For a long time, one of the most dynamic economies in Europe, Sweden, is now struggling. The sharp rise in interest rates on the domestic market and the main export markets for Swedish products are at issue. This will temper our enthusiasm for Swedish assets.
A challenging economic environment
Like the rest of the European Union, Sweden is facing a marked deterioration in the economic situation and should not avoid a recession in 2023. In the third quarter, growth slowed to 2.6%, and the domestic market suffered, with an annual contraction of 5.9% in retail sales. Traditionally, the country has three engines of growth: private demand, investment, and exports. All three are threatened.
Inflation and rising interest rates undermine households' purchasing power and ability to spend and invest. And when demand cools, companies find little reason to invest more. This rather gloomy horizon is not limited to the internal market. Several major export markets for Swedish products (the rest of the EU, USA, Asia, etc.) are also struggling, and exports will suffer. As a result, the economy will experience a recession in 2023.
For the Riksbank, the challenge is daunting. A cheap crown has long been one of the cornerstones of the country’s competitiveness. But when the American dollar is soaring and the price of raw materials, the weakness of the Swedish krona makes imported products more expensive and promotes inflation, which reached 10.8% in September. A much faster increase than wages (expected at +2.8% in 2022) undermines households’ purchasing power.
The Riksbank, therefore, has no choice but to tighten its interest rates sharply, having raised its key policy rate by 1.0% in September to 1.75%. But in a country where household debt is very high (their debt is approaching 200% of GDP, one of the highest levels in the world), this carries a definite risk for the economy.
Real estate as a cash machine
If the Swedes are highly indebted, access to credit and the real estate market have experienced an enormous boom in recent decades. Thanks to easy access and cheap credit, the country has experienced a prolonged rise in real estate prices, which has enabled households to finance their lifestyle. Many regularly refinance the mortgage to take advantage of the increase in their property(s) to borrow ever higher amounts, close to 85% of the property's value, a ceiling imposed by the regulator.
Des crédits qui soutiennent l’investissement mais également la consommation. Or, selon les prévisions de la Riksbank, la chute de la valeur de l’immobilier pourrait attendre 15% face aux prix pratiqués au 3ème trimestre de 2021. Quelques 45% des prêts octroyés crèveront alors le plafond préconisé par les autorités. Autant de ménages qui risquent d’avoir bien du mal à refinancer leur crédit.
Another Swedish phenomenon is the prevalence of variable-rate loans, which are by far the majority in the country. And even when loans are fixed, they are only set for a limited period. More than 80% of mortgages are exposed to rising interest rates in the next two years, which suggests difficulties for many households. This raises fears of a sharp decline in consumption that will inevitably impact the economy.
On the other hand, the rate hikes promoted by the Riksbank are faster passed on to the economy and directly impact the Swedes' ability to spend, not only disadvantages. Since the Swedish economy will react more quickly than others to more expensive credit, Riksbank should be able to end the cycle of interest rate hikes faster than others as the goal of slowing demand and preventing price overheating will be achieved faster.
Taste for risk to the aid of the economy
Although the economic situation is expected to be difficult, Sweden is not without its advantages. Numerous examples of the innovative spirit in vogue for a pair of decades. Skype or Zettle was taken over by the American giants Microsoft and Paypal, respectively. Today, in constant evolution, Klarna, Hexagon, Spotify and Most vital are among the strongest names of Swedish tech.
Only Hexagon is listed in Stockholm, which explains why the information technology sector accounts for only about 9% of MSCI Sweden. But the role of this technology boom in Swedish society is essential. Their emergence makes young Swedes dream, many of whom dream of becoming entrepreneurs in this field. This shows a taste for risk-taking and creates a rare ecosystem in Europe. Of course, higher interest rates make the current situation more complex: it is easier to innovate and invest when credit is cheap, and savings do not yield much than when interest rates "risk-free" are higher. The technology sector is therefore experiencing difficult days, like the American Nasdaq.
But the ecosystem that has enabled the development of so many companies continues to exist, as does the capacity for innovation made possible by a highly skilled workforce. The potential of this sector remains significant, and this capacity for innovation remains one of the reasons why we remain invested in the Swedish equity market.
The bond is to be addressed too. The Swedish 10-year-old is trading at just over 2.1% at this stage, a level barely above that of its German counterpart. But Sweden's financial position is enviable when the economic crisis looms, and countries are tempted to let go of their debt to help people and businesses. With its limited public debt (33.4% of GDP in Q2 2022), Sweden is one of the good pupils of the EU in terms of public finances.
In addition, since the country does not belong to the Eurozone, it should not be called upon to contribute in the event of a new sovereign debt crisis, and its State bond should not be subject to possible shocks. To this is added a currency that is still cheap. Therefore, Swedish debt has every chance to continue honouring its AAA rating and remains a good diversification for balanced or defensive portfolios.