Breakout Market: Norway
February 5th, 2018
Following the largest ever daily drop of the Dow and nearly 4% pullback of the S&P, some investors may be wondering whether the U.S. equity market’s spectacular run is coming to an end. Although many fund managers and analysts believe there are still sunny days ahead, it is worth considering options outside of the U.S. to further diversify an American-heavy portfolio and seek substantial returns. Recent interest by professionals in broad-indexed European equity ETFs has been peaking, but over-diversification throughout the European market may dampen returns for investors willing to take on slightly higher risk. Substantial gains can be made in the next 12 months in specific country markets at limited risk.
Based on political, economic and financial analysis, Norwegian markets look set to provide meaningful returns. From a political standpoint, the last few years have been wearing on European investors. The recent rise in populist nationalism and Euroscepticism has raised concerns about the future of the Eurozone, the Euro, the continent’s regulatory environment and a host of other factors. Although the dramatic throes of politics do not equate policy, political instability and uncertainty can have significant impacts on market pricing. However, after the upcoming Italian elections in early March, Europe will finally have a respite from the recent political elective turmoil. Norway stands as a developed economy with a relatively calm political environment, thus providing a baseline level of investment security that will further improve in the coming year. This immediately removes a significant amount of politics-induced volatility from the market. This is good news for investors, yet despite a relatively positive political outlook, it is important to note some remaining threats. Although political risk and instability levels should lower across Europe in 2018, the UK’s continued negotiation of the Brexit agreement and subsequent trade negotiations and re-negotiations should be monitored for their impact on Norwegian markets. Fortunately, these talks should be relatively slow moving, giving markets sufficient time so as not to overact.
Norway also looks strong from an economic and financial perspective. Markets have held onto upward momentum, with the Oslo Børs All-share Index (OSEAX) showing an almost 18% positive return in the past 12 months and a cumulative 23.8% return two years prior. The weighted index, which tracks the shares of all companies listed on the exchange, also shows a relatively strong correlation to GDP (as shown below). With an expected rebound of Norwegian GDP following a two-year slump in oil prices, this bodes well for future positive market performance.
Perhaps the most significant threat to the Norwegian corporate equity market is the expected rate hike in the coming year by the central Norges Bank. The Bank’s key interest rate has sat at a record low of 0.5% since March 2016 but economists expect an increase of around 0.25% by the end of the year. Higher rates bode poorly for the Norwegian equity market as they are likely to decrease overall business investment and consumer spending, thus driving security prices down. Additionally, subsequent rate hikes could entice a gradual shift by institutional investors away from equities and into the capital markets, an additional blow to pricing. However, analysis shows that any substantial increase in rates by Norges Bank beyond 0.25% is unlikely through the end of 2018. Although wage-driven inflation approached 4.5% in 2016, inflation has since dropped dramatically to a low of just 1.1% this past November. Projected inflation rates are expected to fall short of the desired 2.5% in the coming 12 months, limiting the central bank’s likelihood of a hawkish tightening of monetary policy. On the other hand, projected inflation rates may not sufficiently acknowledge the recent sharp decline in value of the Norwegian Krone. As shown in the graph below, the USD/NOK rate has dropped from close to 8.50 to nearly 7.50 in the past 80 days. A weaker currency means more money is needed to exchange for imported products, thus driving up CPI and inflation rates. Although this could conceivably result in an opportunity for a more hawkish central bank, further analysis shows this will not be the case. First, a weaker currency will make Norway’s exports more competitive on the world market, thus increasing Norwegian exports resulting in an increase in the trade balance. This will serve to boost output, a positive for the equity market. Secondly, even if inflation surprises economists’ expectations, continued rate hikes will be gradual owing to Norway’s high levels of household debt. In order to avoid a significant increase in defaults, Norge Bank is likely will raise rates slowly to ensure higher prices correspond with wage growth.
Through analysis of a variety of factors, Norwegian equity markets look set to continue their upward trend. The best financial tool to gain diversified Norwegian exposure is through Global’s MSCI Norway ETF (NORW). The ETF currently consists of 61 of Norway’s largest companies by market cap and is heavily concentrated in energy, however, it tracks a standard MSCI 25/50 index so as to avoid over-allocation on specific companies. That being said, it does have major holdings in a select few organizations including Statoil ASA (STO) which has been making upward moves for almost two years. Should swings in crude oil prices shake Statoil, this could be a warning bell to exit the market. Look for NORW to reach $17.00 up from $13.78 by the end of year (60% probability).