Sweden is first to Reverse the Negative Course

Sweden is first to Reverse the Negative Course

We’ve written before about the continued unprecedented monetary policy from Central Bankers in this elongated cycle. During this past week (third week of December), we had the first break from the pack. For this we can thank the Swedish Central Bank, the Riskbank, which raised it’s Repo rate by 25 basis points. This brings the Swedes out of a negative policy rate environment that they have been in for five years.

There are several reasons why this is very notable. First, Sweden was the first Central Bank to attempt negative rates in this cycle. Having been at this for the longest period, they have the most experience with its effects. They have been at it long enough that a research paper from Harvard University[1] used Swedish Banking data in a report critical of the practice entitled “Negative Nominal Interest Rates and the Bank Lending Channel”. Second, Swedish policymakers had recently expressed what many of us are thinking – continued negative rates distort the behavior of households and companies in an adverse fashion. Third, Sweden is a small country with their own currency. Breaking from the pack and raising interest rate differentials risks strengthening the currency and therefore, weakening exports and possibly the economy. The economy they are stewards for will incur at least some small damage from this move. Yet they are willing to take this risk.

Why are we in this position in the first place? Policymakers have been so determined and frustrated in their attempts to avoid deflation that they have been willing to try ever more daring tactics with often minute benefits. Sweden is interesting in that, not only were they the first to employ the negative rates, but they held them negative while the economy strengthened. See Below. Sweden’s Consumer Price Index did increase within the past five years, and even reached the desired 2% level over several of the months in the second half of 2018 and the first half of 2019. It would seem to be an odd time to alter the approach given that inflation has trended down in the last six months. Forward expectations are not for stronger inflation, but weaker figures. Therefore, what we can surmise, is that the Riskbank realizes that there is significant damage that has been caused in the foundation of the economy in relation to savers, banking, “zombie” companies and the overall allocation of capital and resources. Credit to them for willing to try something different than the crowd.

Sweden Consumer Price Index

One factor that has been increasingly raised is that inequality and populist political parties are gaining from the extraordinary monetary policy that has been exhaustively used. Allowed to persist, this could threaten the independence of Central Banks. Therefore, self-preservation could have been in the minds of the Riskbank policymakers. The reality is that this move may not last long. The Swedish economy is weak enough that even more tepid results could call for action, and negative policy rates are still a plausible solution to many in Central Banking circles. The move does give some solace to those of us that allocate capital in the markets, and wonder how policymakers cannot see the trouble in $12 trillion of bonds priced to yield a negative return to maturity. The cost benefit analysis of central bank policymaking may just have struck a reversal back towards neutral.

Strategy Performance

International All-Cap Value returned 0.71% (gross basis) in November 2019 versus 0.99% for the benchmark. Year to date performance was 15.32% (gross) versus 16.63% for the benchmark.

Global Small Cap Value returned 1.67% (gross) in November 2019 versus 2.91% for the benchmark.[2] Year to date performance was 14.84% versus 18.64% for the benchmark.

Top Contributors and Detractors

International All-Cap Value’s top contributor was YY, Inc. The Chinese internet software company returned 12.2% in the month of November as Third Quarter user base and sales exceeded expectations. The top detractor in the strategy was Banca IFIS. The stock declined -11.5%, as the Italian Bank announced that negotiations regarding a consolidation opportunity they were pursuing had come to a close.

Global Small Cap Value’s top contributor in November was Chico’s FAS. The U.S. women’s fashion retailer returned 38.7% in November as results calmed persistent fears about the company’s future. The top detractor in the strategy was Gaslog Partners LP. The stock declined -24.2% as investors continue to fear that LNG markets will be oversupplied. Such an imbalance could leave the company vulnerable to declines in shipping rates for their LNG vessels.

[1] “Negative Nominal interest Rates and the Bank Lending Channel”, Harvard University, Brown University and Norges Bank.

[2] Benchmark for Global Small Cap Value comprised of 50% weight iShares Russell 2000 Index (IWM) and 50% weight Vanguard FTSE All-World ex-US Small-Cap ETF (VSS)