Special Edition: Finnish economy returns to flatlining

In this special episode of What’s Up with Stonks, we will focus on the Finnish economy. The economy is going into a small recession and then continues on its familiar path of slow growth. The construction sector is in a slump, but there may be interesting things to pick up from the most hated sector of the stock market. In addition to the gloom, this post will also point out some bright spots in the Finnish economy. However, long-term economic growth requires decisive action from politicians, which is not necessarily something you can count on too much.

Special Edition: Finnish economy returns to flatlining

In recent days and weeks, banks and various institutions have published forecasts and reviews of the Finnish economy. Let's synthesize them.

First, a quick note from an equity investing perspective before jumping into the topic. Nasdaq Helsinki and the Finnish economy have very little to do with each other, despite what you might think. Both are flatlining, but independently of each other. Let's look at the Finnish share of turnover of our top 10 listed companies. Nordea, Finland's most popular stock, generates just over a fifth of its revenue from Finland. For Nokia, the share is estimated to be less than half a percent. Fortum gets a good 70% of its revenues from the Nordic countries, but unfortunately, I couldn't find out exactly what the Finnish share is. Among the blue chips, Elisa and Finnair get more revenue from Finland.

Large companies have production, R&D and headquarters in Finland, so the availability of skilled labor and a positive investment environment are of course important.

When you descend among the smaller companies, Finland is highlighted as the main or only market. For such companies, the long-term development of the Finnish economy is naturally critical.

However, the general index of Nasdaq Helsinki is driven by large companies, so the stock exchange is more in tune with the global economy. I understand that about two thirds of our listed companies' sales come from Europe, which is also characterized by sluggish economic growth. China is an important market for many companies. For example, more than a third of KONE's turnover, just under a fifth for Valmet, 10% for UPM and 8% for Wärtsilä come from China. (This is why I’m so eager to bring up China news in these posts.)

But now, let's get to it. As you all probably know, the Finnish economy is cooling or hanging out in some kind of recession at the moment. A recession is defined as a situation where GDP falls for two consecutive quarters.

If we are talking about a recession in other respects, we are talking about a real depression in the construction sector, but otherwise the situation is not gloomy so far.

I spotted the National Audit Office's heat map of Finland's economy in Marianne's (Inderes’ economist) recent macro comment. As you can see, the only thing that is blushing hot is inflation. Otherwise, confidence has eroded, especially in construction and industry.

This heat map can also be viewed as a composite index, which slams those numerous categories together. It shows that Finland's economy is plunging like in the financial crisis and is now at the level of the economic apathy of the 2010s.

Forecasters at the Bank of Finland and Danske Bank expect the economy to enter a mild recession this year and then return to its familiar slow growth path. Danske's forecast is for a 0.2% fall in GDP, while the Bank of Finland's forecast is for a 0.4% fall. The projected decline is not large, but Finland's economy may grow at just under 1% annually over the next few years, so a drop of even a tenth of a percent is an actual setback. Nordea estimates that the Finnish economy will stagnate this year and next. No recession, no growth. Nordea forecasts inflation to fall to an already civilized 2% next year.

Against recession forecasts, the Bank of Finland's sentiment indicator has so far developed positively, which again underlines the grimness of the situation.

So far, the employment situation has remained strong in Finnish standards. The unemployment rate is just over 7%. The employment rate, i.e., the proportion of people of working age who are in work, is approaching 80%. However, the cyclical peak in the labor market is behind us, as the ratio of job vacancies to jobseekers is falling. As investors will have noticed, many listed companies have also announced efficiency measures and job cuts.

However, the Finnish labor market remains tight, with one job for every three unemployed. However, the labor force does not seem to match the jobs, i.e., the skills of the unemployed do not match the job vacancies.

A strong labor market supports wage growth. As inflation slows at the same time, Finns' purchasing power will increase again. Finns' real earnings, or how much you get for a euro in a shop, plummeted to the levels of the financial crisis during the inflation and energy crisis, but the cause for celebration is that real earnings have started to grow again. This should support domestic consumption.

However, wage inflation is eroding the profitability of listed companies. For example, a recent Inderes review of the IT services sector, including Gofore, Witted, Siili and Vincit, shows how increased competition for customers is driving down prices while wage costs are rising in the staff-intensive developer business. It can be difficult for expert listed companies, such as these dev houses, to pass on increased wage costs to their clients. Thus, their profitability suffers.

Consumer confidence in Finland has recovered from the energy crisis, although it is still weak. Although macro-indicators like these would lead you to believe otherwise, Finnair and restaurant giant NoHo partners are doing well in their home markets. Finns are traveling abroad and spending the evening in restaurants, while complaining about the poor economic outlook. Caricaturedly, the reduced purchasing power due to inflation is being allocated to restaurant meals, while fewer people are picking up tablet PCs from Verkkokauppa.com. Even when the economy looks bad, there are always winners and losers among listed companies in every environment.

Rising interest rates and falling house prices have got the doomsayers going bananas. Will we see a repeat of the tragedy of the 1990s recession, which still seems to act as a yardstick for bad times in the Finnish national memory? So far, house prices have fallen by around 10%.

According to the Bank of Finland, Finns have around EUR 107 billion in mortgages, of which less than EUR 10 billion are for investment housing. Finnish loans are mostly tied to short-term interest rates, the Euribor, which have jumped to 4% in no time. The interest burden on households is therefore increasing. The good news is that the households with the most debt are also those with the highest debt-bearing capacity. Most of the debt is borne by high-income Finns. Second, the Bank of Finland estimates that Finns' net interest payments will be around 2% of income in 2022. Although they are still expected to rise slightly, net interest payments took 4% of Finns' income in the recession of the 1990s as the economy collapsed. Finns accumulated extra savings during the COVID period, which have also helped them get through more difficult times.

So far, there have been very few payment problems, which does not indicate the onset of foreclosures. While we will certainly see individual economic tragedies, the vast majority of Finns should be able to weather an environment of higher interest rates.

It should also be mentioned that one person's interest expense is another person's income, so banks like Nordea are enjoying the current situation. As I like to say, there is a winner in every situation. Instead of moaning, investors should look for the winners, preferably before others. Oh, and Finns are known to have over a hundred billion euros in bank deposits. Interest will also start to be paid on them.

Of course, the construction sector has been hit by the slowdown in housing sales. Every week you read about the bankruptcy of yet another construction company. Residential construction has taken the heaviest hit. In recent years, apartment buildings in particular have been built at a record pace, encouraged by zero interest rates and the urbanization megatrend, but so far the sector is facing a terrible hangover. Building permits are taking a nosedive. With any luck, recovery can be expected perhaps next year or in 2025.

In Finland, construction accounts for up to 15% of GDP, compared to a lower average in eurozone countries. Construction and maintenance of the built environment accounts for up to a fifth of Finland's 2.6 million jobs. Thus, the collapse of the sector hits the economy harder.

There is a lot of doom and gloom about the sector, so here are a few ideas to ease the situation. First, the total size of the construction sector is around 40 billion according to 2021 statistics. Of this, new residential buildings account for EUR 8 billion. This is already less than 3% of Finland's economy of around EUR 270 billion. Less cyclical renovation and infrastructure construction account for more than half of the pot. Secondly, Finnish banks are in good shape. If banks were in trouble like in the recession of the 90s, lending would hit a wall and then the debt-driven sector would collapse. Now the banks can afford to take a hit and keep pumping debt into the economy's arteries.

Finland is also undergoing a massive green transition. Of course, while not all the planned EUR 140 billion of investment will materialize, billions will be spent on building green energy and sustainable industry. Somebody's gotta build those. Things are not standing still as the green transition investment boom continues its inexorable march to feed the economy.

On the Inderes investment forum, user Pohjolan Eka, who often goes against the grain of public opinion, highlighted very well how the construction sector is now despised by investors and opportunities could be found there. I'm not sure if SRV and YIT, the troubled companies known for their constant antics and spoiling Helsinki's aesthetic environment with their boxes, are good investments even now, but Olli Koponen, an analyst who follows our sector, has Buy recommendations for Consti and Sitowise, for example. Admicom, which sells software products to conglomerates, has also been trampled in the stock market and analyst Atte Riikola has a Buy recommendation on it as well. That’s a company that I have in my portfolio as well. Even though the sector is currently miserable, every dog has its day.

Finally, a few words on Finland's long-term economic outlook. There is no strong correlation between stock market returns and economic growth. By contrast, the earnings growth of listed companies is linked to their operating performance. Imagine, for example, a bank called Mordea operating in an economy called Tinland. The GDP of Tinland does not grow. Since GDP is not growing, Mordea is unable to increase its profits. Instead, Mordea pays out the entire profit to the owners in the form of dividends. If Mordea is priced at ten times its earnings, investors get a 10% return each year. Thus, slow economic growth is not necessarily a disaster for investors, but equity valuations are under pressure in the absence of earnings growth prospects.

Unfortunately, the long-term picture for the Finnish economy is similar to Tinland in my example.

The economy grows when more pairs of hands work more productively. Finland's meteoric economic growth from poverty to world leadership over the past 100 years can be explained by huge investments in human capital - education, investment in physical capital and an increasing population. As education levels rise, workers will know how to use more sophisticated machines and equipment, so it's worth investing in them.

All of these factors seem weak. Finland's working-age population, if you include people aged 15-64, has been falling since 2009. If the bar is raised to 74, the working-age population started to decline in 2021. At the same time, the level of education has continued to decline. The most educated are those born in the 70s and 80s. By contrast, the level of education of younger age groups has started to fall. The outlook is that human capital will start to shrink in the 2040s. Investment in fixed capital, which now includes intangible investment such as software, has already slowed down significantly since the recession of the 1990s.

In other words, Finland's economic growth is stalling because there are fewer workers than before and young people joining the workforce are less skilled than those retiring. And there is not enough investment in the country.

The situation is frustrating. According to the Bank of Finland's long-term projections, Finland's economy will grow by an average of 1.2% in the baseline scenario until the 2040s, after which growth will fall to 0.5%. However, the scenario assumes that politicians will increase investment in education. In a weak scenario, Finland's economy enters a permanent downward trend in the 2040s.

It would be interesting to see in the analysts' perma-optimistic forecasting models the assumption that the turnover of the base company will fall from year to year. Now it's just a thought to play with, but for Finland-bound companies it's the default scenario in the current climate, as the overall economy from which companies rip their sales shrinks.

Long-term forecasts are of course imprecise. By turning the tide of education and investment, Finland's economy can do much better. More labor-related migration can reverse the demographic trend. Green investment and energy self-sufficiency make Finland a more attractive place to invest. But these actions require decisive action by politicians, while the sustainability gap should also be closed. However, stubborn Finns have managed to turn the ship around before, so I for one remain optimistic about Finland's long-term development.
 
Thank you for reading the post, get educated and reproduce and let’s get Finland’s economy growing.  Read analysis and make good stock picks!