This is another in a series of articles that makes a fundamental macroeconomic sectoral flow analysis of the economies of key countries across the globe.
The purpose of the review is to see if the local stock market is worth investing in via exchange traded funds (ETFs). These funds are available to all investors, even for non-residents or those not able to trade in the stock market of that country directly.
In this article, we examine Sweden from a sectoral flow analysis perspective to see if the private sector, containing the local stock market, is getting the support it needs from the government and external sectors to continue its march upward.
Details of the methodology employed to analyze these opportunities are available in the sectoral analysis section found later in this article.
The magic formula for success is:
P = G + X
And you can read more about that below.
Which Countries Are Doing Well?
The first port of call is the ETF page at Seeking Alpha and a look at country ETFs and how they are performing.
The chart is from early December 2016. In that time positions have changed a little as the table below shows.
Most countries on the list are in the red and are of no further interest, though we could learn from them what to avoid, as could their governments and politicians. But, as investors, we will leave that to them.
Since the start of this series of articles, Sweden has moved one place up from 25 to 24 on the list and is up 20% over the last 12 months.
We will start the analysis with the government sector.
A review of the most recent Swedish budget and policy papers shows a familiar pattern of a government that thinks that it is a household or business and wants to save money or make a profit from its operations not realizing that it is itself the source of the local currency.
In her latest budget release, the finance minister extols the virtues of tight fiscal policy and cites as an achievement the reduction of the deficit.
"The Budget Bill for 2017 presented to the Riksdag today contains the Government's proposals to continue building our society. The Bill is based on an agreement between the government parties and the Left Party.
"Sweden's economy is strong and unemployment is falling fast, but many challenges remain. In the budget for 2017, we are taking responsibility for Sweden and implementing necessary reforms to protect welfare, get more people into work and meet the climate challenge," says Minister for Finance Magdalena Andersson.
In a world characterized by slow economic recovery, Sweden is strong. Sweden's growth rate is very high by international standards and will continue to be among the highest in our part of the world in 2017. Unemployment is declining and the employment rate is the highest in the EU. Since this Government took office, 120 000 more people have a job to go to.
"We have pursued a tight fiscal policy, and the large deficit of over SEK 60 billion that the Government inherited has essentially been wiped out. This has been achieved despite the strain on public finances following the large number of asylum seekers who came to Sweden in 2015. As a result, we will be able to implement necessary reforms to meet the challenges we face both in the long term and here and now."
(Source: Swedish Minister for Finance Magdalena Andersson)
The following chart from the Ministry of Finance shows that the government has an explicit plan to extract money out of the private sector on an ever increasing basis.
(Source: Swedish Government, Ministry of Finance)
The chart below shows the long-term budget balance:
The chart shows the budget is in deficit and that the net add to the private sector has increased over time. This is a good trend for the private sector going forward.
One notices the familiar pattern of decreasing deficits and then surpluses leading to the dot-com boom-bust and GFC boom-bust recessions.
One can make a good case that with all other things equal, such as the external sector, governments bring on recessions by removing financial assets from the private sector. This pattern repeats itself in other economies and becomes self-reinforcing and politically fashionable as if the government were a business and making a profit.
Removing financial assets from the private sector is similar to draining the oil out of an engine, at some point, it seizes up, and one has to put the oil back in. This process is doomed to continue while we have politicians and mainstream economists who do not understand how reserve accounting works.
While presently showing expansive fiscal policy the political mindset is such that a recession caused by contractionary government policy is a foregone conclusion if history, present attitudes, and budget policy is any guide. Only a compensating net add from the external sector can remedy the situation.
The next chart shows the value of the budget and a measure of how much money is added or drained from the private sector by the government sector.
The chart shows that over the long term the government has been net adding to the private sector and has been a proactive, helpful influence. That said one sees that it is not a consistent net add and that there are quarters where private financial assets are extracted from the private sector and destroyed. There is not a strong trend in either direction.
The Swedish private sector is saddled with some of the highest and most complicated taxes in the world:
- Corporate tax 22%
- Personal income tax 57.1%
- Sales tax 25%
(Source Ministry of Finance, Government of Sweden\Skatteverket)
One sees how the tax system is skewed in the direction of big business paying a 22% tax while workers reach a top marginal rate of a whopping 57.1% on top of a 25% consumption tax on all they buy. This sort of tax regime is excellent for dampening aggregate demand which is the role of federal taxation. Such a regime tends to dampen innovation, small business, and enthusiasm for work and entrepreneurialism as well.
The Federal government does not need tax revenue collected from the private sector to fund itself any more than a corn farmer needs to buy corn at harvest time. It is the source of the money in the first place.
The chart below shows the long term balance of trade position.
The chart shows that Sweden has been steadily moving from surplus to deficit and this is not a good trend for the private sector going forward.
The chart below shows the capital flow situation.
The chart shows a much better picture than the balance of trade above. Here there is a net add from capital flows into the private sector.
The chart below shows foreign direct investment.
Foreign direct investment is a positive picture and has been fairly constant for at least the last ten years and this despite a GFC and great recession in the rest of the world. Positive FDI shows that business people overseas see Sweden as a sound destination for their investment capital and is a strong vote of confidence in the future.
One does detect though that FDI appears to be in a gentle decline long term, but positive none the less.
The chart below shows the current account situation.
The current account pulls it all together and shows that when one considers the external sectors total impact, it is a net add of some 40 SEK billion per quarter. It peaked in 2008 in the GFC boom-bust and held constant ever since.
One can see the whole trend when one compares GDP with the amount of money in circulation, shown in the following two charts:
Both charts show an upwards trending growth profile overall, though GDP is a good deal more uneven than the money supply growth.
One notes that GDP has fallen of late and the money supply has not. This should lead to inflation, and the chart below shows that this is indeed the case.
The inflation rate is creeping higher but at less than 2% is still very low by any standard. This means the Swedish government has fiscal space to create more currency and spend it into being on public health, education and infrastructure or lower those very high personal and consumption tax rates, or both.
One can achieve inflation in two ways. One is positive in that the government puts too much money into circulation and the other is negative in that the economy shrinks and produces less while the money supply rises or stays the same. Greece is an example of the latter.
Sectoral Analysis Methodology
Each nation state is composed of three essential components:
- The private sector
- The government sector
- The external sector
The private sector comprises the people, business and community, and, most importantly for investors, the stock market. For the stock market to move upward, this sector needs to be growing. This sector by itself is an engine for growth and innovation. However, it needs income from one or both of the other two sectors to grow in value.
The government sector comprises the government with its judicial, legislative and regulatory power. The key for the stock market is that this sector can be both a source of funds to the private sector through spending and also a drain on funds through taxes.
The government through its Treasury also sets the prevailing interest rate and provides the medium of exchange. Too much is inflationary and too little is deflationary. It puts the oil in the economic engine and can put in as much as its target inflation rate allows. It is not financially constrained, for a sovereign government with a freely floating exchange rate any financial constraint such as a matching bond issue is a self-imposed constraint.
The external sector is trading with other countries. This sector can provide income from a positive trade balance, or it can drain funds from a negative trade balance.
One should note that a negative trade balance also means that a country has traded currency, that is in infinite supply, for real resources that have a finite supply.
For the stock market in the private sector to prosper and keep moving upward, income must enter the flow. Otherwise, the sector can only circulate existing funds, or is being drained of funds and is in decline.
The ideal situation is that the private sector has a net inflow of funds and is constantly growing, thus giving the stock market headroom within which to expand in value. For this to happen, one or both of the other sectors have to be adding funds to the circular flow of income.
The following formula expresses this simple relationship.
Private Sector [P] = Government Sector [G]+ External Sector [X]
P = G + X
For the best investing outcome, one looks for countries where the government sector and external sector are both net adding to the private sector and causing the local stock market index to rise with the receipt of additional funds.
Sweden is a "luke warm" buy.
The government sector is supporting the private sector with net spending, and the external sector is likewise net adding to the private sector. The two important prerequisites are met.
One then looks to how sustainable this situation is. One can expect the positive external sector trend to continue as this is business and has clear goals and means to achieve them.
The government sector picture is not so optimistic. Inflation is very low meaning the government can afford to spend more and or cut its very high and complex taxes. The government though is a problem and has explicit policy settings and an attitude that in the absence of an external sector surplus will bring about a recession by needlessly draining the private sector of funds. It seems unaware of its sovereign currency creation powers and still has a gold standard mentality some 46 years after the abolition of the gold standard.
Sweden is a buy but needs to be watched closely as the government sector is now working against the private sector's best interests, and does not know it, true believers are truly dangerous. At the same time, there are other countries on the list that offer better investment prospects and one need only read back over my other articles to find those.
Sweden is in a world sense tiny and therefore the ETF coverage is also tiny and a one horse race and should take up only a tiny space in ones investment port folio, if any.
- iShares MSCI Sweden ETF (NYSEARCA:EWD)
The next article takes us to Poland.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.