Macroeconomic Buoyancy Argues for Upgrading Swiss Stocks to an Overweight

Swiss equities have undergone a dramatic reversal of fortune since mid-October after having deflated sharply in value during their September-to-October sell-off. Inspired by resurgent investor bullishness in spite of a 14.8 percent overvaluation of the Swiss unit on the basis of purchasing power parity, retracement of Switzerland’s Stock Market Index (SMI) in excess of the territory it lost previously, represents a monumental achievement. Double-digit recoveries of 9.5, 13.1 and 13.5 percent since October 16 have eclipsed prior losses of 7.5, 8.8, and 8.9 percent in terms of the US, Swiss and Euroland currencies, respectively.

Flight to quality, arising from Russian military belligerence in Eastern Europe, has nurtured safe-haven demand anew for both Swiss shares and Confederation debt – maintaining persistent, uninvited upward pressure on the Swiss franc vis-a-vis its US and Eurozone rivals and debilitating the competitiveness of its exports of manufactures and services, accordingly. Swiss government fixed income securities maturing in ten or more years rank sixteenth highest thus far this year in performance. Indeed, Swiss sovereign bonds of ten-year or greater duration would have earned investors a generous 10.7 percent return in US dollar terms had they possessed such instruments in his or her portfolio since the very end of last year.

Apart from the event risks that continue to invigorate enthusiasm abroad for Swiss equity and bond issuance, comparative economic developments continentally are stimulating interest in Swiss assets too. Switzerland is growing at a modestly faster pace (1.4 percent) than either Germany (1.2 percent) or the euro bloc (0.8 percent). Inflation remains well-contained at zero percent from the corresponding month a year ago, whereas German and Euro-18 price pressures are merely 0.6 and 0.3 percentage points higher than that of Switzerland.

Even though long-term (that is, ten-year) yields put Switzerland at a forty basis point disadvantage versus Germany and the Euroland, Bern’s fiscal condition is in far better shape as a proportion of nominal GDP (0.6 percent) than either that of Berlin (0.1 percent) or Brussels (-2.9 percent) or, for that matter, any other member of Euroland.  Furthermore, the state of Germany’s and the euro currency bloc’s balance of payments pales in comparison to the that of Switzerland since the latter’s current account to money GDP ratio of 14.2 percent far surpasses that of Germany and the European Monetary Union (EMU) by 6.9 and 12 points, correspondingly.

Projected macroeconomic patterns also bode well for Switzerland by contrast with those of either Germany or the EMU. Despite the fact that the country’s two crucial gauges of prospective national economic activity have been exhibiting a subsiding tendency during the past eleven months, neither Swiss leading indicators (LEI) nor the Purchasing Managers Index (PMI) is foretokening a recession anytime soon. At 52.1, the PMI still signals that the economy is expanding (defined as in excess of 50) and a 1.3 percent annual rate of advance in the LEI heralds continued recovery in the Swiss economy.

Another measure foreshadowing a modest strengthening of business activity is the general upturn in housing permits, which – though volatile – is signaling mounting demand for housing, a critical determinant of macroeconomic performance, even for a country as small as Switzerland in terms of both land mass and population.  Lastly, today’s official report of real GDP having increased at an unexpectedly vigorous 0.6 percent rate last quarter, stemming from a pickup in private and public consumption, affirms expectations of the Swiss economy outpacing its German and Euro-18 neighbors in coming two years.

The Swiss economy, overall, should proceed to display further improvement in the next two years, outshining Germany and the Eurozone.  Little, or no, inflation – combined with decreasing unemployment – should furnish consumers with enough incentive to increase expenditures of durable and non-durable merchandise as well as household-related services.  Business fixed investment, meanwhile, is expected to undergo a gradual recovery as negligible borrowing costs and rising domestic demand inspire local businesses to raise output through an expansion of plant and equipment.  Government consumption will influence economic growth to the upside, but only every so moderately on account of the tight reins that the present and future coalition regimes will keep on expenditures and borrowing.  Exports, however, are likely to exhibit steady upward progress, thus contributing to macroeconomic activity provided the central bank can forestall any renewed appreciation of the Swiss franc.

Fiscal responsibility has been and will remain the main cornerstone of Swiss public policy at the national and cantonal levels for some time to come irrespective of the composition of forthcoming federal governments. A projected balanced budget this year will lower its ratio to nominal GDP by 0.08 percentage point. In the next two years, anticipated rising surpluses should lift the quotient steadily into positive territory, attesting to the determination of the present ruling alliance to the tradition of disciplined fiscal management that has long been a hallmark of policymaking in Bern.

The dual monetary policy objectives of the Swiss National Bank (SNB), meanwhile, will continue to concentrate on holding the Swiss franc (CHF) exchange rate at or near its floor of CHF1.2 vis-à-vis the euro via the three-month CHF Libor rate at the lower end of its current 0.00 to 0.25 percent range and targeting domestic inflation under two percent. A stably polity in Bern into the next nationwide election will ensure that nothing, aside from event risk, will distract fiscal and credit policies from achieving its principal goals.

Our evaluation of Switzerland’s economic, political and policymaking prospects makes a compelling case for overweighting Swiss stocks aggregately in spite of geopolitical factors that could occasionally affect them adversely. From a sector standpoint, investors are recommended to avoid the banking sector and focus on its first-class industrial, health care (especially, pharmaceuticals) and consumer discretionary industries.

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