Investment Outlook February 2020 - SEB Group · Summary by asset class helped push valuations and risk appetite to historically high levels, which is currently dissuading us from

Investment Outlook

February 2020

2Investment Outlook: February 2020

02 Contents

03 Introduction If growth holds, the stock market will hold

04 Summary by asset class

05 Risk exposure and allocation We have a neutral view of the stock market

06 Macro and other driving forces Slightly better growth, continued political uncertainty

09 Fixed income investments Searching for returns in the high risk segment

11 Global equities Low yields + reasonable growth = high valuations

13 Nordic equities High valuations limit upside potential

17 Theme: Clean water shortages – A challenge

22 Theme: Digitisation – A powerful megatrend

28 Theme: BoJo, Brexit and the pound in 2020

30 Contact information

Contents


• Growth is stabilising, at lower levels.

• Monetary policy U-turn – the low interest rate environment will persist.

• Weak earnings increases and rising stock markets will make high share valuations challenging.

• The focus on sustainability and strong megatrends are among the reasons for our cautiously optimistic stock market view.

Introduction If growth holds, stock markets will hold

The decade that just ended was dominated by economic growth and rising share prices. The stock market’s performance in 2019 stands out as among the best for a long time. Meanwhile growth slowed perceptibly. This was reflected in corporate earnings that did not climb by 10 per cent, as expected early in the year, but instead probably shrank slightly at the global level.

We are thus starting 2020 and the new decade with a mature economic cycle − which implies modest growth − and with share valuations at peak levels exceeded in modern times only by the stock market bubble around the turn of the millennium.

This is perhaps a frightening picture, but there are many indications that equities may defy what may appear to be the law of gravity for another while. Late in 2019 we saw signals that deceleration has stopped, or even turned into mild recovery. Recession risks have thus eased and we expect growth that should justify at least some earnings increases for listed companies.

Last year’s U-turn by central banks, especially the US Federal Reserve, clearly shows that fears of sharply rising interest rates will not be realised in the foreseeable future. Aside from supporting growth, low interest rates and bond yields also justify higher share valuations, especially if economic growth forecasts are correct.

It is thus justifiable that today’s valuations are at or near earlier peaks. Since the alternatives − typically fixed income investments − cannot reasonably provide a return worthy of the name, higher valuations and thus continued stock market upturns may very well be accepted by the investor community.

Given today’s upturn potential from stabilised growth and continued low rates and yields, but downside risks due to stretched valuations and subdued earnings growth, we are choosing a neutral allocation among asset classes and neutral risk exposure in our portfolios.

But market upturns increase the risks of setbacks. Meanwhile the potential for continued share price increases – at least broad-based ones – is limited. Of the three theme articles in this issue, two deal with areas where growth can be expected regardless of which way the economy moves. First, and perhaps most important, is an indispensable part of sustainability efforts − access to an increasingly scarce resource: clean water. We also explore two aspects of the continuing digitisation megatrend: the potential of robotisation and the role of cybersecurity. Our third theme article concerns one of the most important political processes in modern Europe: Brexit.

As usual, we can expect the unexpected during 2020, with occasional dramatic fluctuations in financial markets. Our continuing ambition is to keep an ear to the ground and be aware of market-moving events, while identifying and creating investment opportunities based on the megatrends that will change our world and drive long-term economic growth.

Wishing you enjoyable reading,

Kai Svensson, Acting Chief Investment OfficerJohan Hagbarth, EconomistInvestment Strategy


Nordic equites

• High valuations will increase the risk of setbacks.• Continued large discounts on cyclical shares.• The sustainability trend is continuing and growing in

strength.

Return expectations, %, next 12 months (SEK)

Equities Return Risk

Advanced economies 7.0% 14.4%

Emerging markets (local currencies)

7.7% 14.1%

Sweden 8.0% 14.4%

Fixed income investments Return Risk

Government bonds -0.5% 1.4%

Corporate bonds, investment grade (Europe, IG)

1.9% 3.3%

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

2.6% 4.3%

Emerging market debt (local currencies, EMD)

6.1% 8.4%

Alternative investments Return Risk

Hedge funds 3.5% 6.0%Source: SEB, forecasts January 2020

Fixed income investments

• As expected, Sweden’s Riksbank raised its key interest rate while the US Federal Reserve paused after three rate cuts.

• A more positive cyclical outlook and low government bond yields will boost demand for corporate bonds.

• High yield corporate bonds are preferable to government and investment grade corporate bonds, given low abso-lute return levels.

• Despite several interest rate cuts, bond yields in a num-ber of emerging market countries are significantly higher than in developed markets, making good current returns possible.

Alternative investments

• Clear equity, fixed income and foreign exchange mar-ket tendencies will provide support for trend-following hedge fund strategies.

• Strong stock markets will create good potential for equi-ty long/short hedge funds.

• Predictable central banks and high risk appetite will create opportunities for macro fund managers.

• Positive performance for underlying asset classes has contributed to positive absolute returns for a majority of hedge fund managers.

During the past quarter, financial data were released show-ing continued weakness in manufacturing, but the consumer sector was consistently strong thanks to high employment, reasonable pay increases and low interest rates. We have wit-nessed certain signs that manufacturing activity is bottoming out, among other things via sub-components of purchasing managers’ indices (PMIs). Investors have picked up on the bright spots, and we have seen an essentially unbroken posi-tive stock market trend over the past quarter.

However, corporate earnings forecasts for the fourth quarter continued to be revised downward, and we expect stagnant full-year 2019 earnings. In 2020, earnings are projected to increase by more than 9 per cent according to aggregated consensus forecasts. We expect them to be only around 5 per cent, since we believe that global GDP growth will be somewhat lower this year than in 2019. Because of upbeat comparative figures and rebounding industrial activity as well as adjusted cost structures, our assessment is that earnings growth will still be positive.

Declining political risks, including a solution to the Brexit issue and the signing of an initial US-Chinese trade agreement, have

Global equities

• 2019 was the best stock market year of the decade, despite the marginal change in earnings.

• The global tech sector gained 45 per cent in local curren-cies.

• In 2020, earnings are projected to increase by more than 9 per cent according to aggregated consensus forecasts. We believe they will be lower: about 5 per cent.

• High valuations will limit potential returns.

Summary by asset class

helped push valuations and risk appetite to historically high levels, which is currently dissuading us from increasing the risk level in our portfolios.

In the global stock market, 2019 was a year dominated by technology giants. The global tech sector gained 45 per cent in local currencies, or 20 per cent more than the second best sector. Apple stood out – its share price surged by 86 per cent! Of major stock markets, the US performed the strong-est, but other stock markets showed solid returns as well. Bond investors also experienced a strong year. Interest rates and bond yields fell while credit spreads shrank, providing healthy returns.

However, the above-trend valuations we are currently witnessing are not entirely favourable, since in practice they imply that we are stealing returns from the future. We thus do not expect the same steep increases in valuations this year, but instead must probably be content with a share price trend consistent with the earnings increases for equities. In fixed income investments, we expect a return in line with underly-ing yields.


During 2019 a portfolio of equity, fixed income and alternative investments showed strong returns. Central banks, led by the US Federal Reserve, fuelled performance via key interest rate cuts and liquidity support − helping sustain risk assets. An initial US-Chinese trade agreement is in place and a soft Brexit is under way. Leading indicators point to a slowdown ahead, which stock markets already expect. The economic playing field is a bit clearer than a few months ago, but pricing is higher.

Weak but positive stock market trend in 2020 In line with general economic trends, global earnings were adjusted lower and are expected to show zero growth in 2019. Share valuations have thus climbed, limiting upside potential. Consensus forecasts for 2020 global earnings growth are about 9 per cent, but we expect it to be about 5 per cent: still enough for a mild market upturn.

Fixed income will find it hard to repeat 2019 The central banks' U-turn towards more supportive policies, as well as weak macro data, led to falling long-term yields in 2019, benefiting the bond market. Low returns on government bonds caused investors to seek higher-yielding assets, which benefited corporate bonds. Due to narrower credit spreads between government and corporate bond yields, combined with falling yields, a mixed bond index showed very positive performance. It will be hard to repeat last year’s returns. We expect yields to remain low and credit spreads to stay narrow, but we do not expect further help from the price component.

Allocation between asset classes Late last summer, we shifted to an underweighting of global equities to take profits on the positive currency effect of Swedish krona weakness. After a strong year-end for Swedish equities, the overall proportion of equities in our portfolios has become neutral. Despite high valuations this is a reasonable risk level, since we expect some strengthening of economic conditions and continued low rates and yields.

In Swedish equities, we reduced the proportion of high-value, exchange rate-driven industrials and boosted our holdings in less cyclically sensitive companies that had not seen the same steep price trend. We shifted our international equity exposure from US growth companies towards lower-valued segments such as Asian emerging markets and the small business seg-ment. In fixed income investments, we have an overweight in corporate credits. Continued low default levels, declining reces-sion risk and liquidity support from central banks are helping sustain corporate bonds. In addition, we have a broad alterna-tive investment portfolio that balances risk.

We expect central banks and governments to again succeed in avoiding a recession. Low interest rates and yields are support-ing valuations and adding liquidity, which promotes risk-taking. However, due to high valuations and the so far unconfirmed cyclical turnaround, we prefer neutral risk-taking for the time being.

Risk exposure and allocationWe have a neutral view of the stock market

Corporate bonds benefited from shrinking credit spreads during 2019

The chart shows the differential (credit spread) between government and corporate bond yields.

Source: Bloomberg

Stretched valuations limit upside potential

The chart shows the changes in price-earnings ratios during the past dec-ade for the MSCI All Country World Index of equities in local currencies.

Source: Bloomberg


Last year was marked by downward-revised growth forecasts and occasional outbreaks of market worries that the world economy would be entering a recession. These worries were primarily based on the sharp decline in sentiment indicators from global manufacturing, which in the EU and in Germany reached recession levels. This, in turn, was probably because the expansion period had been so lengthy that some man-ufacturers were approaching their capacity ceiling. Lower sentiment was also driven by sharp US-Chinese trade tensions during the first half of the year.

Economic acceleration Market uncertainty was at its greatest, and the outlook at its darkest, during late summer and autumn 2019. At the time, many people feared that manufacturing would pull the larger service sector into a clear slowdown: a recession. But our main scenario has been that a recession could be avoided. In the latest Nordic Outlook (published in late January 2020), we at SEB instead describe − as we did throughout 2019 − a world economy that is stabilising and where recession will not only be avoided (at least for the next two years), but where we may even see some acceleration in growth next year.

Compared to a year ago, our global GDP growth forecasts are about half a point lower. In 2020 we expect growth of 3.1 per cent (down from 3.5 per cent in our January 2019 forecast). We are now also making a forecast for 2021, when we expect 3.3 percent growth. It is natural for growth to slow late in an economic cycle. This is usually related to the fact that it is harder for companies to boost production when there is a shortage of resources, especially labour. It is often also due to

inflation, and thus interest rates, rising at the end of a cyclical upturn, suppressing investment appetite and consumer de-mand. The result is often a stronger slowdown (read reces-sion) than we predict this time. So what is different?

Strong labour markets and low interest rates help Labour markets have been strong for several years. In major advanced economies, unemployment is at its lowest in almost four decades, far below the levels that have historically led to labour shortages, faster pay increases and thus rising inflation. We believe that there is still some slack in the labour market. Together with the explicit willingness of US authorities to push down unemployment, this is enough to create room for growth in the economy for another while. Along with other forces such as globalisation and automation, it is also sufficient to hold down wage and salary demands and thus inflation. In both cases, this pattern diverges from previous economic cycles.

Another important factor that diverges from earlier periods of expansion is the performance of the fixed income market. This includes low bond yields, partly due to the above-described inflation situation. The long-standing stimulus policies of cen-tral banks, together with such structural factors as increased global savings, have pushed down interest rates and yields to record lows. But another factor was last year’s quick reaction by the US Federal Reserve. The Fed’s three rapid interest rate cuts in the summer and autumn show a very clear willingness to support the economic cycle. This ambition is reasonable, but the fact that it happened so quickly – responding with stimulus even to early signs of slowdown – generated greater confi-dence in growth policy, at least in the short term.

Macro and other market drivers Slightly better growth, continued political uncertainty

GDP forecasts, year-on-year percentage growth

Market 2019 2020 2021 Comments

United States 2.3 1.8 1.9 The tight labour market hurts growth; Fed and consumption help it.

Japan 1.2 0.9 0.6 Demographic headwinds are leading to slow growth.

Germany 0.6 0.7 1.0 The worst is over for hard-pressed manufacturers.

China 6.1 5.7 5.9 Controlled deceleration.

United Kingdom 1.3 1.0 1.1 Brexit uncertainty will continue to hamper growth.

Euro area 1.2 1.1 1.2 Weak exports, but better domestic markets.

Sweden 1.1 1.1 1.7 Sluggish growth despite favourable conditions.

Baltic countries 3.4 2.2 2.5 The deceleration will level off.

OECD 1.7 1.6 1.7 Subdued growth, but no recession.

Emerging markets 4.0 4.2 4.5 Growth is past its low; a sedate recovery is under way.

World, PPP* 3.0 3.1 3.3 Growth is bottoming out; recession risks are decreasing.Source: OECD, IMF, SEB. *Purchasing power parities.


Strong labour markets and continued low interest rates are thus helping to sustain growth, but there is no shortage of worries and risks, including developments in the field of trade and high global indebtedness.

Less impact from trade issues The US-Chinese trade war has left a clear mark on global growth, probably more than both parties wished. The direct effects of the tariffs imposed during this conflict have in themselves been manageable, but uncertainty about global conditions has had a negative impact on both companies' investments and global trade flows. This has hit the world's emerging market (EM) economies extra hard, since they are often more dependentextra hard, since these economies are often more dependent on foreign trade. It is also in these economies that we have seen much of the recent slowdown.

We now expect the impact of trade issues to decrease in the future. This is partly because the US and China do not seem to want to increase uncertainty, especially during a US elec-tion year. The fact that the Chinese economy is decelerating and that many positive trade agreements are being signed, especially among a large number of Asian countries (which account for one third of global GDP) are other factors that suggest a reduction in the impact of trade issues.

Obviously, the increase in debt is not good. But because of low interest rates, the cost of debt (interest payments) is still manageable. The global increase in debt is largely attributa-ble to Chinese state-owned enterprises – with the authorities

now taking steps to deal with this − and to the US corporate sector. US companies appear to have used their borrowing for reasonable purposes, and their rising profitability is improving their repayment capacity. Debts thus do not currently consti-tute any major obstacle to growth.

We expect a tight labour market to contribute to a continued slowdown in the US, but we foresee growth of just below 2 per cent in 2020, compared to just above 2 per cent last year.

In the euro area, economic deceleration was most evident last year. The region’s relatively large dependence on the manu-facturing sector is a contributing factor, especially in Germa-ny. The slowdown in global car sales as a result of a painful and late conversion to more sustainable fuels is another contributing factor. However, we expect stabilisation ahead.

In the important Chinese economy, we expect a continued controlled deceleration, with Beijing prioritising financial sta-bility and debt management over growth, but if deceleration becomes too pronounced, the government has the resources to support growth.

Because of better momentum in other major EM economies such as India, Russia, Brazil and Turkey − which are all leaving domestic growth constraints behind and are benefiting from somewhat stronger global trade − the EM sphere as a whole will contribute to the slight acceleration in global growth that we expect in 2021.

Subdued pay increases, continued low inflation

In spite of tight labour markets, the rate of wage and salary increases remains relatively low. This, in turn, is holding back inflation, especially core inflation (inflation minus fluctuating energy and food prices), leaving plenty of room for central banks to stimulate their economies if needed.

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Source: Macrobond

Confidence in the future of euro area manufacturing has fallen sharply and is close to recession levels. The same applies globally, though to a lesser extent. However, the service sector appears to be resilient, while stabilisation is discernible in manufacturing − driven among other things by brighter world trade prospects.

42.5

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57.5

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62.5

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-10

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-11

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-11

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-12

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-12

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3

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14

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-15

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16

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17

Aug

-17

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-18

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-18

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-19

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-19

Manufacturing sector Service sector CompositeSource: Macrobond

Manufacturing weakness apparent in euro area

Macro and other market drivers

Wages and salaries Core inflation CPI


Macro and other market drivers

Valuations Equity valuations are at historically high levels, partly be-cause low bond yields and interest rates are making other investments unattractive. If low yields and rates persist and we see a lengthy period of decent economic activity, these valuations can still be justified.

Right now the economic outlook is somewhat brighter, since the manufacturing sector and global trade have probably reached their lows, while consumption remains healthy. The valuation parameter will not be a negative factor as long as there is confidence that the economy and corporate earnings are moving in the right direction. However, we do not expect valuations to rise further. Instead they will stay at around their current levels. Credit spreads between government and corporate bonds have also reached levels that are unlikely to shrink much further.

The return that we can expect to receive will thus come from earnings increases on equities and underlying bond yields. We are aware of signals that may shift the trend in the wrong direction, since there is a significant downside in risk asset valuations.

Risk appetite and positioning Risk appetite was healthy last autumn. It accelerated in De-cember and has remained solid in early 2020. Short-term risk indicators have reached extreme levels, suggesting excessive optimism. Investors are searching for growth in all sectors and geographic regions, while phasing out defensive "safe" positions. The IT sector has been especially popular, since it offers both cyclical and structural growth. Money has contin-ued to move from the bond market and cash equivalents into the stock market. Investors have increased their overweight in equities over the past quarter.

The reasoning behind increased risk appetite is the onset of economic recovery, central bank support and reduced political risk. Aggressive positioning among the investor com-munity is generally negative, since the market runs a risk of prematurely assuming an overly bright future. Any setbacks in the economic cycle, trade talks or geopolitics will then hurt risk assets more than usual. Currently, already high risk appetite is one reason why we are refraining from increasing our risk in the short term.


Government bond yields have stabilised a bit above previous troughs but are still historically low. Given the risk of negative expected returns on government bonds, investors must look to riskier fixed income investments to generate returns.

We prefer corporate bonds with higher risk (high yield) over both government bonds and corporate bonds with lower risk (investment grade). Investments in emerging markets are also attractive, since interest rates and yields in many of these countries are still far higher than in developed markets.

Government bonds (excl emerging markets)

A number of the world’s central banks lowered their key inter-est rates in 2019, while Sweden’s Riksbank went against the flow, raising its key rate from -0.25 per cent to 0 in December. Yield movements in short maturities internationally have been modest, while the very shortest-term yields in Sweden moved upward in line with the central bank’s rate hike, bene-fiting Swedish short-term fixed income investors.

The US Federal Reserve (Fed) has taken a breather after three rate cuts. The Fed’s own forecast is that its key rate will remain unchanged at 1.50-1.75 per cent in 2020. Fed officials have clearly indicated that significantly weaker

future prospects are needed for a rate cut in the near term, while substantially higher inflation is needed for rate hikes to resume. The market has adjusted to the Fed’s communication in the short term, but still expects one cut in late 2020. Our forecast is that inflation will remain below target, which will probably lead the Fed to lower its rate again to 1.25-1.50 per cent this September.

Like the Fed, the European Central Bank (ECB) and the Riks-bank have signalled that their key rates will probably remain unchanged over the next couple of years. The ECB has com-municated more clearly that its room for manoeuvre in the form of additional monetary stimulus measures is starting to become constrained. Central banks continue to struggle with below-target inflation. Combined with still-fragile economic growth, short-term interest rates should remain low. Since our inflation forecast is much lower than the Riksbank’s, there is a greater likelihood of rate cuts than of new steps towards interest rate normalisation (rate hikes).

Fixed income investments have historically served as a haven from equities in uncertain times, when investors look for safer assets. This is now more difficult, given low or negative expected government bond yields. Swedish government bond yields correlate with the long-term yield trend, and periodic declines in bond yields have benefited returns. To capitalise on these periodic yield declines, investors need good tim-ing, which is a challenge for return potential in an ultra-low interest rate environment. Investors who want better return potential from the fixed income market must therefore shift to instruments with a higher risk.

Fixed income investmentsSearching for returns in the high risk segment

The market believes the Fed will deliver another rate cut this September, which will contribute to a temporary downturn in 10-year US government bond yields. Yields will then probably move upward to just above 2 per cent.

Source: Macrobond

Forecasts for 10-year government bond yields

Market Feb 2020 Feb 2021 Feb 2022

United States 1.50 1.50 2.00

Germany -0.50 -0.40 0.00

Sweden -0.05 0.15 0.55 Source: SEB, market data January 2020

Government bond yields have stabilised at higher levels but remain low


Corporate bonds – investment grade (IG) and high yield (HY) A somewhat more positive economic outlook and low gov-ernment bond yields have benefited the credit market, where corporate bonds with lower credit quality (high yield, HY) have performed somewhat better than corporate bonds with better credit quality (investment grade, IG). In 2019, corporate bonds benefited from narrower yield gaps (credit spreads) between corporate and government bonds and from falling government bond yields. Because of the low interest rate en-vironment, investors are shifting their sights from government bonds and mortgage-backed securities to corporate bonds in order to generate higher returns.

ECB bond purchases and Fed liquidity support are other factors that benefit the credit market, given lower corporate funding costs. However, the effects will not be as great as with previ-ous central bank asset purchases. Many companies have also taken the opportunity to extend the maturity of bonds already issued and lower their interest expenses during this lengthy period of low interest rates.

The future economic growth trend is critical to the credit market and to some degree will determine the default rate on corporate bonds. Assuming continued stable economic growth, corporate profitability will keep default risk relatively low. The improved macro picture and supportive monetary policy have led the credit rating agency Moody’s to lower its default risk forecast for US companies with poorer creditworthiness (HY).

However in Europe, the risk forecast has been raised due to weaker economic prospects and declining credit quality. From a historical perspective, there are still very few defaults, both actual and forecast. Companies continue to benefit from less stringent bond terms, which have become increasingly stand-ard in recent years – quite simply, there are fewer bond terms that can force a default.

We believe both high yield and investment grade corporate bonds will generate better returns than government bonds, al-though corporate bond valuations are not attractive, especially if yields are not considered in isolation. In our view, valuations are currently somewhat more attractive for HY than IG. HY bonds also offer higher yields and have a lower interest rate risk than IG bonds.

Emerging market (EM) bonds More stable government finances in terms of better current account balances along with low inflation have reduced the financial vulnerability of many emerging market countries. Despite a number of rate cuts in 2019, interest rates and yields in many emerging markets are still far higher than in developed markets, enabling good current returns. There are prospects of additional rate cuts, which could lead to higher bond prices in the various emerging markets. The fact that the Federal Reserve and other central banks are providing stimulus should benefit this kind of asset a while longer.

Uncertainty factors include political risk in the form of trade wars and protectionism. EM currency trend forecasts present both a risk and an opportunity. A number of EU currencies − mainly in Latin America − have been weakening for a while, but there are now prospects of appreciation.

Strong returns for high yield bonds in 2019

“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. Total return for high yield bonds in both the US and Europe was positive thanks to interest rate cuts and a narrowing of the yield gap between corporate and government bonds.

Source: Bloomberg/ Macrobond

Fixed income investments

Expected return, next 12 months (in SEK)

Fixed income investments Return Risk

Government bonds -0.5% 1.4%

Corporate bonds, investment grade (IG), Europe

1.9% 3.3%

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

2.6% 4.3%

Emerging market (EM) bonds in local currencies

6.1% 8.4%

Source: SEB forecasts, January 2020


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Growth Value

Eurostoxx S&P500Vinx

It is a well-known and perhaps perplexing fact that stock markets have climbed while growth and earnings forecasts have been revised downward. With subdued earnings forecasts and historically high valuations, this puts the burden of proof on optimists. Can already high valuations be defended? We believe valuations are reasonable, given our forecasts of slightly accelerating growth and continued ultra-low bond yields and interest rates. Our main scenario points to weak positive returns this year.

At the sectoral level, valuations of more cyclical and volume- dependent companies will be revised upward when reces-sion worries ease. Among growth companies, those riding on structural trends – digitisation winners and companies whose products contribute to a more sustainable world – will benefit, while more stable companies look overvalued.

The stock market now has its best year of the decade just be-hind it, outperformed by only two years during this millennium (measured by the S&P 500). It has been buoyed by uninter-rupted (though relatively subdued) economic growth and falling interest rates and yields, which helped drive valuations from their lows following the deep recession of 2008-09 to their current highs.

It is natural for lower bond yields to justify higher share valuations and thus share prices when the return on the safe alternative investments falls. Naturally, this assumes that inter-

est rates will remain low. The question then is how much higher valuations can be justified. That depends on future earnings growth, interest rates/yields and risk premiums. Investors at least need to see a positive earnings trend in order to accept higher valuations; otherwise even zero interest rates or yields might look like a reasonable alternative.

A decent earnings outlook Earnings generation for listed companies cooled significantly last year. After strong earnings growth in 2017 and 2018, it looks like there was no global earnings growth in 2019. The largest decline was in emerging markets (EM), while earnings in the US and Europe appear to be generally unchanged. For 2020, analysts are forecasting global earnings growth of around 9-10 per cent. However, in 2019 the forecast for 2020 GDP growth was gradually revised downward. This indicates that earnings forecasts have room to fall, which is also illustrat-ed by surveys indicating that a number of equity strategies and

Global equitiesLow yields + reasonable growth = high valuations

Yields down, stock market up

The past decade was dominated by rising share prices. One contributing factor was falling bond yields, which justify higher share valuations if they remain low. We expect yields to remain low but note that any future stock market upswings will scarcely be fuelled by new yield declines.

Source: Bloomberg

Sectoral structure determines stock market differences

Source: Bloomberg

Divergences in the sectoral structures of stock exchanges drive differences in share price performance. While classic growth sectors such as IT and pharmaceuticals are predominant in the US, cyclical industrials, commodities, energy and financial services sectors set the tone on Europe’s stock exchanges, especially in the Nordic countries.


portfolio managers expect significantly lower earnings growth, in the range of 3-5 per cent. We also share that view. Such earn-ings increases are below historical norms but can nonetheless be tolerated, provided the positive earnings trend strengthens somewhat going forward.

What support does this provide for today’s historically high valuations? If we exclude the unreasonably high valuations connected to the IT (dotcom) bubble around the turn of the millennium, today’s levels – with a price/earnings ratio of around 18-19 in the US and 16-17 globally – are in line with previous highs. Although history does not always guide us correctly about the future, these levels still constitute a clear frame of reference for many investors. In our view, valuations may periodically surpass these levels if the news headlines are sufficiently positive.

Lack of alternatives to equities The acronym TINA (There Is No Alternative) largely explains last year’s stock market rally. When fairly safe fixed income investments barely generate any return, the stock market is an attractive investment alternative. It also explains why compa-nies whose future cash flows are considered reliable − regard-less of the economic cycle − have been priced high in historical terms. In other words, stable equities have to some extent replaced bonds.

Stock market structure determines indices The clear difference we have seen in the stock market perfor-mance of broad US indices compared to their European coun-terparts is explained by higher domestic growth, but mainly by differences in stock market structures. One common, and reasonable, division is between “Growth” and “Value” com-panies. In its simplest form, this consists of placing companies with the highest valuations in the Growth segment, based on the argument that higher valuations reflect higher growth, whereas companies with lower valuations (often with larger

fluctuations in earnings performance) end up in the Value cate-gory. This typically means that classic fast-growing companies in fields like information technology (IT) and health care are defined as Growth companies while more cyclical companies in sectors like industrials, commodities (including energy) and financials dominate the Value company indices.

More fast-growing companies in US indices The difference between the two sides of the Atlantic is illustrat-ed by the fact that the two above-mentioned growth sectors account for 37 per cent of the MSCI index in the US but only 18 per cent of stock market indices in the euro area. For value sec-tors, the picture is reversed; they constitute 29 per cent of the US index and 44 per cent of the euro area index. In 2019, some of the fast-growing US digitisation companies were reclassified from the IT sector to the communication services and consum-er durables sectors; taking this into account, the difference in stock market structure is even more pronounced.

Poorer performance by Value shares Growth shares have performed better than Value shares for virtually all of the past decade, except for a slight correction in the second half of 2019. This difference also has an impact on valuations. Studying changes in P/E ratios, we see that over the past decade valuations for the broad euro area index followed those of US Value shares, while Growth companies gradually commanded a premium with higher P/E ratios. From this per-spective, investors see Europe as a Value market. Of course it is reasonable for companies with faster earnings growth to trade at higher earnings multiples. Higher valuations for US equities are thus attributable to the difference in sectoral structure.

Signs of optimism in the euro area and EM sphere We consider the valuation gap reasonable at present. If the signs of imminent recovery seen in some indicators late last year result in higher growth than expected, stock markets outside the US, such as in Europe and emerging market (EM) countries, should regain lost ground. EM stock markets include a larger proportion of cyclical companies, which also turned in a weaker performance last year due to uncertainty about growth and trade war risks. EM countries were the first to see their economies weaken and look set to be first off the starting block. IT companies account for a large percentage of EM indices, with semiconductor makers such as Samsung and Taiwan Semiconductors now poised for a strong earnings re-bound after a period of inventory draw-downs. As a result, EM corporate earnings are expected to grow faster than those in developed market (DM) countries. The Federal Reserve is also providing liquidity again, and the dollar shows weakening tendencies, which historically has benefited EM stock mar-kets. Low EM valuations will allow multiple expansion − which is nice when combined with increased earnings.

To summarise, as long as bond yields and interest rates re-main ultra-low and growth is sufficient to generate increased earnings for listed companies, this should also be enough to justify current share valuations globally. Our conclusion is that on a global basis, equities should be able to deliver positive total returns in line with the 2020 earnings trend.

Valuations at or near peak levels

Global P/E ratios are at their highest levels since the IT (dotcom) stock exchange bubble at the turn of the millennium. This is justified by far low-er bond yields, but most likely presupposes that listed company earnings will continue to show a fairly healthy trend.

Source: Bloomberg

Global equities


Stock market prospects might look really promising if it were not for valuations. Since mid-August, the Stockholm stock exchange has surged 19 per cent, with a P/E ratio now of around 21, one of the highest since the millennium bubble burst in the early 2000s and almost 5 points more than just one year ago. Higher-than-historical valuations are reasonable, given low interest rates and bond yields, but after the recent upswing we see clearly limited potential for a further rise in the Stockholm index during 2020.

On the positive side, the trade agreement between China and the United States signals a truce in their dispute, at least until after the US presidential election in November. We also see clear signs of a recovery in global manufacturing activity, which is nonetheless in a relatively early phase. Expansionary monetary policy can be expected to continue, and interest rates will remain extremely low during the foreseeable future. After a failed attempt to normalise monetary pol-icy in 2018, central banks will probably be very cautious about tightening again before there are clear signs of higher inflation pressure, and that will take a while. This would be a perfect environment for equities, if it were not for valuations. We continue to recommend cyclical equities and note that the green sustainability wave looks set to intensify further.

Sustainability is not a fad This year kicked off with two events that further reinforce our conviction that sustainable business operations are not only critical in a more long-term perspective. The financial market is now busy trying to assess the risks and opportunities that this transformation can be expected to entail. It will also con-tinue to impact the Nordic stock market in 2020.

The New York-based asset management company BlackRock, one of the world’s largest with 7 trillion dollars in assets un-der management, recently published its annual letter to cus-tomers and to the CEOs of companies its funds have invested in. The message is clear; now large American institutional investors are also working hard for climate change adapta-tion, which they believe is unavoidable and imminent. Climate change will have a lasting and significant impact on the global economy. BlackRock believes that so far, the financial market has been slow to take into account and price these risks, but awareness is growing rapidly and the company believes we are on the verge of a fundamental transformation in how the financial market works in various ways related to sustainabili-ty. Will there still be 30-year mortgages (the standard maturi-

ty in the US) if lenders cannot estimate the impact of climate risk over this timeline? What happens to inflation if the cost of food climbs because of drought and flooding? BlackRock also notes that entire economies – mostly in emerging markets, which are especially vulnerable to extreme heat, drought or flooding – may be dramatically affected.

Sustainability issues continue to grow in importance in the financial market; the fact that large US institutions are now jumping on the bandwagon will not slow the pace – quite the opposite. The sustainability trend is both an opportunity and a risk that must be taken into account by investors in Nordic equities.

The Nordics are far ahead, in relative terms In the long run, companies and countries that do not take sustainability seriously will find it increasingly difficult to access capital, both borrowed and their own − with higher costs as a result. Accordingly, one industry that BlackRock has completely ruled out as an investment option is thermal coal producers, which are no longer included in the firm’s investment portfolios. Meanwhile the companies, regions and countries now taking the lead and investing in improvements to their operations and in the sustainability of society − as well as providing complete transparency in this work − have the potential to generate significant long-term investments at an attractive cost. Corporate Knights, a Canadian media and research company focused on sustainability issues and on environmental, social and governance (ESG) work, annually ranks the world’s 100 most sustainable corporations. Nordic companies, which account for 10 of the world’s 50 most sus-tainable corporations in this ranking, have gained an extreme-ly appealing position.

Even before BlackRock published its annual letter, SEB held its yearly Nordic Seminar for investors in Copenhagen – one of the largest of its kind in the region, featuring presentations by

Nordic equitiesHigh valuations limit upside potential


leading decision-makers at some 140 Nordic listed compa-nies. The trend in recent years towards an ever-sharper focus on sustainability issues, especially from what is a positive perspective for companies, was also clear this year.

For example, one of the largest Nordic technology consult-ants noted that the sustainability aspect now was not only crucial to every project; environmentally-related megatrends such as energy adaptation, the need to adjust infrastructure to climate change and the need for energy efficiency improve-ments are also often driving entire projects. One supplier of materials for vehicle components noted that customers have become much more aware of what demands they can make and what information they can require about their subcon-tractors’ emissions. Requirements by pace-setting companies that were brand-new and unique just a year or so ago have become standard today. For the largest Nordic managers of venture capital funds, it is a given that the companies they buy must be sustainable. Shipping companies compete with one another over who is cutting emissions fastest − not to win over ESG analysts, but because important customers, includ-ing some of the world’s largest oil companies, have promised their shareholders they will reduce the emissions caused by their operations. For these companies, leasing vessels that produce the least pollution is low-hanging fruit. Recycling is an industry experiencing strong growth, while natural gas is taking market share from coal at a rapid pace, especially due to its environmental advantages. Forest product companies are confident that growing opposition to both plastic packag-ing and synthetic textiles will benefit them. There are many examples of Nordic companies that view sustainability as a business driver.

Green stimulus measures around the corner BlackRock was not content merely to point out that climate change will lead to significant risks and opportunities for investors, companies and countries. The firm also noted that coordinated international measures are needed by the world’s governments to achieve the targets set in the Paris Climate Agreement. We also see good potential for addition-al political initiatives to keep the ball rolling, especially in Europe, which enjoys a lead in this area.

Some form of carbon tax on imports would help spread the ef-fects of this environmental policy beyond the region’s borders and also give domestic companies competitive advantages. Despite the complexity of such a measure, it is reasonable to expect discussion of this issue to intensify going forward. A carbon tax may also be especially crucial to certain heavy industries in the region.

The next time new economic stimulus measures are needed, it is reasonable for them to take the form of fiscal stimulus for sustainability-improving investments in infrastructure, climate change adaptation and incentive programmes for households and companies to improve their energy efficiency and/or reduce emissions. There are probably few other alter-natives that can win the broad political backing that this kind of green stimulus package would have, globally but especially in Europe.

A calmer 2020? After markets alternated between hope and despair in 2019 over the trade dispute between the US and China, the recent Phase 1 agreement will hopefully bring stability and continuity in the matter, at least until after the US presiden-tial election this autumn. What was a major source of stock market volatility in 2019 should therefore be a non-issue over the next six months. Although much of the Brexit process still lies ahead, financial market worries about the issue have eased significantly, and recurring episodes of turmoil in the Middle East in recent months have quickly faded again. At this writing, stock markets in Asia are showing clear concern about the spread of a coronavirus, which is reminiscent of the SARS epidemic 17 years ago. As of today, however, we do not see what – if anything – could create nervousness like that caused by the 2019 US-China trade dispute.

Monetary policy, which was the main stock market driver in both 2018 and 2019 – first down and then up – will probably also lead a more unobtrusive existence in 2020. Economic growth is expected to improve somewhat during the year, but even though the labour market, especially in the US, is already relatively tight, inflation is conspicuously absent. Fur-ther easing by central banks around the world is not expected in the near term, but nor is any tightening. In retrospect, after their failed attempt to normalise monetary policy in 2018, which stifled the economic upturn prematurely and caused the stock market to plummet during the last quarter of that year, it is reasonable to expect a longer period of restraint this time. Major central banks, led by the US Federal Reserve, will probably show a fair amount of patience before they attempt to tighten again, after being forced to make a 180-degree turn in 2019. What is often an important stock market driver can thus also be expected to be more neutral in 2020, after having played a major role over the past 18 months.

Nordic equities

Manufacturing activity is rebounding

The chart shows the JP Morgan purchasing managers’ index for the global manufacturing sector.

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Source: SEB, Bloomberg


Manufacturing activity is rebounding Overall we foresee relatively good conditions for a somewhat less nervous stock market this year. There will be less focus on trade policy and monetary policy, while manufacturing activity is expected to rebound from its lows, suggesting an even greater focus on economic growth and leading indica-tors in early 2020. We are looking for confirmation that man-ufacturing activity will improve after a continuous slowdown in 2018 and 2019.

Purchasing managers foresee a turnaround After 18 months of sustained weakening in the global weight-ed purchasing managers’ index (PMI) for manufacturing, the index reached a low in July 2019, after which the trend reversed. Moreover, in November the index surpassed the critical threshold of 50 − indicating economic expansion − for the first time since April. However, leading indicators are by definition forward-looking, and the reason people follow them is that they are expected to precede the real economic trend.

We believe manufacturing activity hit bottom during the fourth quarter of 2019 or early in 2020 for most Nordic industrials. News stories are usually contradictory at such turning points, and corporate earnings reports for the fourth quarter of 2019 are accordingly expected to show volume decreases of 10-20 per cent for many industrials. Meanwhile, the PMI is trending upward. The start of the report period has shown precisely this, and while the pattern is not at all unusual, we can note that − after share price upturns of 40 per cent in five months in some cases − double-digit declines in order bookings are probably not the fuel needed to push the index higher.

Rotation towards cyclicals expected to continue Provided this favourable PMI trend continues, which is our main scenario, conditions are in place for a gradually more positive corporate earnings growth trend in 2020 for cyclical manufacturers. The pattern this year might be the opposite of 2019, with a weak start and then accelerating strength. If this scenario holds, it could be expected to bolster the capital rotation from defensive to cyclical shares that we saw early last autumn but that has recently been on hold.

Along with improved manufacturing activity, which would naturally contribute to better earnings growth for the stock market’s cyclical sectors, we foresee a continued surpris-ingly large valuation gap between cyclical and defensive companies in the Nordic stock markets. Sharply lower return requirements over the past 15 years have apparently not had any visible effect on valuations in the stock market segments most sensitive to business cycles, illustrated in the chart by the 12-month forward median enterprise value over earn-ings before interest and taxes (EV/EBIT) for 10 early cyclical Nordic companies in the industrials, forest product and steel sectors.

It is also noteworthy that − in the slightly longer term − major investments will be required in physical infrastructure, espe-cially in energy and transport, to transform our society into a more sustainable one. Future “green” stimulus packages/adaptation programmes could very well benefit companies and industries that have been rejected today by investors because of their business cycle sensitivity.

Stretched valuations in Sweden and Denmark The greatest challenge for the stock market this year is prob-ably valuations. In the Nordic countries, this is especially true of Sweden, where the P/E ratio has risen by almost 5 points in just one year and is now the highest since the millennium bubble burst nearly 20 years ago. Even with cautious central banks reinforcing expectations that interest rates will remain low for a very long while, improved manufacturing activity and fewer worries that moves by US President Donald Trump will hurt market sentiment before this autumn’s US election, we see a limited upside for Nordic stock markets during the rest of this year. The upturn has already taken place, particu-larly for the Stockholm and Copenhagen stock exchanges. The broad stock index in Stockholm is valued at a P/E ratio of 21, and the index in Copenhagen at a ratio of 22, according to Bloomberg’s consensus forecasts.

Earnings need to catch up We expect solid earnings growth throughout the region in 2020 and 2021. In Finland, we foresee 7 per cent earnings growth in 2020, while in Norway we expect 34 per cent; in 2021 too, expectations are lowest for Finland, at 8 per cent, and highest for Norway, at 15 per cent. In Sweden, we expect 11 per cent earnings growth in 2020 and 13 per cent in 2021. If these earnings forecasts hold, valuations on the Stockholm exchange will look more appealing again in two years.

Nordic equities

Cyclical risk is attractively valued

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Cyclical Median Defensive Median

Source: SEB, BloombergThe chart shows median valuation – enterprise value over earnings before interest and tax (EV/EBIT) based on a 12-month forward consen-sus – for a group of large Nordic defensive shares with at least a 14-year history and a fairly intact structure, compared to a group of large cyclical shares. The defensive group consists of nine companies from Denmark, Sweden and Finland in health care and consumer staples. The cyclical group consists of 10 companies based in Sweden and Finland in the indus-trials, forest product and steel sectors.


Nordic equities

Healthy earnings growth expected for all Nordics

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The chart shows expected earnings growth (adjusted net earnings in local currencies) aggregated for the companies that SEB monitors in each stock market.

In contrast, valuations are not at all the same obvious problem on the Helsinki exchange, although revised earnings forecasts were far more negative in the past year for Finnish listed companies. This has also contributed to lower confi-dence in current forecasts. In the space of one year, earnings forecasts for Finnish companies were revised downward by 13 per cent for 2020, compared to downward revisions of less than 6 per cent for companies in the Stockholm stock market. Better manufacturing activity in 2020 may poten-tially help stabilise earnings forecasts and produce smaller downward revisions this year.

The Oslo stock exchange also looks far more attractively valued, in this case combined with expectations of strong earnings growth. However, earnings forecast revisions have been even more negative in Norway. Earnings forecasts for 2020 were revised downward by 17 per cent in one year. There is also a clear risk that more and more investors, like the above-mentioned BlackRock, will give lower priority to investments in fossil fuels, which can be expected to have a negative impact on oil sector valuations. That kind of trend has already been seen in the past year and, together with large downward revised earnings forecasts, may have helped

Source: Bloomberg

Surge in Stockholm share valuations means more room for a decline

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Copenhagen Oslo Helsinki Stockholm

The chart shows the P/E ratio for broad stock market indices in Sweden, Norway, Denmark and Finland. Valuations on the Stockholm exchange in particular have recently increased sharply.

make the Oslo exchange the worst performer among the Nor-dics in 2019. The oil sector accounts for 24 per cent of the Oslo exchange but is negligible in the other Nordic countries, especially if we consider the valuation of the Finnish energy company Neste, about 80 per cent of which is biofuel-related and only about 20 per cent fossil fuel-related. Low valuations for oil-related companies are one important explanation for lower valuations on the Oslo exchange.

Summary After sharp valuation increases for companies on the Nordic stock exchanges this past year, we see limited upside during the rest of 2020, especially on the Stockholm exchange. We expect a continued rotation into cyclical company shares, bolstered by attractive relative valuations and improved manufacturing activity. The sustainability trend is accelerat-ing internationally and will continue to influence Nordic stock markets – some companies positively and others negatively. In an international comparison, Nordic companies are far ahead in their sustainability work, which is an advantage in the environment we now foresee.


Global demand for clean water is growing rapidly. Meanwhile, the water supply faces challenges from pollution, climate change and inefficient use.

Water is essential for all life on earth and a prerequisite for the world’s food and energy production. Everything we use, wear, sell and eat requires water for production, so we face a very challenging situation.

How scarce are global water resources? Global water consumption has increased sevenfold over the past century. According to World Bank forecasts, demand will increase about 40 per cent by 2030. Annual demand will then be about 3 trillion cubic metres great-er than supply if the trend continues at the same pace. Nearly half of the world’s population risks having to live in conditions of water scarcity. There is no substitute for water, but fortunately there are solutions to this immense challenge.

The general view in our part of the developed world is that clean water is always available – we often take it for granted. But what is the reality?

Looking at a globe, it is easy to conclude that there is an almost unlimited amount of water. Some 70 per cent of the earth’s surface is covered by water. There are a total of 1.4 trillion cubic kilometres of water on earth, and that will always be the case. Water can freeze or vaporise, but it will remain on our planet.

Since 97 per cent of this water is saltwater and another 2 per cent is locked up in polar ice, it means we must live on 1 per cent of the total amount.

A large proportion of this 1 per cent is underground, for example in subterranean lakes. In many cases, that makes it difficult and expensive to access. This is one important reason why, throughout history, people have lived near lakes and rivers.

Theme:

Clean water shortages – a challenge


Today we have better methods for accessing groundwater. However, this water has taken thousands of years to form and will take thousands of years to replenish, so it is important we manage it wisely. The groundwater supply has decreased because about 20 per cent of these reserves have been over-exploited. Shrinking wetlands have also reduced the ecosys-tem’s capacity to clean water.

Fresh water is a renewable though finite resource. As the pop-ulation grows, these limited resources are put under pressure. In many places around the world, we use more water than the earth can provide due to natural limitations.

In theory, there is enough fresh water to meet these needs in a sustainable way. But in practice, resources are distrib-uted very unevenly. Ten countries hold 60 per cent of water resources, with Brazil and Russia having the largest volumes.

Fast-growing demand for a scarce resource Unfortunately, there is already a water shortage in the world. Some 844 million people have no access to clean drinking wa-ter, while another 2.3 billion have no access to basic waste-water treatment infrastructure. Population growth, currently

Theme: Clean water shortages – a challenge

One per cent of the world’s water is usable

Source: havet.nu

Two thirds of the earth’s surface is covered by water, yet only about one per cent can be used for people’s needs. That is because 97 per cent is saltwater and about two thirds of the remainder is locked up in glaciers.

Saltwater 97% Glaciers 2% Fresh water 1%

10 countries hold 60% of water resources

about 80 million people a year, is one of the most important reasons. The fact that a growing share of the population also eats more meat makes the situation even more challenging. Furthermore, industrialisation has led to continued rapid growth in water demand, which is not sustainable in the long term.

Growing needs likely to cause water scarcity

Source: Global Water Intelligence, World Bank, RobecoSAM

The largest percentage of water is still used in agriculture. Water demand is expected to grow by about 40 per cent from 2015 to 2030, when there will be a water scarcity of around 3 trillion cubic metres a year.

70% of fresh water is consumed by agriculture

Agriculture consumes most water Using modern technology, we grow crops in places they cannot grow naturally. Although this has made it possible to meet the constantly growing demand for these crops, unsustainable wa-ter-intensive agriculture destroys many nearby environments. Watercourses and lakes are emptied and the groundwater level falls. The environment around these agricultural lands is also polluted by the extensive use of pesticides.

The agricultural sector accounts for about 70 per cent of water consumption globally and more than 90 per cent in the world’s least developed countries. Forecasts indicate that in 30 years, by 2050, the sector will need to produce 60 per cent more food globally and 100 per cent more in developing countries. The crops that consume the most water are cotton, rice, sugar cane and wheat. Meat production also requires a lot of water, on average more than 15,000 litres per kilo of beef.



Water footprints

Product Litres

A kilo of beef 15,415

A kilo of pork 5,988

A kilo of chicken 4,325

A cotton T-shirt 2,720

A kilo of rice 2,497

A kilo of pasta 1,849

A kilo of sugar from sugar cane 1,782

A margherita pizza (725 g) 1,259

A banana (200 g) 790

A kilo of potatoes 287

A glass of milk (250 ml) 255

An egg (60 g) 200

A cup of coffee (125 ml) 132

A glass of wine (125 ml) 109

A glass of beer (250 ml) 74

Source: Waterfootprint.org

Cotton, which requires a lot of water, today accounts for nearly half the world’s textile production. Sweden’s imported cotton clothing requires 100,000 litres of water per person each year. About 2,700 litres of water are needed to grow the cotton for a single T-shirt.

Forty years ago the Aral Sea, located between Kazakhstan and Uzbekistan, was the fourth largest inland body of water. Cotton is an important source of revenue in the region but has also been a big eco-villain, causing a 75 per cent drop in the lake’s volume.

Manufacturing is another major consumer Manufacturing accounts for about 22 per cent of global water consumption. The Organisation for Economic Cooperation and Development (OECD) predicts that demand from manufac-turing will be four times greater in 2050 than at the turn of the millennium. Water is used as a raw material, but also for cleaning and for heating and cooling in energy production. About 75 per cent of manufacturers’ consumption is for pow-er generation.

Our water footprint People need about 20 litres for their daily activities, such as drinking and washing. Overall, this represents about 8 per cent of fresh water consumption on the planet. Our indirect water consumption is vastly greater. “Water footprint” is one way of expressing indirect use and includes all the water needed for a product or service to be consumed. It is one way to help us understand how production and consumption choices affect the world’s natural resources.

In Sweden, the average daily water footprint is nearly 6,000 litres per person, equivalent to around 40 medium-size bath-tubs full of water. That translates to an annual footprint of more than 2,000 cubic metres.

The annual footprint for an American is about 2,840 cubic metres, and the corresponding figure for a Japanese is 1,380 cubic metres. According to waterfootprint.org, global average daily use is 5,000 litres, but this varies widely depending on where people live and what they eat – from 1,500 to 10,000 litres a day.

How can we balance supply and demand? There is enough water globally to meet the world’s needs, but not without dramatic changes in how we use, manage and distribute the supply.

Increase the water used for intended purposes To begin with, we should make sure that all water is used as intended, which unfortunately is far from the reality today. Water loss or non-revenue water (NRW) is a significant prob-lem across the world and is due, for example, to leakage or theft. As much as two thirds is lost in low- and middle-income countries. In Asia, about 30 per cent of water in cities is lost and a full 65 per cent in some rural areas is lost.

In developed parts of the world, a lot of water is also lost as a result of leakage due to poor infrastructure. In some areas of Europe, the figure is a full 50 per cent. In 2014, the American Society of Civil Engineers estimated that about 15 per cent of all US drinking water was wasted due to leakage. In Mexico City, 42 per cent of drinking water today is lost through leak-age; meanwhile the city faces a water crisis.

Infrastructure improvements on the way The share of water loss due to leakage may seem unnec-essary, and a lot of resources are also invested in water infrastructure, with more on the way. However, given inade-quate infrastructure and the state of existing facilities, major investments are needed. In the period 2010-2030, more than USD 1.8 trillion is expected to be spent by the 36 mainly af-fluent members of the OECD in this field, twice the amount to be spent on infrastructure for electricity, roads and railways combined. The question is whether that is enough.

Eat food that requires less water According to FAO Aquastat (the water resource database of the Food and Agricultural Organisation, a UN agency), 1,000 times more water is needed to feed agricultural products to a population than to quench its thirst. Globally, the need for food is expected to grow 70 per cent by 2050, which is a challenge for water resources, but what we eat makes a big difference. More than 15,000 litres of water are needed to produce a kilo of beef, compared to 1,500 litres for a kilo of grain.



High global population growth

The world’s population is expected to increase more than eightfold by 2050 compared to 1900. This is the main reason for the growing scarcity of clean water.

Water and wastewater treatment and re-use Globally, a surprisingly small percentage of all water is recy-cled. Water treatment is any process that makes water usable again for various purposes, everything from drinking water to industrial production. According to FAO Aquastat, water re-use accounts for only 2.4 per cent of global water use.

According to the UN, perhaps more than 80 per cent of wastewater from households globally ends up in rivers and seas with no treatment whatsoever. This is low-hanging fruit. With the right technology, the share of water that is re-used should increase quickly and significantly.

Unfortunately, micro-pollutants are a by-product of our affluent society. Small chemical and biological particles are used in millions of items made in developed economies. Phar-maceuticals, personal hygiene items and cleaning products are examples of goods that pollute, but so does wastewater from factories that make textiles, tyres, paint and plastic. Fortunately, there are cost-effective solutions to this problem as well, but older wastewater treatment processes must be updated.

How can we produce more usable water? As noted earlier, the total amount of water on earth is con-stant, and 97 per cent is saltwater. There are methods for desalinating water, thus increasing the proportion that can be used for people’s needs. The use of such methods is growing, mostly since 2010 and primarily in the Middle East. Water is now desalinated in more than 150 countries. Although great advances have been made over the past 50 years and energy use is now a tenth of what it was in 1970, desalination is still energy-intensive, with energy accounting for 60 per cent of costs in the desalination process. Desalination has limited use given its cost, but great potential.

Desalination is a method that is being used increasingly but, according to Global Water Intelligence, still only about one per cent of the world’s population depends on desalinated water for its daily needs. Israel stands out, with desalinat-ed seawater accounting for a full 40 per cent of water for household use. Given higher water prices, desalination would be used to a greater extent, but then everything that contains water would also be more expensive, which would lead to other problems.

Energy solutions with lower water needs Energy production accounts for about 15 per cent of global water consumption, and this figure is expected to rise, driven by increased demand for energy and strong growth of uncon-ventional energy sources, such as shale oil. Shale oil requires a lot of water; meanwhile 50 per cent of shale oil wells operating today are in US regions with high or very high water scarcity (source: CERES 2014).

Thermal power plants represent about 80 per cent of global electricity production, and cooling them accounts for 42 per cent of fresh water consumption in the EU and nearly 50 per cent in the US. "Thermal power plants" is an umbrella term for power plants that use heat to generate electric power. From a water perspective, solar energy and wind power are the most efficient energy sources available today. They require only one tenth as much water as nuclear power plants per electric-ity unit and one sixth as much as a coal-fired power plant.

More efficient water use We must become better at managing our scarce water resources. For example, we grow crops in places where they cannot grow naturally. In southern California, more than 7.5 billion litres of water a year are used to grow alfalfa sprouts. Water for this is taken from the Colorado River hundreds of miles away, which means the price growers pay for their water does not even cover the delivery cost. A more efficient way to water crops is micro-irrigation, which entails using water exactly where it is needed, for example, at the crop’s roots. Crops that require less water and are even drought- resistant have also been developed.

Water management in homes and businesses One way to reduce water use is to update white goods. According to the American Water Works Association, in-door water use could be reduced 35-70 per cent with more efficient fixtures and appliances such as showers, toilets and washing machines.

Source: UN population estimatesG

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Clean water – a human right

In 2010, the UN declared access to clean water and sanitation a human right. This is also one of the 17 goals on its 2030 Agenda for Sustainable Development. It is a challenge to price a valuable, limited resource and at the same time give everyone access to it.

Despite major improvements, in 2014 only about 60 per cent of the world’s 250 largest companies had any long-term strategy for how to manage the challenges of ever increasing water scarcity. We can assume that this issue has climbed much higher on these companies’ agendas since then.

Increased awareness leads to change Although the price of water does not indicate it is an essential good, thereby persuading people to manage it efficiently, such knowledge can strongly influence our behaviour. One im-pressive example is Cape Town, South Africa. Water scarcity there was becoming increasingly acute, and people started talking about Day Zero, the day when the water would be turned off and no longer flow from taps. The date determined was April 12, 2018. Because people started communicating about this and there was a fixed date, they dramatically changed their behaviour.

This led to the Day Zero date being postponed numerous times, and it has now been put off to an indeterminate future date. Still, as a result, during early 2018 the city had halved its water consumption compared to four years earlier.

In a few decades, cities such as São Paulo, Melbourne, Lon-don, Beijing, Tokyo, Barcelona and Mexico City will reach Day Zero if their water use does not change radically.

Should water be more expensive? Many people see water as a cheap good, barely affected by market forces or scarcity. The result has been inefficient over-use. For example, water revenue in New Delhi corresponds to only 20 per cent of what is spent to supply water. Higher water prices would increase the incentive for more efficient use and improve water sector finances. In 2010, the UN declared access to clean water and sanitation a human right. This is also one of the 17 goals on the UN’s 2030 Agenda for Sustainable Development. It is a challenge to put a price on a valuable, limited resource and at the same time give every-one access to it.

Image source: UN in collaboration with Project Everyone

Fortunately, the example of Cape Town shows that awareness about the value of water and its limited supply can be enough to bring about a dramatic change in behaviour.

Great opportunities for investors For anyone who wants to invest in this theme, there are great opportunities. In every field, there are companies more or less focused on these challenges. Examples include various wastewater treatment methods required to enable water re-use, infrastructure improvements, new methods for detecting and locating leaks, desalination, water-efficient irrigation methods, more water-efficient products and water-efficient energy sources.

22Investment Outlook: February 2020 22

Digitisation has already changed our everyday lives in fundamental ways, and this trend is continuing. Digitisa-tion has also brought radical changes to most businesses, in everything from production and inventory manage-ment to communication and marketing strategies. Rapid developments make it hard to identify future winners, espe-cially from an investment perspective. But the potential that resides in the great power of such transitions makes it well worth trying.

In the last Investment Outlook, we de-scribed developments in artificial intel-ligence (AI). We are continuing here by exploring two other trends in digitisa-tion − robotisation and cybersecurity.

Powerful and fast-moving Digitisation is not a new trend. But the rapid transforma-tion that resides in radical technological change and in trends like this is far from over. It will create winners and losers for a long time to come; the fields of robotisation and cybersecurity will undoubtedly produce both.

Shares in the Ericsson telecom group had extremely high valuations two decades ago, with stratospheric earn-ings expectations. Equity analysts were divided. Some defended Ericsson’s valuation based on the potential of the mobile telephone segment. At the time, mobile phone markets were dominated by Nokia, Ericsson and Motorola. Optimists based their valuation on the belief that “smartphones” would make a breakthrough and we would want to use our phone to take photos and even surf the internet! However, many were sceptical − why would anyone want to do that?

The continuation of this story is interesting for sever-al reasons. The revolution arrived, and today almost everyone takes their smartphone for granted. We use it for things that the most visionary people could not even have dreamt of back then: navigating trips, ordering home deliveries of food and keeping track of the kids...

This is just one example of the power of a megatrend such as digitisation. But it also illustrates that the winners are not always those that we consider obvious. None of the above-mentioned companies is among today's mobile phone winners. Instead, other types of winners have emerged, such as game app developers and music streaming services. Rapid developments make it hard to identify future winners, especially from an investment perspective. But the potential that re-sides in the great power of such transitions makes it well worth trying.

Theme:

Digitisation – A powerful megatrend


Robotisation − Growth driver of the future?

One recurring theme in today's economic discourse is the ageing population. Baby boomers are now reaching retire-ment age, and because of declining birth rates in the world’s advanced economies, working-age people will decrease as a percentage of the total population. A shrinking labour supply will limit economic growth opportunities, which in turn will make it harder to raise living standards − at least as fast as we have become accustomed to in recent decades.

So how will the world economy continue to grow, despite a lower labour supply? One way is to become more efficient in using the resources we have. Historically, technological development has been one of the most important factors in these contexts. As the quantity of labour shrinks, robot-aided automation may be one of the keys to continued efficiency improvement and thus to healthy economic growth.

Although there are disparate views about the long-term macroeconomic effects of robotisation (what happens, for example, if low-skilled jobs become fewer?), regardless of the consequences for the economy as a whole, businesses are investing a lot of money in this field. Their pursuit of cost sav-ings, speed and flexibility, in turn, is leading to rapid growth among suppliers of robotics technology.

Both digital and physical technology The digital world can undoubtedly help us a lot by gathering many of our chores in one place and thereby making us more

time-efficient. But only in the last few decades we have created enough computer or processor power to effectively expand digitisation to create "smart" computers. In the field of RAAI (robotics, automation and artificial intelligence), the ambition is also to create smart computers that do physical work for us, and development work is progressing rapidly.

In 2018, almost 30 per cent of all work was done by ma-chines and computers. This is expected to grow to more than 40 per cent in the next three years, according to an analysis by the World Economic Forum. The trend is clear − we are automating more than ever.

Today we increasingly encounter robots in our everyday lives − everything from self-driving cars to robotic vacuum clean-ers and robotic lawnmowers. But in concrete terms, what is it that businesses are investing so much in? Since the potential applications are numerous and wide-ranging, a few examples will suffice.

Theme: Digitisation – A powerful megatrend

Robots − a fast-growing market

As new research and development takes place, new opportunities will emerge in the robotics market. Demand will increase in more and more sectors. Because of new, more highly developed functionality, the size of the global market for robots both inside and outside of manufacturing is projected to rise sharply.

Source: Tractica. 2019-2025 numbers are projections

The future of manufacturing is automation

The need and demand for robots in the manufacturing sector has increased sharply over the past decade, as businesses seek economies of scale, cost savings, precision and industrial safety. Since the 2008 finan-cial crisis, global sales of industrial robots have climbed significantly.

Source: Statista

64

83

104

132

165

209

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100

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200

250

2018 2019 2020 2021 2022 2025

USD

bill

ion

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100

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400

42% – the share of all work to be performed by robots and machines by the year 2022

Sale

s, th

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of u

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2

19

24

31

34

36

42

49

54

54

55

82

Brand perception

New production requiring more equipment

Applications enabled by new technology

Decreasing robot prices

Responding to labour shortage

Physical unburdening of employees

Increasing employee safety

Higher flexibility in production

Increasing productivity

Improving robot capabilities

Improving quality

Reducing costs

In the manufacturing sector, industrial robots are used in a variety of applications. For example, robots can be pro-grammed to perform repetitive tasks that are dirty and/or dangerous for humans to perform. At the same time, they of-fer a high degree of precision and accuracy, which is of course desirable in large-scale production. Traditionally, industrial robots have been kept separate from parts of the production chain where human hands are required. Nowadays so-called collaborative robots or "cobots"are becoming more common. These are smart robots designed to work together with hu-mans and contribute to further development.

At large warehouses, the work to be done is often complex. Here, logistics robots can help with such tasks as loading, packing, sorting and checking. Often a navigation tool is used, with robots handling a majority of all logistics by means of label reading. Goods are then moved on rails or conveyor belts to the correct transport or storage shelf, where the next robot can take over.

Robots also have great potential in modern agriculture. In countries that previously suffered from food shortages, better agricultural technology can be an important tool in achieving more efficient production. For example, John Deere − a US-based manufacturer specialising in farm and forestry machinery − has developed technology that uses the Glob-al Positioning System (GPS) and AI to do everything from sowing and ploughing land more optimally to analysing when it is time to harvest. There are also machines that optimise the dosage of fertilisers and pesticides, thereby lowering costs to farmers and reducing adverse environmental impact.

In the health care sector, the above-mentioned demographic changes are leading to structural growth, mainly due to the increasing health care needs of an ageing population. With


Machines are taking over

In 2018, machines and computers accounted for about 29 per cent of all work in the world. This figure is expected to increase sharply in the coming years, and by 2025 it is projected to reach 52 per cent, or more than half of all work.

Source: The Future of Jobs 2018 (World Economic Forum)

the help of AI, doctors can make diagnoses faster and tailor their treatment plans to individual patients, reducing staff workload and decreasing the risk of misdiagnosis. Robots can also do anything from providing assistance during surgery to disinfecting hospitals and acting like real-life patients during training sessions. The long-term consequence should be improved quality and safety in medical procedures.

A potential sustainability boost This trend also has positive effects from a sustainability perspective. Sustainability issues are becoming increasingly important, and the outlook for companies offering sustaina-bility solutions, products and services is promising. Given the potential improvements in efficiency, safety, quality of life and other areas, robots may be a key element in efforts to achieve the United Nations Sustainable Development Goals.

By lowering production and warehousing costs − thereby making it more profitable to decentralise these functions − we can reduce the need for transport, which the World Health Organisation (WHO) cites as one of the fastest grow-ing climate change villains. This is directly linked to the UN’s global Sustainable Development Goals, perhaps mainly Goal 13: Climate action.

Furthermore, thanks to robots, increased efficiency in agri-culture can help increase the food supply and decrease the use of harmful pesticides. Robots can also be used to inspect water pipes and other infrastructure.

Health care robots can assist the elderly and help achieve the goal of health and well-being. The list goes on. In the long term, this can contribute to such UN sustainability goals as No. 2 (zero hunger), 3 (good health and well-being), 14 (life below water) and 15 (life on land).

48

58

71

52

42

29

2025

2022

2018

Humans

Machines

Efficiency is driving robotics investment

In 2018, when McKinsey interviewed 85 companies about robotics, one parameter stood out clearly as the number one reason for investing. Cost savings are consistently among the most important reasons for the current robotisation trend in most sectors.

Source: McKinsey Global Robotics Survey 2018



The beneficiaries of robotisation In many parts of the economy, sectors and listed companies, robotisation can thus generate significant benefits in terms of efficiency and quality as well as from a sustainability per-spective. The beneficiaries include a wide range of compa-nies − perhaps most obviously the companies that deliver robots, but also those that most consistently take advantage of robotisation in their existing business. In both cases, the main beneficiaries are most likely to be found among indus-trial companies with relatively high technology content in existing or potential solutions, and among similar companies in medical technology, development of heavy machinery for agriculture, warehouses, etc.

Of course, these investments carry risks: mainly because these companies principally specialise in some form of indus-trial production and work business-to-business. This means their operations are cyclical, to a greater or lesser extent. They are sensitive to global industrial demand, especially from China, which accounts for much of the world's manufac-turing. There is a risk that a new escalation in the US-Chinese trade conflict, or a faster-than-expected deceleration in global growth, would hurt these companies and their share prices. However, for the long-term investor, this situation actu-ally creates interesting buying opportunities. The underlying trend is likely to continue driving the growth of robotisation in the long term.

Cybercrime is driving IT security shares

Because of IT attacks, the ISE Cyber Security Index − which follows 47 American IT companies − has generated substantially better returns than a global equity index over the past two years. In 2019 the return outperformed such an index by about 3.5 per cent, and in 2018 by more than 18 per cent (in USD).

Source: Bloomberg

Cybersecurity − From student network to global spider web

When the internet was commercialised in the 1980s and 1990s, probably very few people thought it would achieve today's incredible size and global presence. Today, we use the internet more than ever, for everything from communication to entertainment.

In the early days of the internet, a tightly-knit group of researchers and academics focused primarily on solving the critical technical aspects of the network, rather than the security aspects. Initially, it was impossible for outside parties to access the new network, and group members trusted each other completely.

20/20 hindsight? Nowadays the picture is almost the exact opposite. Using the internet today assumes that “everyone should be connect-ed to everyone” and “everyone should be able to access everything”. Individuals, businesses and public authorities in-creasingly manage their daily tasks digitally, given the speed and agility that the internet can often provide us. However, this places great demands on security and our ability to limit what information other users can access, in order to ensure that what we do online has no undesired consequences. The lack of security-mindedness in the early days of the internet is probably one of the reasons why the demand for IT security solutions has grown explosively in recent years.

Security online As more and more people choose digital work methods, this increases the incentives for criminals to join the digital scene too. Cybercrime is one of the fastest-growing security threats in the world. During the period 2011-2018, the annual num-ber of reported cybercrimes in Sweden (in the form of fraud) soared from about 20,000 to more than 135,000, equivalent to an average increase of 31 percent per year, according to data from Statistics Sweden.

One common way for individuals to obtain some digital pro-tection is to use antivirus software. For businesses, it is often a matter of several different solutions: for example, data encryption, protection of financial transactions and commu-nications security. Since few players in the cybersecurity market have the necessary technology or knowledge in all these areas, businesses often have to buy such services from a number of different suppliers.

The consequences for businesses that are victims of this type of crime or that mishandle customer data can be enormous,


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2015 2017 2019 2021Global cost of ransomware attacks, USD billion (LHS)

Time between ransomware attacks against businesses,seconds (RHS)


More attacks at higher cost

Data and IT systems are becoming more and more important to busi-nesses as digitisation rapidly increases around the world. Incentives for cybercriminals have greatly increased. This has led to a surge both in the number of attacks and their complexity, as well as the costs to the businesses that are affected.

Source: Cybersecurity Ventures, Kaspersky Lab

both financially and in terms of brand perception. This is why cybersecurity and digital information management have become two very important issues for most businesses. One study shows that 60 per cent of US small businesses that have been affected by a cyberattack have gone bankrupt within 6 months of the attack. Due to the serious consequenc-es, there is a growing trend towards preventive cybersecurity investments.

Globally, we thus expect cybersecurity spending to exceed USD 1 trillion during 2017-2021, and the value of the dam-age caused by cybercrime is expected to total about USD 6 trillion during the same period (source: Cyber Security Ven-tures). The size of these losses is one of the key drivers of the cybersecurity sector, which in both 2018 and 2019 produced better returns than the world stock exchange on average.

New EU rules can lead to huge fines The European Union’s General Data Protection Regulation (GDPR) is an important step in making the internet safer for private individuals. GDPR was adopted in May 2018 and regulates how companies collect and manage customers' per-sonal data. Businesses that violate GDPR rules can be fined up to EUR 20 million or as much as 4 per cent of annual global sales, whichever is higher.

In addition to financial consequences, inadequate manage-ment of personal data and cybersecurity often adversely affects a company's brand. The media are very interested in this type of incidents, and those that receive significant atten-tion can lead to lack of confidence, customer dissatisfaction and steep fines.

Important trends in the sector Attackers today use very complex methods, often based on artificial intelligence (AI). One of the fastest growing cybercriminal techniques is ransomware − illegally accessing someone's computer and encrypting its files. The attacker can then hold these files hostage and demand a ransom, often paid in a hard-to-trace currency such as Bitcoin. In addition, the affected company or person is often forced to buy "cus-tomer support" from the organisation that attacked them. The number of ransomware attacks rose by a full 350 per cent in 2018, according to NTT Security.

So where does AI figure in all this? Attackers often search for potential victims on social media. With the help of AI, they can scour LinkedIn, Instagram, Twitter and Facebook to profile a target. Then the attacker can send very realistic, tailor-made “phishing emails” and persuade a person to unwittingly give away sensitive information.

But don't despair − cybersecurity companies also use AI extensively. By training smart security software using AI, they can quickly identify potential risks.

Another important trend in the cybersecurity sector concerns what is known as the Internet of Things (IoT). Today not only are computers and mobile phones connected to a global net-work, but they have been joined by other technologies such as self-driving cars and smart home solutions. As a consequence of this “new internet”, there is an exponential increase in the number of connected devices around the world. By 2025, approximately 100 billion devices are expected to be inter-connected worldwide.

Smart solutions everywhere

The digitisation of urban environments, industry, health care and our own homes accounts for many of the world's interconnected devices. Who doesn’t want a refrigerator that automatically generates shopping lists, or the ability to turn on the heat at the summer cottage via mobile phone? The pie chart shows market shares of the Internet of Things by sub-sector.

Source: GrowthEnabler

Smart cities

IndustryHealth care

Connected homes

Connected cars

UtilitiesWearables Other

26%

24%20%

14%

7%

4%

3%2%


15.417.7

20.323.1

26.7

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2015 2016 2017 2018 2019 2025


However, the combination of automation and communication in these devices will require a high standard of security in the future. For example, who would want to climb into a self-driv-ing car if a hacker could suddenly take control of it?

Important infrastructure such as power generation plants, hospitals, bridges and traffic signals is also at risk for cy-berattacks. Due to a ransomware attack on one major French hospital in November, staff members were forced to limit themselves to emergency care only, since their 6,000 computers were shut down. Unfortunately, there are many potential targets for cybercriminals seeking to inflict harm.

A fast growing, highly competitive sector One of the key risks for cybersecurity providers is the very rapid technological development in the sector. New products and services can quickly make existing technology obsolete. This means that companies can suffer from hard-to-predict changes in growth and competitive conditions. Cybersecurity companies generally also have narrow product offerings and are heavily dependent on patents and intellectual property rights. This means there is high company-specific risk to their profitability.

Fraud stands out in the statistics

In Sweden, the number of computer fraud cases increased almost sev-enfold over an eight-year period. Fraudsters are using complex AI-based methods to profile their victims and send realistic phishing emails that trick them into giving away sensitive information.

Source: SCB

0

50,000

100,000

150,000

200,000

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2011 2012 2013 2014 2015 2016 2017 2018

Computer fraud casesFacilitated by the internetAll fraud cases

Continued major investment potential Because of rapid development, the cybersecurity sector is fragmented and includes many niches. Numerous fast-grow-ing companies in these fields offer good potential, but given company-specific risks, a broader exposure through a the-matic fund or thematic exchange-traded index fund may be preferable. In this way, investors can enjoy a more balanced exposure, while limiting the influence of short-term share price fluctuations in individual equities.

As part of the broad digitisation trend, we have seen sig-nificantly increasing market interest in this type of equity investment. As a result, valuations are already relatively high. At the same time, growth prospects are very strong and potential economies of scale can make acquisitions a positive driving force in both cybersecurity and robotics in the future. The need for, and benefits of, these products and services is growing every day as technology advances.

An interconnected world

Our new addiction to being constantly online opens the doors for digital criminals. The number of interconnected devices is growing exponentially as everything from infrastructure and hospitals to cars and smartphones increasingly seeks to utilise digital functionality. Criminals strike quickly when holes in data security open up.

Source: Statista

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ions

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ces


28

Brexit – the United Kingdom’s withdrawal from the European Union – and its consequences have been on the agenda for more than four years. It has indeed been that long since then-Prime Minister David Cameron called for a referendum on the country’s EU membership.

After last December’s general election, when the ruling Conservative Party and its leader, Boris Johnson, won a landslide victory, it now appears that we are nearing the end – or in any case, the beginning of the end.

Landslide victory in the December 12 election The Conservative (or Tory) Party campaigned to leave the EU based on the new EU-UK agreement reached in the late autumn of 2019. In the negotiations, the new prime minister, Boris Johnson (sometimes called BoJo), managed to remove the so-called “backstop guarantee” that risked forcing the UK to remain in the EU customs union until a new trade agreement guaranteeing there would be no hard border between the Republic of Ireland and Northern Ireland was in place. The backstop was instead replaced by a rather complicated solution for Northern Ireland, which will continue to follow many customs union rules even after the UK leaves the EU. The election was a landslide victory for the Conservative Party, which won 43.6 per cent of the votes and a clear majority in the House of Commons. The general election was in many ways an election about Brexit; the Tory electoral victory confirmed the 2016 referendum result and must be regarded as a clear mandate from UK voters that they were ready to leave the EU on January 31, 2020.

What will happen now? As early as December 20, the House of Commons voted 358-234 – by a majority of 124 – in favour of the prime minister’s withdrawal agreement and its plan to leave the EU on January 31. This was followed by frantic political activity in the British Parliament aimed at getting all the pieces of the puzzle in place ahead of withdrawal.

Theme: Brexit

BoJo, Brexit and the pound in 2020


Transition period until December 2020 On January 31, the UK formally left the EU. The rules for the so-called transition period, which are part of the withdrawal agreement, then replaced membership rules. The transition period runs until December 31, 2020, during which time the relationship between the UK and the EU will in practice be the same as before, except that the UK will no longer have any political influence in the EU. Thus no major differences will be apparent this year, although the UK is no longer an EU member.

New negotiations New EU-UK negotiations will soon start up, aimed at reaching a free trade agreement that will eliminate trade barriers and can take effect on January 1, 2021. June 30 is a critical date since it is the last day the UK can request an extension of the transition period if this should be necessary. The EU can accept an extension of up to two years, but the Johnson government has ruled out such an extension and has even included a ban on extending the transition period in the legislation governing the UK’s withdrawal from the EU.

On December 31, 2020 the UK will leave the EU in practice, and a new trade agreement is intended to take effect then. If no new agreement is in place and no extension of the transition period has been activated, there is a risk that the UK will end its transition period without a trade agreement, which could mean that trade between the EU and the UK would then be based on World Trade Organisation (WTO) rules.

What kind of agreement does the UK want? The UK is apparently aiming for a trade agreement that, first of all, covers all trade in goods between the EU and the UK. Recently, Mr Johnson has spoken increasingly about also including trade in services.

People often cite the free trade agreement between the EU and Canada – the Comprehensive Economic and Trade Agree-ment or CETA – as a model for how the EU-UK agreement might look. CETA is the most wide-ranging free trade agree-ment the EU has negotiated to date. It covers, among other things, customs duties and rules governing trade in goods and some services, intellectual property rights and public procure-ment. The agreement also provides opportunities for continued close collaboration between the EU and Canada.

It took a total of seven years of negotiations and various delays before the EU and Canada were able to sign this agreement.

One reason was that all national parliaments must approve EU trade agreements. In the case of CETA, for instance, the Wallon-ia region of Belgium used its veto right to hold up approval by the Belgian parliament. Wallonia demanded that the agree-ment contain stronger labour, environmental and consumer protections.

Bulgaria and Romania also refused to approve the agreement as long as Canada did not abolish its visa requirement for citizens entering Canada from the two EU countries. So it took about seven years to negotiate and gain approval of the CETA pact, and this is something the UK government now plans to do in less than one year.

Although the circumstances are completely different – for instance, identical laws are initially in effect in the EU and the UK – it feels like quite an ambitious plan, and the risk of failure cannot be ruled out. In particular, there is the risk that a single EU country will oppose the agreement for some reason. One solution might be to negotiate the agreement in different phas-es, starting with the most critical areas and then expanding the agreement and adding further details. Should the ratification process in the national parliaments be drawn out, it also seems possible that the agreement could be allowed to take effect temporarily and then apply officially as soon as the European Parliament approves it.

Trade agreement negotiations to drive the exchange rate In recent years the exchange rate of the British pound has been dominated by Brexit, and the probability of UK with-drawal without an agreement has determined the rate. The increased likelihood of a hard Brexit weakened the pound, and vice versa. Since last summer, the risk of a hard Brexit has decreased because of the new withdrawal agreement and the new UK government; as a result, the pound strengthened by nearly 1 Swedish krona during the autumn. Going forward, trade agreement negotiations will drive the exchange rate. If negotiations go smoothly, the pound will probably appreciate somewhat from today’s level. But if negotiations go poorly, with an increased risk that the transition period will end without an agreement, this will be reflected in a weaker pound.

Brexit and the turbulence surrounding Brexit have been ongo-ing for more than four years now, and we will have to put up with this for at least another year. However, it now seems we are at least seeing the beginning of the end.

Theme: BoJo, Brexit and the pound in 2020


Contributors to this issue of Investment Outlook

This report was published on February 4, 2020. Its contents are based on analysis and information available until February 3, 2020.

Kai Svensson Acting Chief Investment Officer Investment Strategy [email protected]

Johan Hagbarth Economist Investment Strategy [email protected]

Jonas Evaldsson Economist Investment Strategy [email protected]

Gustaf Blidholm Economist 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]

Cecilia Kohonen Investment Communication Mgr Investment Strategy [email protected]

Elisabet Törnered Trainee 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.

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Investment Outlook February 2020 - SEB Group · Summary by asset class helped push valuations and risk appetite to historically high levels, which is currently dissuading us from