The Zurich Stock Exchange has a long-standing presence in our portfolios, with companies from defensive sectors such as food (Nestlé), pharmaceuticals (Novartis, Roche) and finance (UBS). However, the earning potential of these assets is gradually eroded due to relatively gloomy economic prospects, valuation levels close to the global index, and an overvalued Swiss currency.
The Credit Suisse saga: the result of poor economic conditions
Switzerland is going through a delicate period. Like the rest of Europe, it suffers from the conflict in Ukraine, which makes its energy supply more expensive and, like other major European exporters, it does not cope well with the fact that demand in the European Union, by far its leading trading partner, is stopped. The Chinese demand stays on.
These factors weigh on an economy that stagnated in the second quarter compared to the previous quarter and whose annual growth no longer exceeds 0.5%.
To these setbacks, common to so many other countries, Switzerland adds its problems: those of its financial sector. On this front, the most visible event was the near bankruptcy of Credit Suisse, forced to be bought out by UBS, its long-time rival. A process was done urgently in March, and many elements must be revised.
The failure to prioritise between shareholders (who received something in exchange for the Credit Suisse shares they owned) and debt holders (some of whom lost everything) raises quite a few questions, leads to a significant number of lawsuits, and above all inquiries about the governance of the financial system Switzerland’s reputation as a haven for investors. And that’s not all.
Switzerland, which has long been « THE » country of banking secrecy, quickly attracting capital from all over the world, has rushed to follow the sanctions decided by the United States and the European Union against Russia, its assets and those of its citizens abroad. There is nothing to reassure other foreign investors (Chinese, among others) who say that in case of disappointment between their country of origin and the West, their assets could well find themselves on the front line in case of sanctions. Assets under management of Swiss private banks decreased by 11% in 2022.
The Swiss banking sector is losing momentum, to the benefit of Singapore Switzerland in Asia, among others.
The Swiss franc: close to the top
Faced with these gloomy prospects, the Zurich stock exchange struggles to take off. While the US market has gained some 17% since the beginning of the year, the Swiss market is satisfied with a 6% increase in local currency but 10% in euros.
The franc appreciation against euro currency may be surprising, as bond interest rates remain much higher in the eurozone than in Switzerland. Currently, Swiss 10-year debt is trading at just over 1.0%, against 2.7% for its German equivalent, 3.2% to 3.4% for the French, Belgian or Portuguese debt, 3.7% for the Spanish, and even 4.5% for the Italian debt at the same maturity. However, this gap is justified by investors' inflation expectations.
With little trouble, the Swiss National Bank (SNB) managed to control inflation. If a last increase in the SNB’s key interest rates on 22 September cannot be ruled out, the bulk of the work is done, with a policy rate of 1.75% gradually bringing it back to land and, at 1.6% in August, Swiss inflation is below the SNB’s target, which is 2.0%. This is a very different scenario from that of the eurozone, where, despite a critical rate of 4.5%, inflation was still 5.3% for the same period. As a result, in real terms, Swiss bond yields are not so uninteresting, and the euro is suffering against the franc.
Currently traded at less than 0.96CHF, our currency is close to its historical nadir against the Swiss franc, established a year ago, and, at such a level, the franc is overvalued, in our opinion.
This has its advantages: first, it has helped to control inflation better, limit the loss of purchasing power of Swiss households and pressure on wages, and inflate the returns of investors who bought these quality financial assets. But at the same time, it is difficult not to see this as a threat to Switzerland’s competitiveness and a factor weighing on the interest of new purchases of Swiss financial assets.
Despite the recent setbacks of the economy, particularly its banking sector, Switzerland remains a competitive and innovative economy focused on high-value-added products and services. It is, therefore, always likely to succeed.
But we must face the facts: the Zurich stock exchange is costly at the current price level. The price/earnings ratio of the MSCI Switzerland index is close to that of the global index, while the Swiss market does not benefit from the same momentum.
The fact that this market is denominated in a currency close to the peaks while others (Japanese yen and Chinese yuan, to name a few) are settled makes the comparison more delicate to Swiss assets.
The latter is essential to a portfolio because it makes it relatively stable. It constitutes an excellent diversification, which helps limit the whole's risk. But the increasingly high price for this diversification may push us to look for alternatives, at least in some of our portfolios.
We keep buying some Swiss company's shares and hold others in our portfolio.
