What Is In Store For Switzerland's Markets? Asks Coutts

Norman Villamin

Europe - Coutts

26 April 2013

Here are comments from Norman Villamin, chief investment officer, Europe, at Coutts. The remarks are taken from the regular Spotlight publication sent out by the bank.

Economic outlook

The Swiss economy remains stronger than the rest of Europe, but is still struggling to regain broad-based momentum. However, the recent depreciation of the Swiss franc versus the euro should help offset some of the downward pressure on the Swiss economy stemming from weaker demand from the eurozone. We expect exports to the eurozone to be less of a drag on growth momentum in the months ahead.

Meanwhile, domestic demand should be supported by strong fourth-quarter growth in private consumption, as stable employment and ongoing deflationary pressures combine to boost purchasing power.

Foreign exchange outlook

We expect the Swiss franc to weaken against the euro over the next six to 12 months as concerns about systemic risks facing the euro area recede. Given our forecast for the euro to weaken moderately against the dollar from current levels, this also implies Swiss franc losses against the dollar. The Swiss franc remains at historically strong levels which primarily reflects investor concerns about the viability of the euro area, with investors seeking the perceived safety of Swiss assets

We expect investor concerns about systemic risks facing the euro to moderate further over the next six to 12 months. Such a trend should be accompanied by a moderation in safe-haven flows into Swiss assets, eroding one of the key factors behind the strength of the franc in recent years. Given our forecasts for moderate euro weakness against the dollar, this implies a move towards Swiss franc parity with the dollar over this period.

Fixed income outlook

Yields on one to five-year Swiss government bonds are essentially zero, while only Swiss government bonds with maturities longer than 10 years still offer a yield above one per cent. We see Swiss franc denominated corporate bonds issued by non-Swiss companies as the best alternative to Swiss government bonds. But here too, the potential to generate decent positive returns is quite limited.

Given the lack of options, Swiss franc-investors may need to expand their search for yield to higher-yielding euro-denominated corporate bonds. However, we would favour hedging any opportunities in dollar-denominated bonds for Swiss-referenced portfolios, given the lack of a similar cap on moves in the dollar-Swiss exchange rate.

Equity market outlook

Switzerland has been the best performing equity market in Europe over the first quarter, for three main reasons. First, risk-averse investors have been shifting out of fixed-income instruments into defensive equities with high dividends. Meanwhile, earnings from pharmaceutical companies have surprised on the upside, while remaining more stable than forecast in the consumer staples sector. Finally, investors have been pushing up the valuations of European companies that have global brands with large emerging market exposure.

As we see earnings remaining strong in the leading sectors of the SMI, we therefore don’t envisage a de-rating of Swiss equities, though we think the laggards in the agricultural, construction and insurance sectors may have greater scope for positive earnings surprises.

Valuations and earnings

The Swiss Market Index's out-performance so far this year has led to a significant re-rating relative to the rest of Europe, and it now trades at a 30 per cent premium in terms of price/earnings ratios. Prices are at 14 times forecast earnings for the SMI, versus 11 times for the rest of Europe.

It does seem paradoxical that Swiss equities have outperformed so strongly as eurozone fears have subsided this year, but this has probably been driven by the big rotation from the bond market to high-yielding and defensive equities. Should economic conditions become more benign this year, we would expect the Swiss market to unwind some of this out-performance versus Europe. Still, we wouldn’t expect any large reversal, with Swiss earnings and dividends being generally more stable.

Sectoral opportunities

We think pharmaceuticals will have good earnings growth in the next few years, having diversified into other strongly growing areas of healthcare. We also forecast growing dividends from these companies, while valuations are currently below long-term averages.

The consumer staples sector is also likely to benefit from growing exposure to emerging markets, while remaining in demand from investors for its defensive qualities given continuing political and economic uncertainty.

Agricultural chemicals will continue to benefit from a long-term shortage of arable land given rising populations and consumption in emerging economies. Improved pricing power and higher barriers to entry in this industry should provide stable earnings growth in the coming years.