iShares MSCI Sweden ETF: not at this stage (NYSEARCA: EWD)
Prices change when events are different from what the market expected them to be. -Peter Bernstein
As noted in last week’s “Leaders-Laggards” section of the Lead-Lag report, international equities haven’t quite been able to gain any meaningful traction on US equities. In international equities, the European region in particular has proven to be difficult ground this year, with the iShares Core MSCI Europe ETF (EUR) generating negative returns of 18%. If you thought that was bad enough, how about the iShares MSCI Sweden Capped ETF (NYSEARCA:EWD) which focuses on 47 Swedish stocks, which fared much worse, giving up a quarter of their market capitalization on a YTD basis.
Given the correction we saw this year, should you consider EWD?
Well, to be honest, I don’t think now is the best time to look at Swedish equities. Large parts of the country are in the throes of election fever, with the main event set to begin next month. Historically, equities rarely tend to provide stable returns when a country is in the midst of election fever. I could understand getting on board if the polls suggested a certain party was on track to win the election, but that doesn’t seem to be the case in Sweden, as there isn’t a huge amount of choice between warring parties .
Admittedly, the Social Democrats (S) have managed to gain ground from the previous poll in November 2018, but reports from Sweden suggest there is still no clear coalition that could claim a majority. With an ambiguous political environment like this, expect Swedish stocks to be crippled by increased volatility.
Just to reiterate my point, also note how the standard deviation of EWD has increased over the past few months and is currently at a rather high 27.56%.
Additionally, as discussed in the “Final Thoughts” section of last week’s edition of the Lead-Lag Report, the China/Taiwan rumbles have the potential to upend the volatility quotient in global markets and get you stuck at a high beta play such as EWD (1.24x beta) is not the most sensible strategy at this point. Alternatively, if you want to better understand some of the broader risks that could arise from recent China-related tensions, you might consider listening to my conversation with Michael Pettis.
The other major theme to consider is EWD’s heavy exposure to industrials, which make up nearly 40% of total holdings. I mentioned the European energy crisis in some articles of the Lead-Lag report, and Sweden is another European country that has had to deal with this unsavory situation. Swedish manufacturers in particular had to take it on their backs because it completely upset their operating cost bases. Consider the trajectory of producer prices which are currently rising at record highs of 25% on an annual basis, and much of this is due to pressure in the energy-related products segment, which is up 82% in June.
It’s not just about energy. China-related lockdowns have also wreaked havoc on the supply chain, and these manufacturers are hardly best placed to pass on all those costs as consumer inflation in the country hits its highest level since the late 1980s. In such an environment, it is not surprising to find that consumer confidence in Sweden has fallen to its lowest level in almost three decades.
By extending the net beyond industrialists and consumers, it’s not like the economy as a whole is expected to do well. While GDP growth in Q2 stood at 4.2% and was higher than the 0.4% growth seen in Q1, the periods ahead will see a dramatic slowdown. The government expects only 1.9% growth for the fiscal year, meaning the second half is likely to be much slower than the 2.3% growth seen in the first half. The slowdown isn’t likely to end there, as growth in FY23 will likely be even weaker at just 1.1%.
Despite EWD’s steep decline this year relative to its European compatriots, the valuation hasn’t improved much. EWD is still trading an expensive forward P/E of 15x, which represents a premium of around 27% to the corresponding multiple of IEUR. Given some of the other risks I’ve covered in this article, it would probably make sense to sit on the fence at this point.
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