The Northern Light

On the back of the US-China trade war, global equity markets have felt the heat in August. As a consequence, fund managers have faced multiple challenges on strategic allocation across various asset classes.

Some strategists view this as an “Art of the Deal” negotiation style, as a number of investors anticipate that some sort of agreement between US and China will be reached. Such investors may view this period as an entry point on particular asset classes or sectors that have been heavily hit during this trade war. However, more cautious investors prefer to be exposed to less volatile, safer assets -particularly sovereign bonds. Whether a trade deal will take place or not is still uncertain.

The trade war has caused uncertainty in a global economy that is already facing contractions in manufacturing activity and waning economic growth, resulting in a compression for global yields. When you combine deteriorating macro data with the trade-war, volatility is here to stay. In this type of environment, one could reduce downside risks using strategic positioning with a low correlation approach to the global market. Norwegian assets, for instance, can potentially provide a hedge with the adequate right risk-return profile.

Just to put the reader into context, Norway was voted the world’s most resilient country in 2019, according to a report from commercial property insurer FM Global. The resilience index ranks 130 countries and territories according to their resilience to disruptive events. It ranks countries by economic productivity, political stability, control of corruption and corporate governance.

In comparison with Malta, Fitch’s credit rating for Norway stands at AAA with a stable outlook, while Fitch’s credit rating for Malta stands at A+ with a positive outlook. Back in 2009, Malta managed to weather the euro-zone crisis better than most EU member states due to a lower debt-to-gross domestic product (GDP) ratio and backed by a sound banking sector. To get things into perspective, the Maltese debt-to-GDP ratio stood at 46%, as in 2018, while Norway recorded a government debt equivalent to 36.2% of the country’s GDP in 2018. The average Euro-Area debt-to-GDP stands at 85%.

Both countries have different models; Malta is dependent on foreign trade, manufacturing, tourism, and a net importer of energy sources. Malta joined the EU in 2004, while Norway opted out of the EU during a referendum in November 1994. The country has an abundance of natural resources in addition to oil and gas, including hydro-power, fish, forests, and minerals. Norway is the second world’s largest exporter of seafood, after China and is one of the world’s leading petroleum exporters. Additionally, in anticipation of eventual declines in oil and gas production, Norway saves state revenue primarily from petroleum sector activities in the world’s largest sovereign wealth fund, valued at just below $1 trillion.

When compared to other Euro zone countries Norway and Malta boast higher than average Year-on-Year (YoY) GDP growth figures, lower unemployment figures, lower debt-to-GDP ratio and an attractive current account balance. Coincidentally, both football teams have also been drawn in the same World Cup Qualifiers group and will be playing each other on September 5th.

The OBX Index, the Norwegian equity market, reported gains of 3.1% in Euro terms, while the Eurostoxx 50 Index reported gains of 12.2% Year-to-Date (YTD), as at the time of writing. The European and US markets were set tumbling at the end of July as the Federal Reserve reduced US interest rates by 0.25%. This sparked a sell-off since investors had been hoping for more stimulus. Additionally, the re-emergence of a trade war put pressure on the global equity market in August, as the VIX and V2X indices (US and European volatility indices) reached levels last seen at the beginning of the year.

During these events (up to the 26th August), the Eurostoxx 50 Index and S&P 500 Index fell -5.40% and -5.91% respectively, while the OBX index fell by -3.7% in Norwegian Krone. The only equity markets to have fallen less in this environment are the Maltese and Swiss equity market (falling -1.2% and -2.2% respectively). It must be pointed out that on a YTD basis, the Maltese equity market holds a negative correlation versus the Eurostoxx 50 index.

The argument here is that in a downturn market, both the Norwegian and Maltese equity market may be less susceptible to the trade war jitters. The correlation on a YTD basis between the Norwegian equity market and the S&P 500 Index stands at 0.55, while the correlation YTD of the European equity market to the S&P 500 Index stands at 0.73. A primary benefit of assembling a portfolio with a low correlation is a reduction in the volatility of the overall portfolio returns.

Looking at the components of the OBX Index, it comes to no surprise that 50% of the index is composed of two major sectors, the Energy and Consumer Staples, where on a Total Return YTD basis these two major sectors have returned -7.9% and +22% respectively.

Therefore, allocating to the right thematic or sector in place is essential. If one had to be exposed to specific holdings in the Norwegian consumer staples sector double-digit returns could have been achieved. A number of Norwegian consumer staple companies listed on the OBX Index have provided Return on Capital Employed ratios of over 20% for the last three years, along with attractive margins and current distribution yields close to 4.5%. Several Norwegian companies in this sector have substantial room for growth, with a number of stocks trading at 15 times earnings.

Having a diverse revenue segmentation is another crucial consideration when picking certain stocks as geographical diversification will generally and likely shield earnings of a company from political risks. To conclude, the Norwegian theme would mean adding Norwegian krone to a portfolio; which comes with the added benefit of adding a “safe” currency based on the robust economic data mentioned earlier but should also be considered in the context of the currency being correlated to the price of Brent oil. As a reminder the Norwegian economy is highly dependent on the petroleum sector, therefore sudden movements on the commodity may influence your ultimate underlying investment.

Mark Muscat, B Com (Hons) (Banking and Finance), M Sc (Melit), is a Financial Analyst at Jesmond Mizzi Financial Advisors Limited. This article does not intend to give investment advice and the contents therein should not be construed as such. The Company is licensed to conduct investment services by the MFSA and is a Member of the Malta Stock Exchange and a member of the Atlas Group. The directors or related parties, including the company, and their clients are likely to have an interest in securities mentioned in this article. Investors should remember that past performance is no guide to future performance and that the value of investments may go down as well as up. For further information contact Jesmond Mizzi Financial Advisors Limited of 67, Level 3, South Street, Valletta, on Tel: 2122 4410, or email [email protected]