iShares MSCI Sweden ETF: Not At This Juncture (NYSEARCA:EWD)

Prices change when events are different from what the market has expected them to be. – Peter Bernstein

As noted in last week’s “Leaders-Laggards” section of The Lead-Lag Report, international stocks haven’t quite been able to gain any meaningful traction over U.S. equities. Within international stocks, the European region, in particular, has proven to be a difficult terrain this year, with the iShares Core MSCI Europe ETF (IEUR) delivering negative returns of 18%. If you thought that was bad enough, how about the iShares MSCI Sweden Capped ETF (NYSEARCA:EWD) which focuses on 47 Swedish stocks, which has fared a lot worse, giving up one-fourth of its market cap on a YTD basis.

Given the correction we’ve seen this year, should you be considering EWD?

Key themes

Well, to be honest, I don’t think it is the most opportune time to be looking at Swedish equities. Large parts of the country are well in the throes of election fever, with the main event set to kick off next month. Historically, equities rarely tend to provide steady returns when a country is in the midst of election fever. I could understand getting on board if the polls suggested that a certain party was well on course to win the elections, but that does not appear to be the case in Sweden, as there’s not an awful lot to choose between the warring parties.

Admittedly, the Social Democrats (S) have managed to gain some traction from the previous poll in Nov 2018, but reports from Sweden suggest that there’s still no clear coalition that could stake a majority claim. With an ambiguous political environment such as this, expect Swedish equities to be hamstrung by heightened volatility.

Just to reiterate my point, also notice how EWD’s standard deviation has picked up in recent months and is currently at a rather elevated level of 27.56%

Besides, as noted in the “Closing Thoughts” section of last week’s edition of The Lead-Lag Report, the China/Taiwan rumblings have the potential to upend the volatility quotient across global markets, and wedging yourself to a high-beta play such as EWD (beta of 1.24x) isn’t the most sensible strategy at this juncture. Separately, if you’re interested in better understanding some of the broader risks that could germinate on account of recent Chinese-related tensions you may consider listening to my chat with Michael Pettis.

The other major theme worth considering is EWD’s strong exposure towards industrial stocks, which account for almost 40% of the total holdings. I’ve touched upon the European energy crisis in some pieces in The Lead-Lag Report, and Sweden is yet another European country that has had to deal with this unsavory situation. Swedish industrials in particular have had to take it on the chin as it has totally upended their operating cost bases. Consider the trajectory of producer prices which are currently growing at record highs of 25% on an annual basis, and much of this is down to pressure in the energy-related product segment, which was up by a whopping 82% in June.

It isn’t just the energy issue. Chinese-related lockdowns have also battered the supply chain, and these industrialists are hardly in the best position to pass on all these costs when consumer inflation in the country has reached its highest point since the late ’80s. In an environment such as this, it is no surprise to discover that consumer confidence in Sweden has plummeted to its lowest level in nearly three decades.

Spreading the net beyond industrials and consumers, it’s not as if the broader economy is expected to be just fine. Whilst GDP growth in Q2 came in at 4.2%, and was better than the 0.4% growth seen in Q1, the periods ahead will see a dramatic slowdown. The government only expects 1.9% growth for the FY, which means H2 will likely be a lot slower than the 2.3% growth seen in H1. The slowdown is not expected to stop there, as growth in FY23 will likely come in even lower at only 1.1%.

Conclusion

Despite the pronounced drawdown of EWD this year, relative to its compatriots from Europe, the valuation picture hasn’t improved a great deal. EWD still trades a pricey forward P/E of 15x, which represents a ~27% premium over IEUR’S corresponding multiple. Given some of the other risks that I’ve covered in this article, it would probably make sense to sit on the fence at this juncture.

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