In the US, for example, the Federal Reserve has delivered a business-friendly corporate backdrop characterised by abundant liquidity and low volatility. However, the Swiss National Bank’s own policy efforts have been primarily directed towards reining back the unrelenting strength of the Swiss franc and constraining the associated tightening of monetary conditions. This has proved something of a one-sided battle with systemic crises and geopolitical events positively encouraging FX market participants to search for perceived safe havens.
The 2010 Greek crisis followed swiftly on the heels of the 2008 Lehman-driven meltdown and, with countries on the southern periphery of Europe struggling to finance debt, the Swiss National Bank (SNB) was unable to stem the tide of unstinting demand for the franc, despite making foreign currency purchases amounting to CHF67 billion in 2016 alone. In overall terms, the franc strengthened by 40% between 2006 and 2010. Since then we have seen a second period of franc appreciation of around 30% or more from mid-2013 to date. Inevitably, the SNB’s forced, yet unexpected, decision to dispense with its peg to the euro in January 2015 proved the focal point of the latter leg of franc strengthening.
Against such a challenging backdrop, Swiss companies embarked on a major drive to increase efficiency. This was an especially important focus for companies with international earnings streams as they were hurt more by the prevailing environment than their domestic-oriented counterparts. Consequently, the rally that we have seen in Swiss stocks has been predicated on valuation expansion, rather than being earnings driven – although we have encouragingly seen an improving earnings trend over the last 12 months.
The major question investors in Swiss equities are now facing is how to insulate any potential downside relating to, what appear to be, extended valuations. We believe the answer lies in seeking companies that can grow their earnings and sales organically, as this will swiftly filter through to the bottom line. In this respect, it is worth considering that valuations will become more compelling if higher earnings are achieved without a commensurate uplift in the share price. Consequently, the attributes that we look for include structural growth, a strong competitive position, high capital returns, margin expansion and an international focus.
Indeed, we see two major drivers for the Swiss equity market in the period immediately ahead:
First, at the micro level, companies are now very lean, having optimised both the supply chain and production. In addition, the weakness of the eurozone economy has given rise to growth initiatives, an expansion of geographical footprints and significant innovation. Second, at the macro level, European and emerging markets have proven especially weak in recent years but the data is now much more encouraging. This combination of healthy companies benefiting from an economic tailwind is expected to drive earnings upgrades. In reflection of this, we hold a strong overweight in the small and mid-cap segments because of their greater potential to grow earnings. We expect to retain this positioning unless, or until, we see evidence of a looming recession or the valuation gap becomes excessive.
Overall we remain constructive on Swiss equities in spite of elevated valuations, believing that the low-yield environment will continue to be supportive. In terms of risks, an obvious one is the threat posed by any material increase in bond yields, while another would stem from a global recession. There is no indication of either of these scenarios coming into play in the near future.