Stock market rally has worryingly narrow shoulders

Interest rate expectations have fallen in the market at lightning speed. Investors are already looking to the post-inflationary period, which is reminiscent of the years before the pandemic. A fall in interest rates would be positive news, especially for mortgage borrowers and many equities. 

To celebrate the Independence Day of Finland, let’s look at the historical returns of the Helsinki Stock Exchange. Then we look at the inflation figures and the Finnish economy. Interest rates are coming down, which is good news for Finland whose economy is in the doldrums. Finally, we look at the narrow shoulders of the global boom market. Few stocks are still rising, which is bad news for the continuation of the bull market.

Nasdaq Helsinki is one of the best stock exchanges in the world

For Independence Day, I have traditionally talked about the long-term returns of Nasdaq Helsinki. Although it doesn't feel like it right now, Nasdaq Helsinki is one of the best in the world in terms of total returns. From gaining independence in 1917 until today, the real total return of the Helsinki Stock Exchange has been around 5.8% per year. €100 in 1917 has turned into €39,000 today, adjusted for inflation.

 

Total returns include reinvested dividends. Since investing is about increasing one's purchasing power in the future, the erosive force of inflation is factored into returns. The Helsinki Stock Exchange is historically one of the world's best, although its history includes a bloody civil war, politically unstable times, two world wars and a collapse in the value of money, the inflation of the 1970s, high taxation, the terrible recession of the 1990s, the euro crisis and, most recently, the scourge of what the Investment Forum calls the “scam market”. If anything, this shows how it pays to keep at least some of your money in productive companies, as the value of Finnish cash has been eaten away many times over by inflation. In a surprisingly unstable period of independence, there are several of them.

Finnish companies have done well in the world; you can see KONE lifts, Huhtamäki coffee cups, Revenio tonometers, Marimekko dresses, Harvia saunas, Outokumpu steel, Konecranes cranes, Wärtsilä marine engines, Nokia network equipment or even Qt software almost everywhere. Well, you'd need an access card to run into some of them, but you catch my drift.

There were so many companies on the Helsinki Stock Exchange in 1917 that the number was not reached until the late 1980s. Freedom for foreign investors only came in 1992. The stock market practically lay dormant during this 60-year period. Thus, the history that is more relevant for today only begins in the 1990s. In 1992, the stock market was blatantly cheap, so let's take 1990 as a starting point. Since then, the stock market has returned more than 8% per annum in real terms. The corresponding return for the S&P 500 index is just over 7%. In contrast, due to Nokia's spectacular rise and dramatic demise, the stock exchange’s returns in the 2000s have been weaker. I have used a general index to calculate returns, where the weight of Nokia is not limited. However, it is an depressively realistic description of the evolution of the wealth of the nation as a whole. However, in recent history, the stock market has performed reasonably well. The weighted index has risen by 8.5% per annum in nominal terms over the last 10 years.

Long-term returns are real, but they do not reflect the day-to-day experience in the stock market. Nasdaq Helsinki has been and still is very volatile. In the frenzy of the late 90s, the stock market rose by +160% in one year at best. In turn, the stock market fell for three years in a row in the early 2000s, going down more than 30% in two of those. In the 2008 financial crisis, the stock market halved. In this sense, the bear market of recent years has been relatively mild at the general level of the stock market, although individual companies have received a proper beating.

Inflation falls rapidly in the eurozone and Finland 

Inflation in the eurozone is coming down promisingly. According to preliminary data, the general price level rose by only 2.4% on an annual basis. Core inflation, which is monitored more closely by the central bank, rose by 3.6%. On a monthly basis, the price level fell by 0.5%, although month-on-month inflation is often bouncy. Overall, the data is on the right track.

 

Inflation is expected to recoil slightly in December due to energy prices, but market forecasts expect inflation to return below the 2% target as early as next summer.

With the recent general fall in market interest rates and weak economic data, expectations of movements in the ECB's policy rate have fallen rapidly and sharply. Where previously the longer-term interest rate was forecast around 3%, the policy rate is now expected to fall to 2% in the near future. These are just guesses about future developments, but they are the best the market has to offer.

Finland's economy, which is more sensitive to interest rates than many other eurozone countries, is holding on for its dear life, which is why a rapid fall in interest rates would be welcome news for the Finnish economy.

In Finland, prices peaked in the spring. Since then, prices have fallen on a monthly basis. According to recent data, Finland's GDP fell by 0.9% in the third quarter. In virtually all sectors except the metal industry and transport, the economic situation deteriorated sharply.

Every component on which economic growth is built fell: private and public consumption, exports, imports, and investment. Everyone knows the plight of the interest-sensitive construction sector. For example, building permits and construction starts are at their lowest levels in the 21st century. The weak Finnish economy is not a problem for our many large listed companies with international markets, but Finland-driven companies are not having an easy time. This is reflected in the depressed share prices of small companies.

Stock market rally has worryingly thin shoulders

The global boom that began a year ago started with a bang, but this year its shoulders have shrunk alarmingly. As I have pointed out in several posts, the rise in stock market indices is basically explained by the rise in the share prices of mega-techs such as Apple, NVIDIA, or Microsoft. Other stocks have been going horizontal.

There is nothing strange about such a development, but it is worrying for the sustainability of the rise. This graph by Jurrien Timmer shows the cumulative ups and downs of the S&P 500 index at the top. At the bottom of the graph, the percentage of companies that have outperformed the S&P 500 index over a 12-month horizon is highlighted by the power of the color scale. The larger the percentage of companies that beat the index, the broader the rise, and vice versa.

 

In January 2023, 65% of companies had still outperformed the index. Now that figure is down to 25%. Such similar bull market spearheads have occurred ominously in the wake of the tech-bubble burst in 1998-2000 and in January 1973, just before the infamous down market of the 1970s.

Here is the same graph but the top panel has been changed to an inflation-adjusted S&P 500 index, which visualizes the essence of bull and bear markets even better. The turbo bear market of the 1970s, which lasted more than 10 years, was not merciful to shareholders. In the early 70s, winning shares were known as Nifty Fifty, many of which were trading at exorbitant valuation multiples. They really took a beating in the ensuing bear market.

 

The good news is that the tech-bubble burst in the early 2000s, for example, affected the very stocks that had been winners in the late 1990s. Thus, the majority of stocks outperformed the index in a bear market.

In fact, many companies, such as Warren Buffett's Berkshire Hathaway, which invests in the most traditional businesses, were already in a down market during the general upturn. Such stocks, in turn, performed well later when tech stocks rebounded. As I like to say, every market has its winners. While other investors were buying the hottest dot-com stocks at any cost, there was time for smart investors to quietly accumulate a portfolio of traditional businesses at a low price. Time will tell whether the same pattern will be repeated this time as investors' attention flocks to the AI hype.

These bad bear markets were triggered by the recession. While stocks anticipate - or at least try to anticipate the future - most of the historical down markets have coincided with a recession. This interesting Bank of America graph shows the decline of stock markets from the peaks to the bottoms during the recession and also calculated from six months before the recession. In practice, investors panic when the economy rumbles. Of course, it must be pointed out that these are obvious things only in retrospect. The economy is such a complex beast that recessions are often only noticed afterwards. Thus, at the very moment when stocks are falling, the economy does not necessarily seem to be in recession. This is something to keep in mind in case the US and the global economy really does slip into recession at some point in the future.

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