In Sweden, the economic engines of recent decades have been undermined by the soaring cost of credit and falling housing prices. Will the country be able to reinvent itself, diversifying the sources of growth?
The answer is yes. Our belief relies primarily upon its companies remaining very competitive. But this will only happen with breaks; the risks are higher than before.
Households in bad shape
In Sweden, rising interest rates mark the end of an era. Real estate - whose prices tripled between 2006 and the peak in early 2022 - has been the cornerstone of the household wealth effect for several decades. And credit was very abundant and very cheap.
Until 2015, households had access to mortgages with no principal repayment, on which they only paid interest on the debt. And since interest rates were meagre, it looked like free money. So naturally, households have benefited, with this type of mortgage reaching 70% of total loans in 2015.
Financing its housing in this way, but also its way of life, has met with particular success, pushing household debt to one of the highest levels in the world, at more than 200% of disposable income.
The variable rate that hurts
However, almost all of this credit is done at a variable rate or with a brief period of fixed rate followed by a variable rate. According to the Swedish Riksbank (central bank), over 80% of loans have a fixed rate of 2 years or less. This means that households are quickly exposed to market conditions. And with such a high level of debt and rising interest rates (mortgages currently have an interest rate of about 3.5%), the debt burden explodes.
This makes the real estate market difficult. The most vulnerable households are driven to separate from their property, and potential buyers face significantly less attractive credit conditions than in the past.
Residential real estate prices have fallen by 12% since their peak in 2022 and could fall by as much as 20%-25% before finding a new balance later in the year.
Much will depend on inflation and how far the Riksbank will have to go to control it. There is no doubt that Swedish demand is falling sharply. In February, retail sales fell by 9.4% compared to February 2022. Investment fell in the fourth quarter, as did GDP, which lost 0.9% year-on-year compared to the quarter.
However, despite this sluggish demand, inflation remains very high. It reached 9.7% for February, a figure higher than those recorded in the eurozone (8.5%) or the United States, and fell to 8,5% in March, still higher than expected in the eurozone. The cheap Swedish krona has a lot to do with this, as it makes imported products more expensive.
The Riksbank should therefore review its crucial interest rates one last time, at 3.25%, despite the risks for the economy, the real estate sector and the fears weighing on the banking sector, both in Europe and the United States.
Life beyond the real estate
As we can see, the risks to the Swedish economy (particularly its domestic market) have increased, and the country will hardly avoid a recession.
However, there is a need to put things in perspective as, given the significant challenges facing the Swedish economy, it shows strong resilience. If activity retreats, we are far from the precipitous decline announced with a 0.9% decline in GDP. After the substantial decline of the last months, the PMI indices show the activity in contraction, yes, but not deep, especially for services which reach 48.6 points for the month of March.
As for the fall in retail sales (which mainly measures the sale of goods), it says more about the fact that Swedes change their consumption habits than their spending. Indeed, these are increasingly focused on services (+27% spent on restaurants and cafes in February compared to February 2022), so that, taken as a whole, household spending grew by 1% year-on-year—an increase in expenditures made possible by the fact that the labour market remains in shape. At 7.4% in February, according to Eurostat, the unemployment rate remains relatively subdued, and the employment rate has even slightly improved.
This is an economy that is stabilising and that, after a challenging 2023 year, could well recover.
The corporate asset
The strength of the Swedish economy remains in its enterprises. Fortunately for the country, recent decades' ultra-expansionary credit conditions have not only boosted the real estate market. Combined with a highly skilled workforce, a focus on new technologies, and some Swedish success stories that have inspired a generation of young entrepreneurs, they have helped create a unique ecosystem in Sweden and to make it one of the European leaders in fields such as fintech (Klarna), streaming (Spotify), 5G (Ericsson) or batteries (Northvolt). More generally, all Swedish companies benefit from this technological know-how to reinvent themselves and become globally competitive.
While the deliberate choice by the authorities to keep the Swedish krona at low levels hurts inflation, it is a boon for Swedish exporters, whose competitiveness it strengthens. In annual terms, Sweden has not had a current account deficit for a quarter of a century. Therefore, companies benefit naturally and do better than the Swedish economy. The gain in the Stockholm market since the beginning of the year is now only 4.8% (in €) and 7.4% in local currency.
Given the heightened risks to this economy, we broke away from Swedish equities a few months ago as part of the defensive portfolios. On the other hand, for the different portfolios, the intense competitiveness of Swedish companies will come back in evidence, and this market remains attractive for the medium and long term. We are, therefore, still buying on the Stockholm Stock Exchange and Swedish bonds. For the neutral portfolio, 5% equities and 5% bonds.
