – central banks have reverted to their traditional recipe of cutting key rates and planning quantitative easing. This has driven down government bond yields to extremely low levels, while providing hope that the economy might re-ignite, and also channelling capital from government bonds into riskier investments such as equities and corporate bonds.

It is clear from the capital flows we have been able to follow within each asset class that investors are genuinely uncertain whether this medicine will work. Capital flows clearly demon-strate that the average investor is struggling to maintain a reasonable long-term risk allocation between various asset

classes, while ensuring safety by reallocating funds to de-fensive exposures within individual asset classes. Among the results are that investors are trying to avoid government bonds in countries with negative yields, that they have cut back on riskier corporate bonds and that their equity portfolios priori-tise defensive companies and structurally growing companies with modern business models.

The current situation is shaky and there is great concern that we will end up in a new recession, where defensive positions are expensive. We have chosen to shift our portfolios in a more defensive direction. At present, we are underweighted in equities but still have a reduced overweight in corporate bonds with short average maturities. In addition, we have a broad portfolio of alternative investments that balance the risk in the overall portfolio. Yet we would like to point out that for a long-term investor the pricing of government bonds, for example, is very high. As a result, a situation will arise in the future where weak risk appetite will be reversed – perhaps as early as this autumn – for example if the trade war moves towards a solution and the Brexit issue is finally resolved. We believe that the next couple of years will see continued volatility, with lower inflation and trend economic growth than we have become accustomed to. We also believe it will be hard for interest rates and yields to work their way up to “normal” levels. Combined with an ever-increasing investor focus on sustainability issues, this bodes well for active instead of passive asset manage-ment, which will bring about major shifts. There should be good potential for contributions from active asset allocation. If this connection is valid, it is extremely reasonable to assume that the same is also true within each respective asset class.

Risk exposure & allocationWe are now underweighted in equities

Weak krona and central bank stimulus positive for equities

The chart shows the return for the MSCI AC World, a broad global equity index; the SBX Swedish equity index; the OMRX Swedish fixed income index; and a European high yield (HY) index that is currency-hedged to SEK. The lengthy upturn in asset prices since 2009 is being propped up by central banks and the weak Swedish krona.

Source: Bloomberg/Macrobond

US stock market sending different signals than Treasury yields

The chart shows the performance of the S&P 500, a broad US equity index, and 10-year US Treasury notes. The S&P 500 has been volatile in recent years but has still reached new peaks several times. This normally means we can expect a reasonably bright future. The 10-year Treasury yield sends the opposite message, having reached very low levels. The common denominator is the Federal Reserve, which is trying to push down interest rates in order to generate growth.



Macro In the last Investment Outlook (May 2019) we drew a divided growth picture, but with positive signals from the political arena that justified the optimistic tone in the world’s finan-cial markets. We also noted clear support by central banks, mainly due to more dovish monetary policy by the US Federal Reserve (Fed). Apart from central bank policies, markets have faced headwinds from several directions this past summer.

Today’s growth picture is dominated by deceleration. We see this most clearly in various purchasing managers’ indices (PMIs), especially in manufacturing, which in many places are below the 50 mark that usually signifies the threshold between expansion plans and a more cautious attitude. We also see it in decelerating world trade: from yearly average growth of around 5 per cent before the Lehman Brothers crash to around 2 per cent since then, and near-stagnation today.

The signals from the political arena have also become increas-ingly harsh. After last spring’s optimism about a US-Chinese trade agreement, the mood became more confrontational this summer. Most observers now expect a long journey, with more bumps in the road. Direct effects on the economy and trade are limited so far, but combined with other uncertainties the negative effects on business and household sentiment may still push down the economy. There is also reason for concern about trade talks between the US and the European Union, although a cease-fire is still in place. In Europe, the Brexit process (British withdrawal from the EU) will naturally dominate this autumn and includes the risk of an adverse economic outcome. The risk of a “hard” (no-deal) Brexit has increased substantially, due to the new British prime minis-ter’s ever-tougher stance.

In addition, the economic cycle is “tired” after a record-long expansion period – mainly in the biggest economy, the US. This is reflected, for example, in a tight labour market, which is becoming increasingly evident and will hamper future growth potential.

More and more observers are talking about an increased risk of recession, with the world entering a period of significantly weaker growth. They can also point to a classic recession indicator – an inverted (or negative) yield curve – meaning that long-term government bond yields are lower than short-term ones. This happened in the US during the summer and has historically been a reliable indicator that a recession can be expected after several quarters.

We agree that the risk of recession has increased, but we believe that those who maintain that a recession is imminent are too early. A number of counterforces indicate that growth may remain decent over the next couple of years, though lower than in recent years. The most obvious is the stability of the domestic economy in many countries, driven by relatively strong service sectors. Another contributing factor is a benign overall situation for households. Low unemployment (the lowest for 50 years in the US), rising asset values, some real wage increases and cheap home mortgage loans are keeping spirits high. US households also have a historically high savings ratio, so they have only a limited need to boost their savings if uncertainty rises. In the trade field there are also bright spots, especially in the form of recent agreements between the EU and Japan, the EU and South American countries and among the countries of Africa. Both sides in the US-Chinese trade conflict are also aware of the risk that an escalating conflict may carry a high price in the form of falling stock markets and growth; this awareness should serve as a stabiliser.

Macro and other market driversIncreased risks will slow down growth

GDP forecasts, year-on-year percentage growth

Market 2018 2019 2020 2021 Comments

United States 2.9 2.3 1.8 1.7 Fed rate cuts will prop up economic growth.

Japan 0.8 1.2 0.7 0.5 Continued stimulus measures, continued slow growth.

Germany 1.5 0.5 0.7 1.2 Weak manufacturing a drag, but the bottom has been passed.

China 6.6 6.3 6.1 6.0 A slow recovery in domestic demand.

United Kingdom 1,4 1.3 1.4 1.5 Brexit uncertainty is hurting the economy.

Euro area 1.9 1.0 1.1 1.3 Decent growth despite weakness in Germany.

Sweden 2.3 1.5 1.3 1.7 Subdued growth, bottoming out in 2020.

Baltic countries 3.9 3.4 2.3 2.4 Growth is decelerating.

OECD 2.3 1.6 1.5 1.5 Central banks are supporting a tired economic cycle.

Emerging markets 4.7 4.2 4.5 4.7 The EM sphere will remain a global growth engine.

World, PPP* 3.7 3.1 3.2 3.3 Increased risks and weak growth, but no recession.Source: OECD, IMF, SEB *Purchasing power parities


Finally, and perhaps most importantly, the shift in central bank monetary policies is an important force in softening the de-celeration and prolonging the cyclical upturn. This is precisely what the Fed successfully did in in both 1995 and 1998. On both occasions, the US central bank cut its key interest rate three times and helped maintain economic growth. One could argue that conditions are worse this time around, since we are further along in the economic cycle, with less energy left in growth engines such as labour markets. Yet we expect looser monetary policies in both the US and the euro area to help sustain growth.

Overall, we expect a deceleration of global economic growth from 3.7 per cent last year to 3.1 per cent in 2019. We then expect a marginal speed-up in 2020 and 2021, driven by improved growth after Europe bottoms out this year and a speed-up in some emerging markets, especially countries with previous economic problems like Brazil and Russia. This will be enough to maintain global growth, despite continued con-trolled deceleration in both the US and China, but the image of a tired global economy with clear downside risks – especially political ones – is likely to dominate financial market condi-tions this autumn.

Inflation and central banks In the classical pattern, inflation should already have taken off at this late stage in the economic cycle. There are several reasons why this has not happened – globalisation, automation and falling inflation expectations are holding prices down while structural factors such as ageing populations are contributing to lower demand. Although we are seeing some wage and sala-ry increases in major economies, their pace is slow and they are largely offset by rising productivity, which eases the impact of

pay increases on business expenses. In recent years, compos-ite inflation in major industrial countries (the US, Japan, the UK and the euro area) has varied between 0 and 2.5 per cent. If we adjust for fluctuating food and energy prices, we see that “core inflation” has been very stable at around 1.5 per cent. We expect this to persist, and inflation will typically be lower than – yet close to – central bank targets.

This inflation picture gives the central banks manoeuvring room. As mentioned, the Fed has undergone a radical policy shift, which is visible in financial market expectations. Late in 2018, investors expected Fed rate hikes of about 75 basis points (0.75 percentage points) looking one year ahead. Today they expect cuts of around 100 bps, after the Fed has already cut its key rate once this summer. This shift is unpar-alleled in modern times, and our forecast is somewhat more cautious than that of the market: we expect three 25 basis point cuts during the next several quarters.

Others have followed the Fed’s example. About 15 other central banks have recently cut their key rates. Central banks in some of the other advanced economies do not have the same manoeuvring room, since their interest rates are already low, but their policies are moving in the same direction. In the euro area, we expect the European Central Bank (ECB) to lower its already negative deposit rate for banks in two small steps, meanwhile also stimulating the economy by resuming bond purchases and providing cheap, unlimited lending to banks. In Sweden, we believe that this autumn the Riksbank will be forced to retreat from its signals of a higher key rate ahead. A rate cut cannot be ruled out, but we expect an unchanged repo rate for the next two years. Overall, the ultra-low key rate environment is likely to persist during the foreseeable future.

Global trade is losing momentum

There has been a clear slowdown in world trade, but so far it is no bigger than in earlier decelerations during this economic upturn phase (2012 and 2015). Future trade war developments may affect trade in either direction, depending on the outcome.

Source: Macrobond

The rate of pay increases has speeded up, but not to alarming levels. Structural forces point to continued low core inflation (consumer price index adjusted for volatile energy and food prices).

Source: Macrobond

Rising wages and salaries, stable core inflation

Macro and other market drivers


Valuations By definition, negative government bond yields mean that the asset class is expensive from a historical perspective. This rubs off on all other asset classes too, but wider yield spreads between government and corporate bonds along with falling price-earnings (P/E) ratios for equities imply that these assets are more attractive, at least in a longer-term perspective. We expect low positive corporate earnings increases during the next 12 months, resulting in a P/E ratio on a global basis of around 15 times, a more or less stagnant earnings level. This is a completely normal valuation level, and a low level compared to the way government bonds are valued, but it should be emphasised that this has been the situation for several years as an effect of aggressive central bank monetary policies. If we remove defensive sectors and large growth companies from a global equity index, however, the remaining equities appear to have downright low valuations. If we achieve some kind of clarity about the future that does not involve recession, some of these valuation gaps are likely to narrow.

Risk appetite and positioning Positioning among market players has become successively more defensive. This process has been under way for two years, and at present it would probably require a recession to shift positions further in a defensive direction. During the same period, risk appetite has suffered two major setbacks; once during the fourth quarter of 2018 and again in the summer of 2019. In principle, this means that if we suffer a recession in the near future the stock market will fall, but the need for risk reduction is more limited than many people fear. On the other hand, if we should avoid a recession, move past Brexit and gain some sort of clarification about how China and the US will carry out their future trade, this is likely to make it necessary for many investors to shift their portfolios in a more aggressive direction again.

Examples of risks Obviously further rapid deterioration in the economy would create a difficult situation. This is why the trade war and the actions of central banks and political leaders pose both positive and negative risks during the coming year. Continued friction between China and the US, combined with overly cau-tious central banks – whose ammunition is also limited – plus the unwillingness of political leaders to enact fiscal stimulus, would be a difficult combination. The opposite, however, could provide stability and rising risk appetite.

Brexit and heavily indebted governments such as Italy also pose risks, as does the total debt level in the entire financial system, which has reached worrying levels. But low interest rates and yields, combined with the fact that a large propor-tion of these debts are governmental, will lead to continued low interest rates and yields as well as lower potential growth instead of being a source of clearly heightened volatility.

Macro and other market drivers


Recent months have been dominated by turmoil in financial markets, largely linked to the sharp decline in bond yields. Stimulative central bank monetary policies have benefited exposures with both interest rate and credit risk. We see advantages for credits (corporate bonds) with higher risk, and the US Federal Reserve’s dovish approach will enable a continued good performance for emerging market bonds for a while longer, although there is greater uncertainty.

Government bonds (excl emerging markets) Central banks have continued their U-turn, with last year’s tightening replaced by a far more dovish approach and the beginnings of interest rate cuts. In July, the US Federal Reserve (Fed) lowered its key interest rate from 2.50 to 2.25 per cent while the European Central Bank (ECB) signalled a likely rate cut going forward.

The big question is how much potency central banks still have. Can they cut rates as much as the market wishes in order to prevent weaker economic conditions? This time around, however, recession worries are not driven primarily by weak economic data but are related more to future risks of

political events in general and US President Donald Trump’s trade war with China in particular, with prospects of a quick resolution looking increasingly dim.

Since the downside risks of this trade policy look set to per-sist, this suggests the Fed will implement additional “insur-ance cuts”. We believe the next cut will occur in September, followed by additional rate cuts in December and the first quarter of 2020. This would imply a US key interest rate of 1.50 per cent by mid-2020. As for the cut to be decided at the September meeting, we believe 0.25 percentage points is most likely since that does not signal any panic about the economic situation, while letting the Fed keep some ammu-nition in reserve. It will no doubt be needed going forward. Our forecast is that the ECB will cut its deposit rate for banks by 0.10 points in both September and December, bringing it to -0.60 per cent. It will also take other steps, including a resumption of its asset purchase programme. It is also likely that the new ECB president, Christine Lagarde, will uphold the spirit her predecessor Mario Draghi invoked with his “whatev-er it takes” policy.

As for Sweden, given weak economic data and dovish global central banks, we no longer expect any more rate hikes from the Riksbank. Our new forecast is that its key interest rate will be unchanged this year and next. We believe the Riks-bank would cut its key rate in the event of a deeper economic downturn and unforeseen downturns in inflation and inflation expectations, although that is not our main scenario at present.

Fixed income investmentsCentral banks preparing for new stimulus measures

The decline in bond yields has continued

Central bank actions have led to sharply falling bond yields this year. Our forecast of further stimulus measures implies that the global low interest rate/bond yield environment will persist. A more stimulative monetary policy affects our forecasts for 10-year government bond yields.

Source: Macrobond, SEB

10-year government bond yield forecasts

Market Sep 2019 Dec 2019 Dec 2020

United States 1.59 1.40 1.30

Germany -0.66 -0.70 -0.70

Sweden -0.30 -0.35 -020 Source: SEB, market data September 2019


Corporate bonds – Investment grade (IG) and high yield (HY)

Stimulative central bank monetary policies have benefited not only exposures with interest rate risk but also exposures with credit risk, such as corporate bonds. Credit spreads – the difference between yields on corporate and government bonds with the same maturity – widened somewhat during the summer, while interest rates and yields continued to fall, which has benefited returns on credits.

Falling yields on government securities are spilling over into the credit market, and yields on many high quality (investment grade) credits are negative. All else being equal, conditions for generating returns will be more difficult if a continued fall in yields is not factored in. For investors who need to balance risk in their total portfolio using fixed income investments, owning investment grade corporate bonds may be warranted.

However, we expect HY and IG bonds to generate better returns than government bonds and hope to benefit from higher yields in the credit market. To some extent, low yields and narrow yield spreads between government bonds and corporate credits also limit the return potential for corporate bonds in the high yield segment. However, changes in yields have less effect on HY bond prices, although this is one fixed income market segment that generates relatively good returns in absolute terms. Stimulative central bank monetary policies bolster the outlook for credits, although the effect will be more limited than earlier in the year. Short-term risks that may have a negative impact on the credit market are an escalation of the US-Chinese trade war and growing concerns about general economic conditions.

Emerging market debt

Emerging market (EM) bonds continued to perform well during the late spring and summer. Returns on EM bond in-vestments have been generated by higher yields in emerging markets and by price rises, since yields in some markets have fallen, and because of appreciation in some EM currencies. However, recently the trend has been somewhat subdued. The trade war between the US and China not only affects the stock market but also the fixed income and currency markets. Meanwhile, political uncertainty in Argentina is having some impact on other Latin American markets, although they have shown good resilience so far.

Looking ahead, an escalating trade war may naturally be one uncertainty factor, especially since no resolution is apparent-ly in sight, but there are positive factors offsetting this. The Fed’s stimulative monetary policy is benefiting many emerg-ing markets, while inflation in EM countries has generally fallen to levels like those in the OECD economies. Combined with decelerating growth and falling global yields, this creates room for monetary easing. Many large EM economies have already cut their key rates faster than expected, but more easing is on the way. All in all, conditions are in place for a continued positive performance for EM bonds, although we lowered our return forecasts the last quarter. This asset class also carries a relatively high risk, which justifies a certain degree of caution.

Continued potential for EM debt, but uncertain currency effect

Yield to worst shows the effective yield in per cent that an investment generates if all bonds are redeemed by the issuer on the earliest date they can be redeemed. In other words, the current average yield is around 5 per cent.

Source: Bloomberg/ Macrobond

Fixed income investments

Expected return, next 12 months (in SEK)

Fixed income investments Return Risk

Government bonds -1.3% 1.2%

Corporate bonds, investment grade (IG), Europe

0.9% 2.7%

Corporate bonds, high yield (HY), Europe/US 50/50

3.7% 3.9%

Emerging market (EM) bonds (local currencies)

7.0% 8.1%

Source: SEB forecasts, September 2019


Falling yields and interest rates have propped up global stock markets as economic growth and earnings have gradually slowed. The US Federal Reserve (Fed) has reverted to stimulating stock markets by lowering its key interest rate. The first rate cut has occurred, and more are expected. Other leading central banks will probably follow, but will central banks come to the rescue again and prevent a further economic slowdown? The market is sceptical.

Scepticism about an economic recovery can be seen in the fixed income market, where short- and long-term yields are now about the same. This is a clear sign that the fixed income market is pricing in a worse economic scenario. In early August, the classic US yield curve – the spread between 2- and 10-year Treasury yields – inverted, which means the long-term yield was lower than the short-term yield. This was interpreted as a warning signal about the general economic trend and gave the stock market the jitters. The broad S&P 500 index of US listed companies fell nearly 3 per cent in one day. Yields can certainly be a good indicator of the future economic trend but are also an important parameter for share valuation. They are used to discount future cash flows – the lower the yield, the lower the cash flows needed to warrant the valuation. Put simply, stock markets have higher valua-tions when yields are low and vice versa. Another factor in share valuation is risk premium, which increases when the market is uncertain, thus pushing down share prices. If we had a calmer global political environment while macro data

stabilise and yields remain low, stock markets would benefit. However, a calmer political environment assumes that the US and China are getting closer to an agreement in their trade talks. It appears we will not see any comprehensive agree-ment being signed in the near future, so we will have to live with a politically higher risk premium for another while.

Another factor is corporate earnings, which have trended negatively since December 2018. As the global economy has slowed and soft data have indicated that companies are un-certain about the future economic trend (and are thus putting investments on hold), earnings forecasts have been revised downward. Cyclical sectors – such as the auto industry, com-modities and semiconductor manufacturing – have been hit hardest. Some of this can now be seen spreading to related sectors in traditional manufacturing. The banking sector is also struggling, especially in Europe, which suffers from zero interest rates and a negative ECB deposit rate. Falling long-term yields and interest rates also make it difficult to earn

Global equitiesTrade war is dictating stock market mood

Large US growth companies and European banks have moved in opposite directions.


The relative performance of growth and value stocks correlates with the relative trend of short- and long-term yields

The chart shows that the flattening of the US yield curve correlates with the poorer performance of value stocks compared to growth stocks. A flatter curve indicates lower future growth and inflation.


09511.051.11.151.21.251.31.351.4

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2014-08-20 2016-08-20 2018-08-20

US yield curve (10-year minus 2-year yield)

Global value index/growth index

US growth companies have been a driver, European banks a millstone

Large US growth companies +83% (Russell 1000 Growth, Net)

Global index +29% (MSCI ACWI NET)

European banks -35% (MSCI Europe Bank Index Net)

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2014-07-30 2016-07-30 2018-07-30


money on classic bank activities – borrowing short-term and lending long-term. US banks have had it easier since they are less dependent on traditional lending and are instead reliant on fees and transactions, for which conditions have been favourable. However, a flattening of the US yield curve (a nar-rower yield spread between short- and long-term Treasuries) is also unfavourable for US banks.

Winners again have been companies with structural growth and modern business models as well as innovative technolo-gies, such as Amazon, Microsoft, Apple, Netflix and Facebook. The health care sector has delivered earnings growth along with upside surprises, but due to fears about US govern-ment regulation, the sector has not performed as well as the market in general. Ahead of next year’s US elections there is a clear risk that high health care costs will be used to score political points. We thus cannot count on higher valuations driving up share prices in the near term. However, in the long term there may be good opportunities to buy into the sector, which is experiencing structural growth and is also relatively unaffected by cyclical fluctuations.

Low interest rates and yields favour growth stocks Growth stocks have continued to far outperform equities with low valuations. A number of variables explain this. Valua-tion spreads are record-wide; the internet has had a crucial impact on traditional business models, which have quickly become obsolete. New players, without the baggage of old structures in the form of antiquated IT systems or unprofit-able retail chains, have quickly become established. Often these new players are also backed by venture capital, of which there is an abundance.

The growth in passive investments (for example, index funds) and smart beta products (hybrids between passive and active management) favours positive price trends and low volatility, which has further bolstered the performance of quality and growth stocks. Low yields and interest rates glob-ally benefit growth stocks, since lower discount rates make cash flows further in the future more attractive. Valuation spreads should narrow over time, but right now the market prefers non-cyclical companies that can grow on their own. If yields turned upward, that would trigger a trend reversal for value stocks. Given the discount rate, investors would want cash flows in the shorter term. That would also have a positive effect on bank earnings and be a favourable econom-ic indicator – an encouraging signal for commodities and for volume-dependent companies in traditional manufacturing with low valuations. However, there are currently few signs that point to higher yields and stronger economic conditions. It is thus likely there will still be a premium on growth and quality stocks until we see signals of a reversal in the general economic trend. Once this rotation occurs, it will go quickly given the extreme positions and large valuation spreads.

Clear slowdown in global earnings growth Ever since the first concrete signals of decelerating economic growth appeared in late 2018, corporate earnings forecasts have been downgraded. For 2019, global earnings forecasts have been pushed down so far by over 6 percentage points to about 1 per cent.

Earnings forecasts for the second quarter were revised downward ahead of the report period, thus allowing these forecasts to be met and even exceeded. The stock market

Record valuation spreads between growth and value stocks

European value stocks are valued at a 12-month forward price/earnings ratio of more than 10, while European growth stocks are valued at a P/E ratio of almost 20.

Source: Bloomberg

Earnings revisions for the MSCI ACWI Net

Source: Bloomberg

Global earnings forecasts have been gradually revised downward since the beginning of the year.

Global equities

-7.00%

-6.00%

-5.00%

-4.00%

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North America weighs heavily in global index

The MSCI AC global index is dominated by the US, which also has the world’s biggest companies, in the form of Microsoft, Apple, Alphabet (Google) and Amazon.

Source: Bloomberg

response to the report period was mildly positive, although forward-looking comments were cautious. Q2 earnings trends were about the same as in Q1, but the economic slowdown had a further negative impact on volume-dependent man-ufacturers. The consumer sector remained strong, thanks to low interest rates and high employment. Sales growth exceeded earnings growth in Europe and the US, indicating some squeezed margins. We can thus expect companies to re-view their cost structures. Earnings estimates for the remain-der of the year have continued to head south. In our view, earnings will now grow marginally for the full-year 2019. We expect downward revisions to end up around current levels, but estimates for 2020 are still too high, which should damp-en the market mood for the rest of the year.

Global equities complement a Swedish equity portfolio Since we have adopted a more cautious approach to the stock market, it may be appropriate for investors to review their risks. There are positive diversification effects from a broader geographic spread, which will be reviewed below.

For Swedish investors, global equity exposure provides clear diversification effects. As a rule, equity funds are not cur-rency-hedged. The greatest currency exposure for investors is to the US dollar, since the country accounts for nearly 60 per cent of the MSCI all country global index. They also have indirect exposure to the USD since other currencies are more per cent weight, which is appealing since these currencies as a rule strengthen in times of turmoil.

We also gain exposure to large, fast-growing sectors such as technology and media. Technology and media account for 22 per cent of the global index. Adding Amazon and Alibaba, which are on the borderline between technology and retail, the figure is 24 per cent. Pharmaceuticals, biotechnology and medical technology as well as service companies in health care are also sectors with structural growth; they account for about 12 per cent. Last but not least, consumer companies account for almost one fifth of the global index. This category of companies is attractive since it provides broad exposure to the global consumer level.

European equity exposure is similar to Swedish equity expo-sure, with industrials and financials as relatively large sectors. The share of exports is high and the largest end-customer category is other companies (business-to-business or B2B). However, the share of stable consumer companies such as Nestlé, Unilever and L’Oreal as well as large pharmaceuti-cal companies such as Roche and Novartis accounts for a relatively large percentage and complements a Swedish or Nordic equity exposure.

An exposure to emerging market (EM) equities provides a large proportion of IT and banking. A high percentage of their sales are to EM countries, which is positive from a diversi-fication perspective. However, there tends to be a positive correlation between EM companies and increased risk-taking, which is also the case for the Swedish stock market.

IT and financials the biggest sectors globally

IT and financials have the greatest weight in the MSCI AW global equities index. If we add the newly reclassified Facebook, Alphabet, Tencent and others that are now included in communication services, these modern companies are clearly dominant.

Source: Bloomberg

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Nonetheless, the US is the major stock market that offers the best diversification compared to the Swedish stock market. It gives us exposure to American consumers, since this is the largest end-customer category for US companies. In sectoral terms, investors gain exposure to market leaders in IT and media. On an aggregate basis, US corporate earnings have weathered economic downturns better, which is attributable to the country’s customer structure, sectoral structure and flexible labour and capital markets. Investors also often flee to US assets in turbulent times, which strengthens the currency.

Conclusion Because of the economic slowdown, geopolitical turmoil and weak corporate earnings trends, we have a more cautious approach to equities than usual. It may therefore be wise for investors to re-examine their diversification between asset classes, but also within the equities asset class. The global stock market offers diversification via currencies, sectors, business models and customer structures, balancing the relationship between future returns and risk – which could be a smart move in times of turmoil.

Global equities


The stock market has experienced rapid mood swings this year, with investors being thrown between hope and despair by the ups and downs of tensions in the trade negotiations between the US and China. Worries about the trade war and its economic impact have greatly intensified in recent months. Sector rotation from cyclical to defensive sectors has been extreme on Nordic stock exchanges over the past three months. Throughout the year, overall indices have been supported by increasingly dovish central bank monetary policies and downgraded interest rate forecasts. We expect a continued volatile trend going forward and believe the outcome of the US-Chinese trade conflict will be crucial to whether stock markets in general will move up or down in the year ahead. Normally, a US president would avoid single-handedly triggering a recession in the run-up to an election year, but the current situation is far from normal.

The stock market started the year with dawning hopes that the US and China would reach a relatively quick new trade agreement that is mutually beneficial and gives companies a stable framework for their operations. Such an environment would also stimulate capital spending, which would have contributed to a milder economic slowdown than we are now seeing. To top it off, all of the world’s central banks abruptly changed course and started to provide more dovish commu-nication. However, this favourable environment for equities was upended by several indignant tweets by Donald Trump in early May. The trade dispute again escalated, with stock market sentiment deteriorating quickly and dramatically. In-vestors regained courage thanks to falling yields and interest rates, undramatic second quarter corporate earnings reports and signals that trade talks would resume. In August, there was yet another shift, with the US promising new tariffs on Chinese goods and the stock market downturn accelerating.

At this writing, signals from China that it is “willing to resolve the trade dispute with the US through calm negotiations” are the only thing that has soothed investors and propped up the stock market after Trump declared in a deluge of tweets: “We don’t need China and, frankly, would be far better off without them,” “American companies are hereby ordered to imme-diately start looking for an alternative to China,” and “Who is our biggest enemy, [Fed chairman] Jay Powell or Chairman Xi [Jinping]?”. In addition, Trump announced a five per cent increase in tariffs on Chinese goods worth about USD 550 billion per year. There is an obvious risk that the trade dispute will escalate into an out-of-control trade war and a general conflict on numerous levels.

Lower return requirements have saved the stock market On the plus side, we have return requirements and central banks. During 2019 there has been increasingly dovish com-munication from central banks, while US interest rate expec-

tations have fallen steadily. European market interest rates have also fallen since autumn 2018, and recently the Euro-pean Central Bank (ECB) has been increasingly explicit that new stimulus measures are on the way, probably including quantitative easing, which should have a far greater positive impact on the stock market than a key rate cut from zero.

Nordic equitiesFrom upbeat to downbeat and back again

Investors thrown between hope and despair

The chart shows the VINX Nordic equities index in the past year. Inves-tors have been repeatedly thrown between hope and despair during this period. This year’s negative trade-related news has been tempered by continuously downgraded interest rate expectations. Last autumn’s stock market slump was triggered by worries about interest rates but intensified late in 2018 due to worries about a US-China trade war, which has now become a reality.


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The upward interest rate trend, mainly in the US – along with expectations of more normalised monetary policies, including the winding down of various quantitative easing packages around the world – was a major reason for the stock market slump during the last quarter of 2018 and a crucial catalyst when the market started to decline in October last year. Since then, the interest rate trend has only been in one direction – downward – providing increased support for the stock market. Obviously, there are periods when negative news sto-ries about free trade, general economic conditions and Brexit negotiations as well as Italy’s government crisis have been far too bleak to allow the downward revision in interest rate fore-casts to offset them, which is why the net result has been a stock market decline. However, we believe key interest rates have been the trump card that has saved the stock market this year. Key rates have had an increasingly positive impact, regardless of what various stock market commentators and presidents have communicated on the matter.

Extreme sector rotation already a reality The trade war has played a key role in the rapid decline in manufacturing activity we have seen since the autumn of 2018; escalation of the trade dispute has reduced investor risk appetite and hurt the prospects of the many cyclical companies in the stock market. Virtually all companies that produce goods of some kind are more or less negatively affected by the tariffs, but above all their desire to invest is adversely impacted by this kind of uncertainty; it rapidly leads to a downward spiral.

It is thus hardly surprising that both economic and corporate earnings forecasts were revised downward significantly dur-ing the summer, especially for open, transparent economies

with large international trade volumes and more limited home markets such as those in Europe. GDP growth forecasts for China appear to be set at around 6.0-6.2 per cent; if Chair-man Xi says growth will be 6 per cent, then that is also what will be reported. However, many Nordic listed companies noted a sharp recession in their respective niches in China during the second quarter. Because of its large home market and favourable baseline situation, including a historically strong labour market, the US has so far weathered the global economic slowdown remarkably well, but there too GDP and corporate earnings forecasts have been revised downward.

Due to the combination of cyclical headwinds and lower return requirements, there has been a historically extreme sector rotation on Nordic stock exchanges during the past quarter. Over the past quarter (and year) the performance of Nordic equities in the four most cyclical sectors – industrials, finan-cials, materials (metals, forest products and chemicals) and en-ergy (oil) – relative to that of the three most defensive sectors (health care, consumer staples such as food and utilities such as electric power companies) – was the worst since the 2008 financial crisis. After this kind of extreme period, relatively little is needed to trigger a significant counter-reaction.

Sector rotation is reflected in share valuations The strong sector rotation under way during the past year and quarter is apparent in all Nordic stock markets. Roughly the same sectors have been winners and losers in all four countries, but the different sectoral structures in the four stock markets have led to a historically large valuation spread. The Copenhagen stock market (KFX index) is valued at a historically high price/earnings (P/E) ratio of 20, which

Source: SEB, Bloomberg

Nordic sector rotation in the past quarter the strongest since 2008

The chart shows the performance of the four most cyclical Nordic sectors (industrials, energy, materials, financials) relative to the three most de-fensive (health care, utilities, consumer staples). Over the past 13 weeks, cyclical equities have underperformed defensive equities more than at any other time since the autumn of 2008, when the collapse of the Leh-man Brothers investment bank triggered a global financial crisis.

Interest rate forecasts have accelerated downward

Source: Bloomberg/MacrobondThe chart shows 6-month forward short-term interest rate forecasts in the US (based on the implicit yield on a generic 6-month forward rate agreement for 30-day US Treasury bills). In the autumn of 2018, the upswing in interest rates and poorer economic prospects helped worsen the stock market mood. Since then, interest rate forecasts have fallen steadily, alongside a deterioration in trade relations and economic pros-pects, which has helped the stock market significantly.

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is 12 per cent above the average for the past five years. Meanwhile, in Oslo and Stockholm valuations are 7-8 per cent below the average for the past five years, while valuations in the Helsinki stock market are near a five-year low, with a P/E ratio of less than 14, or 14 per cent below the average for the past five years.

Sixty-five per cent of the index of the 20 largest companies on the Copenhagen stock exchange consists of the three most defensive sectors – health care (pharmaceuticals, medical technology and hearing aids), consumer staples (breweries) and utilities (the wind turbine maker Ørsted). Another 6 per cent of the Danish index consists of companies classified under materials but in reality dominated by two suppliers of ingredients for the food and household products sectors.

On the Oslo exchange, oil-related operations are the largest sector, totalling 26 per cent of the index, while financials and materials (metals and chemicals) weigh heavily. The main sta-biliser is consumer staples, which in practice consists of salmon farming and other food companies. Together the 25 largest companies in the OBX account for 23 per cent of the index.

The largest sectors in the Helsinki stock market, as in Stock-holm, are industrials followed by financials. Materials (forest products, chemicals and steel) is another sector that weighs very heavily in the index of the 25 largest companies on the Helsinki stock exchange (HEX 25). The four most cyclical sectors together constitute 68 per cent of the index in Finland and 61 per cent in Sweden. In a comparison with historical

valuations, Helsinki was also affected by the relocation of Nordea’s head office from Stockholm to Helsinki, which has given the largest Nordic bank an even greater weight in Finland now than historically. Banks are normally valued at a large discount to the stock market average, and that discount has increased during the past year.

Overall, Nordic stock markets are valued marginally lower than the average for the past five years, but the difference is unu-sually large between the different markets. The Copenhagen exchange, with its stable health care companies and breweries, will remain attractive as long as the US-Chinese trade dis-pute dominates the global economic news flow, but after the extreme capital rotation from commodities, industrials, banks and energy equities over the past year, the recovery potential is considerably greater in Helsinki, Oslo and Stockholm.

Conclusion The stock market has experienced rapid mood swings this year, with investors being driven between hope and despair by the ups and downs of tensions in the trade negotiations between the US and China, usually first communicated on Donald Trump’s Twitter account. We expect a continued volatile trend going forward and believe that the outcome of the trade dispute will be crucial in determining whether the overall stock market goes up or down over the next twelve months. Normally, a US president would avoid single-handed-ly triggering a recession in the run-up to an election year, but the current situation is far from normal. After a historically extreme capital rotation from cyclical to defensive sectors in the past year and quarter, there is significant recovery potential for many Nordic equities in cyclical industries, but a positive catalyst is needed for this potential to be realised. The longer that the current uncertain situation persists, the more extreme the relative returns of defensive sectors are expected to be.

Unusually large P/E ratio variations between Nordic stock markets

The chart shows the P/E ratio (12-month forward) for the four Nordic stock markets. The P/E ratio for the Nordic region as a whole is marginally below the average for the past five years. Copenhagen pushes up the average substantially and is valued 12 per cent higher than its average for the past five years whereas Helsinki is valued at a 14 per cent dis-count compared to its five-year average. Oslo has the lowest valuation as usual, but both Stockholm and Oslo are valued just below their respective average for the past five years.

Source: Bloomberg

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The electrification of transport and the related challenges and growth po-tential receive frequent attention. Bat-teries are one major challenge for the success of electric cars, but energy storage plays a much wider role in en-suring a greener future. An improved ability to store large amounts of en-ergy can also facilitate a transition to more sustainable energy production. We see tremendous potential for en-ergy storage solutions going forward, but there are many alternative solu-tions with different challenges and ad-vantages. It is far from certain which ones will be the biggest winners.

Electric cars are just one sub-market

Many people probably associate energy storage primarily with batteries and perhaps specifically with the rapidly growing market for electric car batteries. This is a large and growing market, but far from the only one that will drive the battery market in the years ahead. According to Bloomberg New Energy Finance (BNEF), electric car battery sales are projected to increase to 25 times the current volume by 2030. The market for really large batteries for power grids, charging points and other applications is expected to grow even faster. In a few years, it will be twice as big as the car battery market; today it is less than half as big.

Wind and solar power have the same Achilles’ heel The biggest problem for wind and solar power is that the pace of production is determined by wind speed and sun-light, not by how much power customers require. This cre-ates great imbalances between supply and demand. As a result, these energy sources need to be supplemented with other more flexible sources, which are often both dirty and expensive. Since they are only used during peak demand, these sources also have low average capacity utilisation.

According to the US Energy Storage Association, electricity generation plants dedicated to handling peak power de-mand have average capacity utilisation of 5 to 7 per cent. They are powered by fossil fuels. Even in countries like Sweden and Norway, with good access to cheap, flexible and clean hydropower, it is difficult to balance wind power with hydropower; in particular, short-term fluctuations have negative consequences.

While power grids that are supplied with a large proportion of renewable energy may have difficulty meeting demand during certain periods, at other times they provide surplus electricity at extremely low prices and generate power that completely goes to waste. By supplementing renewable sources with energy storage solutions, both extremely short-term and far more long-term ones, the supply can be-come more adaptable and flexible while surplus production can be utilised when weather conditions are favourable.

Theme: Energy storage

Lifting sun and wind to the next level


Electric cars and renewable power in symbiosis There is a natural symbiosis between the growth in electric cars and energy storage solutions as a complement to renew-able energy production. The two application areas for energy storage come together and reinforce one another in several ways:

• There is no climate-related reason to electrify the transport sector if the electricity cannot be generated by sources with lower emissions than modern combustion engines (although it may benefit the local environment in cities).

• There is a clear risk that, above all, peak loads in the power grid will be even more extreme if many vehicles have to be charged quickly and simultaneously.

• Old car batteries can be connected together in battery banks to balance grid load or as charging points; right now, we are seeing explosive growth in the number of spent batteries from electric and hybrid cars.

Are electric cars good for the environment? The short answer is yes; given the right conditions, they are better than conventional combustion engines that run on petrol or diesel. According to the International Council on Clean Transportation (ICCT), carbon dioxide emissions per kilometre over the economic life of a passenger car (150,000 kilometres) are more than 70 per cent lower for an electric car that runs on carbon dioxide-free power sources than for an average European car that runs on petrol or diesel. Emis-sions are also less than half the amount produced by the most

energy-efficient conventional passenger cars in Europe over their economic life. If they instead run on a dirtier energy mix with a large element of coal-based power, the positive effect may be completely eliminated, but that is not a relevant argument against electric cars in countries such as Sweden, Norway or France. As a transitional solution and for heavy ve-hicles and aviation, bio-based fuels are an attractive and now rapidly growing alternative that has greater advantages the dirtier a country’s electricity generation is. However, ironical-ly, it is mainly the Nordic countries (along with California) that have also come furthest in this respect.

The biggest problem with electric cars from a carbon dioxide emissions perspective is battery production; the emissions produced in making batteries are as great as those produced in making the rest of the car. There are also numerous media reports about how mismanaged production facilities for critical minerals used in batteries – mainly cobalt but also lithium – are poisoning their surroundings and exploiting their workforce under slave-like conditions. Obviously, few electric car buyers want to contribute to this, but it does not make sense to blame the lithium batteries that are a product of this criminal behaviour. As with all other businesses, companies and public authorities must act responsibly.

Batteries are a challenge for electric cars, but battery-pow-ered electric vehicles have a big head start over the al-ternatives. It is worth noting that China, the main driver in electrifying the transport sector, recently introduced major subsidies (around 800,000 yuan – equivalent to about 1 million Swedish kronor or nearly USD 100,000 – per vehicle)

The chart shows the projected reduction in total CO2 emissions per kilo-metre over the service life of a passenger car (150,000 km) – comparing an average EU car that has a combustion engine using conventional petrol or diesel to the most efficient conventional car, an electric car powered by the average EU electric power mix and one powered by CO2-free electricity.

Source: International Council on Clean Transportation, ICCT

Theme: Energy storage – Lifting sun and wind to the next level

Rapid growth expected for large and gigantic batteries

The chart shows the global market in billions of dollars for electric car bat-teries and for really large batteries for power grid load balancing and sim-ilar stationary applications. The rapid growth in electric cars is expected to lead to electric car battery sales 30 times the current volume in 2030. However, sales growth for large batteries is expected to be even faster, with that market overtaking the car battery market in just a few years.

Source: Bloomberg New Energy Finance

Transport sector emissions can be sharply reduced with electric cars that run on CO2-free electricity

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to buyers of fuel cell cars, whose greatest advantage is that they do not need the batteries that conventional electric cars use. Meanwhile, subsidies to buyers of conventional electric cars with batteries were halved, which had a major negative impact on Chinese electric car sales in July, although China is still the world’s leading electric car market. Morgan Stanley noted that at the Shanghai automotive trade fair this past April, half of all cars shown had electric motors, compared to only 17 per cent last year.

All in all, we believe continued rapid electrification of the transport sector is highly likely going forward. As a result, there will be growing demand for car batteries and energy storage solutions for power grids.

Car batteries can enjoy a second life Given the sales success of electric and hybrid cars over the past decade, we are now seeing an enormous increase in the number of spent car batteries. What should we do with them? One interesting alternative is to give them a second life as part of a large stationary storage solution. Even after a battery has become too inefficient for a car, it may be good enough to last another ten years in various stationary applications. In one solution, BMW connected 500-700 old car batteries together at a warehouse in Leipzig. The facility is hooked up to the power grid and is filled up with electricity when prices are low (lots of wind and low demand) and sells it when it is more expensive. Renault, Nissan, GM and Chinese automaker BYD have similar projects. Old car batteries con-nected together are also used as backup solutions (in case of a power outage), for electric car charging points and in com-puter server halls. A longer lifespan and good second-hand value for old car batteries can improve the bottom line for electric cars in both financial and sustainability terms.


If the EU is to achieve its emissions reductions targets, all sectors must make improvements

The chart shows EU carbon dioxide emissions in millions of tonnes of carbon dioxide equivalents by sector and the total emission targets for 2030 and 2040. The ambition for 2050 is to reduce emissions by 80-95 per cent.

Source: Eurelectric

Energy storage can raise solar and wind power to the next level The percentage of electric power generated from renewable sources is rising sharply in the 36 mainly affluent member countries of the Organisation for Economic Cooperation and Development (OECD). That is not just because these sources are environmentally friendly and thus subsidised by govern-ment authorities in many places around the world, but also – and at least as importantly – even without subsidies they are extremely competitive against all types of conventional power generation. Since most exploitable hydropower assets have already been developed in these countries, when new power generation capacity is to be built, in practice it is a question of choosing wind power, solar power or natural gas. Only in countries where emissions are not measured at all or are extremely low is coal an alternative. According to the US Energy Information Administration (EIA), even when a coal-fired power plant is forced to recycle only 30 per cent of its carbon dioxide emissions, as is the case in the US today, cost increases are making this dirty power source far more expen-sive than natural gas, solar power and wind power (calculat-ed excluding subsidies). According to the EIA, nuclear power is relatively expensive.

The share of electricity generation from renewable sources in the OECD rose from below 5 per cent in 2013 to more than 27 per cent in 2018, according to the International Energy Agency (IEA). The growth in renewable energy comes entire-ly from sources other than hydropower. However, hydropow-er is still the biggest renewable source, accounting for half of renewable electricity generation last year. Renewable sources are growing at the expense of fossil fuels. There is also a clear shift from coal, which decreased by 7 percentage points, and oil, which decreased by one point, in favour of

Wind and solar power are very competitive even without subsidies

The chart shows the cost (highest, lowest and average) per MWh of electricity generation over an expected service life of 30 years for dif-ferent kinds of power generation facilities, excluding subsidies, for a US power plant that can start operating in 2023. The coal generation plants in this calculation are assumed to include the legally stipulated 30-90 per cent carbon dioxide recycling. In practice, the figures for a US power plant improve significantly when tax breaks, mostly for solar power and offshore-based wind power, are included.

Source: United States Energy Information Administration, EIA

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natural gas, which increased by 4 percentage points. Available statistics for the world as a whole are somewhat older, but the share of renewable sources in non-OECD countries was much like that for OECD countries in 2016. The biggest difference between the OECD and the rest of the world is the more wide-spread use of coal, which accounts for almost half of all elec-tricity generation outside the OECD. One important reason why the switch to renewable sources is not going faster is the lack of flexibility in solar and wind power generation. It is particular-ly problematic when these two renewable sources account for a large share of total electricity production in a system. That is where energy storage solutions come in.

Water pumps, compressed air, flywheels, hydrogen and other storage solutions Although this theme article mostly deals with the rapidly grow-ing market for gigantic batteries as energy storage solutions, by far the most commonly used technology today is based on water that is pumped up to one reservoir when electricity is cheap and is then released back down to another reservoir through a turbine in order to generate new electricity when prices and demand increase. This will be discussed in more detail below.

There are also technologies based on flywheels (primarily to balance short-term fluctuations in production/demand), compressed air, thermal energy storage, molten salt, aerial lifts that hoist concrete blocks connected to a generator when electricity is cheap and then release them when there is greater demand, and so on. There are many different solutions. Another alternative is to produce hydrogen gas from water using electrolysis when electricity is cheap, which is especially attractive if vehicles with fuel cells (powered by hydrogen) were to become more commercially successful in the future.

Major investments However, the business opportunities in energy solutions are perhaps best illustrated by a number of concrete examples. Below we describe a few major investments in energy storage solutions that are planned or were recently carried out, produc-ing good results.

Neoen’s Tesla battery in Hornsdale, South Australia The French energy company Neoen focuses on solar and wind power as well as commercial energy storage using gigantic batteries. The main asset in its energy storage operations is an enormous battery facility in Hornsdale, South Australia, with capacity to store 129 MWh and handle a flow of 100 MW. The facility, located next to its 300 MW wind farm, helps balance the load in the region’s power grid and generates profits for Neoen by buying electricity when it is cheap and selling it when it is expensive.

When it was built in 2017, the Hornsdale battery plant was by far the largest of its kind and is probably best known for having been built by Tesla in 54 days after Elon Musk (Tesla’s CEO and founder) made a bet with Mike Cannon-Brookes (an Australian IT entrepreneur) in a public discussion via Twitter

in March 2017 about whether he could solve the problem of South Australia’s chronic power outages with a gigantic battery. Musk promised that Tesla would deliver and install the facility in 100 days of the contract being signed or would do it for free. Musk won the bet with 46 days to spare. South Australia is the Australian state with the largest share of elec-tricity from solar and wind energy, almost 49 per cent, which has led to heavy demands on the power grid and thus been blamed for contributing to recurring power outages (Australia has a strong coal lobby).

In 2018 Neoen’s energy storage division – whose most important asset by far was the giant battery in Hornsdale – generated earnings before depreciation and amortisation of 14 million euros and had total assets of 53 million euros at year-end, including non-operational projects under construc-tion. Neoen also states that the Hornsdale battery has had a significant positive impact on profitability for the company’s Australian wind farms, contributing to the 59 million euro earnings increase (before depreciation and amortisation) re-ported for these in the same year. An independent consultant report commissioned by Neoen also indicates that the state’s power grid operator saved the equivalent of 24 million euros by stabilising energy flows to and from the Hornsdale battery and balancing the power grid load (while at the same time making money for Neoen).

Kauai, the Hawaiian pioneer The Hawaiian island of Kauai, which is green in many senses, has long had great ambitions for renewable energy. Several years ago, it was able to supply the island’s entire population with virtually all the electricity it needed during the daytime using solar panels. Unfortunately, for years the island had to supplement this supply with diesel-powered generators at night, but it achieved a breakthrough in its effort to increase the total share of electricity generated from renewable sourc-es to 50 per cent by 2023 with the construction of a com-bined solar panel and electric storage facility from Tesla in 2017. That year, Tesla delivered a 13 MW solar power plant supplemented with a battery system with the same flow capacity – 13 MW – and a 52 MWh storage capacity. The in-vestment was quickly successful and Kauai revised its target upward – to meet 70 per cent of its electricity needs with renewable sources by 2030; the old target of 50 per cent has already been met. Recently a second combined solar power and battery facility from AES Corporation was completed on the island, with a storage capacity of 100 MWh. The facility will sell electricity to the Kauai Island Utility Cooperative at a fixed price of 11 US cents per kWh over 25 years. A third fa-cility is under construction, which is expected to increase the share of renewable energy to 60 per cent by the end of 2019.

These successes have also inspired others. The Hawaiian Electric Company announced in January this year that it is planning seven similar facilities for the much more heavily populated islands of Oahu, Maui and Hawaii with a total stor-age capacity of 1,048 MWh and agreed to bring long-term average prices as low as 8 US cents per kWh (nearly 1 million



Renewable energy is increasingly important, and natural gas is replacing coal and oil

The chart shows a breakdown of electricity production by energy source in the OECD countries in 2013 and 2018 (preliminary data). Renewable sourc-es have enlarged their share by nearly 5 percentage points to more than 27 per cent, while fossil fuels have declined by 4 points to less than 51 per cent. During the period, nearly 4 percentage points of electricity production shifted from the dirtiest alternatives (coal and oil) to natural gas.

Source: IEA

of the 1.4 million residents of the state of Hawaii live in Oahu while the population of the Garden Island of Kauai is about 67,000).

Government agency in India demands solar power at night The state-owned Indian electricity company Solar Energy Corporation (SEC) noted recently that despite their low power generation costs, renewable energy sources have not been able to replace fossil-fuelled power plants that supply elec-tricity during peak demand periods. This has contributed to significantly higher costs during the hours when demand is at its highest. SEC is thus launching a tender process for a 25-year agreement to supply 1.2 GW of renewable power generation capacity that will be combined with at least 1.2 GWh of energy storage capacity (using any technological solution) – including a guarantee of 24-hour availability, which in practice requires that operators must sometimes supply electricity to SEC even when the sun is not shining and the wind is not blowing. The pricing in the agreement is also intended to encourage com-panies to supply electricity at peak demand periods based on renewable sources.

Hydropower in both directions Hydroelectric power is extremely competitive, and although it has negative environmental consequences, it is as climate- smart as power generation can be. Good access to hydropow-er, the production of which – unlike wind and solar power – can also be regulated based on electricity demand instead of adjusting production to the vagaries of the weather, also gives countries like Sweden and Norway an advantage in terms of their potential to expand wind and solar power. In practice,

water reservoirs serve as energy storage solutions in the two countries, which they do especially well between peak and off-peak seasons. However, most countries are not blessed with similar natural resources to the same extent but instead need other solutions.

By pumping water back up into reservoirs, known as pumped-storage hydropower, the energy storage potential in a hydropower plant can be further increased. This is an old method and widely used in many places around the world. In the US alone, such facilities have total capacity of 22 GW, generate 23 GWh annually and consume 29 GWh, but they are paid much more for the 23 GWh they sell than they pay for the 29 GWh they use.

The US utility Duke Energy is currently expanding its capacity by 300 MW at one of its hydropower plants by means of en-ergy storage pumps. It is adding another tunnel through which water can be pumped from Lake Jocassee, South Carolina up into a reservoir located on a nearby mountain and then released again when electricity demand increases. The facility, whose expansion will be completed in 2023, supplements Duke Energy’s growing solar and wind power assets. The company plans to expand its total renewable power generation assets by 2.6 GW during the period 2016-2020, which will increase its energy storage needs.

Many large pump projects are being planned around the world, but in China alone it is reported that more than 30 facil-ities with 1,000 MW of capacity or more are under construc-tion. According to the State Grid Corporation of China, the Fengning Pumped Storage Power Station will be the world’s largest facility of its kind, with 3.6 GW of capacity when com-pleted in 2021.

Summary and conclusion We see very good potential for strong growth in energy storage and related solutions for many years to come. This is being driven by the need for cleaner power sources combined with stable and reliable access to electricity for users, as well as by the electrification of the transport sector, which is continuing at a rapid pace. However, there are many differ-ent solutions to meet the need for energy storage, and the rapid growth in large and gigantic batteries poses significant challenges. Energy storage solutions should also enable the next big step in the growth of wind and solar power and thus become a crucial component in the coming transformation of energy systems around the world. Given growth and changes of the magnitude we foresee, there will clearly also be sub-stantial investment opportunities.

23Investment Outlook: Maj 2019

Sustainability. Once the rallying cry of dedicated eco-activists, it has become a word, a debate and a set of issues that no one can avoid. In public discourse, we hear the views of everyone from a former US vice president to countless scientists and dedicated young people. Knowing what are truths or opinions is difficult in many cases. How big the problems are, what needs to be done and how to do it are questions with no simple answers. But the great majority realise that things must be done to ensure sustainability.

Your investments make a difference

Every day we encounter such expressions as “climate- smart”, “source separation” and “flight shame”. How big the problems are, what needs to be done and how to do it are questions with no simple answers. But the great majority of people – and definitely SEB as a bank – real-ise that things must be done to ensure that we and future generations can live in a sustainable world.

We can all contribute. We all need to take a stand on such questions as how we travel, what we eat and how we dispose of our waste. But equally important is to think about how our capital is invested. Taking the train instead of flying is good, but meanwhile providing capital – di-rectly via equities and corporate bonds, or indirectly via mutual funds – to environmentally unfriendly companies obviously counters the effect of such actions. Many of us can make an even bigger contribution to long-term sustainability by ensuring that our savings end up where they are the most beneficial.

Two questions immediately arise here: How do we achieve this? What effect will it have on our financial returns? There is no simple or exact answer to either question, although the one about returns is somewhat easier to address. But let’s begin with the harder question of “how”.

If we look at such professional investors as mutual fund managers, pension funds and foundations, it is clear that their methods for sustainable investing vary – but also that they have evolved over time. These issues have been on the table since the 1970s, but they began to attract broader attention about a decade ago – often in connection with equity investments and under the label

Theme: Impact investing

Doing good while making money


of socially responsible investing (SRI). This was a matter of excluding companies from a given portfolio: producers of undesirable products like tobacco, chemical weapons or fossil fuels and companies criticised for their operating methods or for violating international conventions. The latter are usually grouped under such concepts as corporate social responsi-bility (CSR) and environmental, social and governance (ESG) issues. It is important to note that for many investors today, ESG analysis is an integral part of the investment process: they take potential ESG risks into account when evaluating a stock as an investment.

Exclusion: A matter of conscience Many use exclusion as the basis for their sustainable invest-ments, but there is an occasionally lively debate about the benefits of exclusion. Often the objection is that the world will not become a better place because we choose to avoid com-panies with dubious operations, but that instead it is prefera-ble to try to influence them in a positive direction by becoming involved and putting pressure on them.

Exclusion as a phenomenon also poses challenges. Let’s take an example. Swedish snuff (“snus”) and e-cigarettes are addictive products with certain unhealthy side effects. There may reason to eliminate manufacturers of these products from a portfolio. But many smokers switch to snus or e-cigarettes (“vaping”), thereby reducing the number of lung cancer deaths. This is undoubtedly a positive effect, which we might want to encour-age. So how should investors treat a company that makes snus or vaping products? There is no obvious answer.

Yet for most of us, exclusion is relevant to some extent. Ban-ning some types of companies from a portfolio can be viewed as taking an ethical position, often connected to personal preferences. Many of us have opinions about what business-es we cannot imagine participating in at all via ownership, regardless of the debate on the benefits of exclusion.

Now that the exclusion approach has become widespread, more and more investors are now talking about inclusion – focusing on actively choosing companies that are viewed as making positive contributions. This, too, can be done in different ways, with different approaches, often depending on their purpose. Many investments of this kind fall within the concept of “impact investments”, which the rest of this theme article will explore.

Letting capital have an impact Impact investing is a relatively new investment field. The largest organisation in this field, the Global Impact Investment Network (GIIN), was established only 10 years ago (and is the source of the facts in this article unless otherwise stated). GIIN defines impact investments as “investments made with the intention to generate positive, measurable social and en-vironmental impact alongside a financial return”. They mainly involve supporting social projects aimed at improving the lives of vulnerable groups in society and funding projects that actively impact our environment in a positive direction. Two

clear examples are microfinance funds – which supply invest-ment capital to small-scale entrepreneurs in emerging market economies – and green bonds, which earmark capital for vari-ous environmental projects. We regard impact investments as the most proactive form of inclusion. They make up one of the fastest growing branches of the sustainable investment tree.

Impact investing is growing and evolving Impact investing not only supplements previously used methods of sustainable investing but also contributes a new and necessary source of funding in order to address the major challenges of today. There have of course been investments in these fields for many years, initially funded by the public sector. But in recent years, escalating problems combined with stretched government finances (and a lack of interest by some governments) have made it increasingly obvious that public sector initiatives are not enough to address the existing chal-lenges. Partly as a result of this, interest in philanthropic efforts in this field has increased over the past few years. Philanthropy is a matter of giving away capital, either via organisations or to specific projects. This trend is clearest in the US, where many people separate “doing good” from making financial invest-ments. The aim of their investments is more or less to merely optimise their returns, then give away a proportion of the profit for important causes (Warren Buffett and Bill Gates are per-haps the best known such philanthropists). Of course philan-thropy is praiseworthy. But as an alternative, impact investing is now rapidly growing – especially in Europe. The obvious difference between philanthropy and impact investing is that the latter expects a return on capital. Impact investing thus implies combining two wishes: returns and impact. A logical consequence is that the return requirement posed by impact investors increases the importance of ensuring that these investments are sound and generate both a positive impact and good financial returns, something that suggests that these investments are more likely to be effective.

The impact investment market is growing rapidly, but since this is a relatively new phenomenon it is unclear, far-flung and difficult to quantify and measure. The definition of what it in-cludes is also changing. The original definition – investments in projects that would otherwise not have been initiated – is still used by many investors in public discourse. Here we are taking a broader approach and also include existing invest-ments that have a positive impact.

The total invested amount is estimated at more than USD 500 billion. By way of comparison, roughly 25 per cent of the USD 13 trillion managed by professional investors takes sustainability into account in some way. Impact investments were initially concentrated in the private equity field – and for natural reasons this is still the largest source of such investments. Other major investment fields are infrastructure, listed shares and private debt. In the latter field, green bonds have been joined by blue bonds (to save the seas) and social impact bonds, which typically address the concrete needs of a specified vulnerable group in society, for example solving the housing situation of young homeless people.

Theme: Impact investing – Doing good while making money


New taxonomy a source of guidance The growth of impact investing is being driven largely by market forces. Many people are calling for an expansion of this type of investments, but the public sector is also taking steps in the same direction. Perhaps the most highly publi-cised example is the Paris Agreement on climate change and its 2 degree target, along with the discussion about emission rights and carbon dioxide taxes. The ambition is to actively steer capital investments in the right direction with the aid of commonly accepted problem definitions and goal formula-tions. One clear example is the recently launched European Union proposal for a common classification system (taxon-omy), aimed at creating tools for financial investors to help achieve the Paris climate target. This taxonomy would lay a foundation to enable investors to define what companies car-ry out operations that make it harder to achieve the target (so they can be excluded) and what companies benefit efforts to achieve the Paris target. The next step is the EU’s plan to include sustainability targets in addition to the carbon dioxide challenge, thereby including more companies in the classifi-cation system. This is undoubtedly an ambitious approach, which shows the importance of interaction between public authorities and market forces. Having this type of guiding principles makes it easier for the market and for us investors to know where to put our money and to measure how suc-cessful our investments are.

The most widely used guiding principles for investors in this field are the Sustainable Development Goals (SDGs) adopted by the United Nations (see below). The UN has identified 17

areas that are vital in creating a sustainable world, and 75 per cent of impact investors say they will follow these goals or take them into account in their investments. Both the UN goals and the EU taxonomy not only help us define and under-stand the existing needs and the market, but are also tools for creating measurability. The ability to measure social and environmental effects, as well as financial returns, is crucial in evaluating impact investments and justifying continued growth in this field.

With sustainability as a starting point Unlike investing by means of exclusions, sustainability issues rather than profitability drive the investment process and di-rectly determine what to invest in, but profitability and valua-tion issues are also important since investors expect a return. In our opinion, there are many indications that “impact” may become the third dimension of capital investments – along-side “risk” and “return”.

One aspect of impact investing worth discussing is this: In what phase of a company’s development do we provide the greatest benefit as investors? One spontaneous thought is to invest in companies that are already delivering products and solutions that contribute to a sustainable world. This is fine, of course, but we could meanwhile argue that the impact may not be as large. These companies have already completed their transformation. Perhaps the impact would be greater if we chose to invest in companies that have just begun their transformation. In concrete terms, this may be a choice between investing in a company that already produces


The UN’s Sustainable Development Goals serve as guiding principles for investors

Source: United Nations



renewable energy such as wind power or an oil refinery that is transforming its operations from fossil fuels to renewables. The answer is perhaps not “either-or” but “both”.

Returning to the second question at the beginning of this article: What effect will this type of investments have on our financial returns? There are no easy answers. Financial theory tells us that if we limit our investable universe, we also limit our potential returns in relation to the risks we take. Fewer than half of today’s impact investors also state that their return requirements are below what can be expected from the market as a whole. A majority thus expect returns in line with the alternatives, or better. What, then, is the story? There is an old “truth” about sustainable investments: that they occur at the expense of returns. We believe it is time to kill off that myth. Of course any kind of divergences from an index – for example due to exclusions – may lead to portfolio underperformance during some periods, since excluded companies may perform well during a given period (oil company share prices may rise during periods of rising oil prices). But most research on the financial effects of traditional sustainable investments shows that over time, there is no proof that sustainable investments underperform traditional investments. Instead, the contrary is true. One major study* that aggregates the findings of 2,000 different analyses on this topic concludes that 90 per cent of them show that sustainable investments generate equally good or better returns than traditional investments.

In our assessment, over time both traditional sustainable investing and impact investing can generate returns as good as investment alternatives that have no such focus. There are

also many indications that their long-term potential is better, especially in the case of impact investing. Impact investments will not provide the best returns during all periods (no single type of investment will). For example, it is conceivable that equities excluded from many portfolios may become so cheap that those who buy them can earn a good return, at least in the short term. And of course there is a risk that impact investments will become so popular that their valuations will become very high, limiting their short-term potential – a classic supply and demand issue.

One way of thinking about impact investments and their potential returns is to ask ourselves the following questions: If you were forced to choose today – and given the trends we are seeing in society – would you prefer to invest long-term in the shares of a company that extracts fossil fuels or one that develops renewable energy sources? Which company has the higher long-term potential? And which one would it feel best to be earning money from?

There is no exact answer to the question of how best to contribute to a sustainable world through our investments. But there is no doubt that we can all contribute in the right direction by thinking about these issues and choosing invest-ments according to what feels best, both from a return and an impact perspective.

Different ways of exercising influence via impact investments

Investing in a company with a high ESG awareness and with products that have a positive impact (Company A) is of course positive. But perhaps an investment in a company undergoing a transformation to a better form of impact (Company B) is more beneficial. An impact investment fund often chooses to put money in both.

Source: SEB

* Journal of Sustainable Finance: Gunnar Friede, Timo Busch& Alexander Bassen. “ESG and Financial performance: Aggregated evidence from 2000 empirical studies.”


Contributors to this issue of Investment Outlook

This report was published on September 10, 2019. Its contents are based on analysis and information available until September 9, 2019.

Fredrik Öberg Chief Investment Officer Investment Strategy [email protected]

Johan Hagbarth Economist Investment Strategy [email protected]

Kai Svensson Portfolio Manager Investment Strategy [email protected]

Esbjörn Lundevall Equity Analyst Investment Strategy [email protected]

Louise Lundberg Economist Investment Strategy [email protected]

Henrik Larsson Portfolio Manager Investment Strategy [email protected]

Pernilla Busch Investment Communication Mgr Investment Strategy [email protected]

Cecilia Kohonen Investment Communication Mgr Investment Strategy [email protected]

This document produced by SEB contains general marketing information about its investment products. SEB is the global brand name of Skandinaviska Enskilda Banken AB (publ) and its subsidiaries and branches. Neither the material nor the products described herein are intended for distribution or sale in the United States of America or to persons resident in the United States of America, so-called US persons, and any such distribution may be unlawful. Although the content is based on sources judged to be reliable, SEB will not be liable for any omissions or inaccuracies, or for any loss whatsoever which arises from reliance on it. If investment research is referred to, you should if possible read the full report and the disclo-sures contained within it, or read the disclosures relating to specific companies found on www.seb.se/mb/disclaimers. Information relating to taxes may become outdated and may not fit your individual circumstances. Investment products produce a return linked to risk. Their value may fall as well as rise, and historic returns are no guarantee of future returns; in some cases, losses can exceed the initial amount invested. Where either the underlying funds or you invest in funds or securities denominated in a foreign currency, changes in exchange rates can impact the return. You alone are responsible for your investment decisions and you should always obtain detailed information before taking them. For more informa-tion please see inter alia the Key Investor Information Document for funds and the information brochure for funds and for structured products, available at www.seb.se. If necessary, you should seek advice tailored to your individual circumstanc-es from your SEB advisor.

Information about taxation: As a customer of our International Private Banking offices in Luxembourg and Singapore you are obliged to keep yourself informed of the tax rules applicable in the countries of your citizenship, residence or domicile with respect to bank accounts and financial transactions. You must yourself provide concerned authorities with informa-tion as and when required.

Investment StrategySEBSE-106 40 Stockholm, Sweden

Contact information

Stefan Cederberg Equity Analyst Investment Strategy [email protected]

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