This article was written by Daniel Steck, Analyst, and Fund Manager ,it was published in Sphere on March 29, 2024.
Swiss equities got off to a somewhat sluggish start to the year in 2024. The SMI has gained just under 5% and the SPI under 6%, while the EuroStoxx50 is up 12% since the start of the year. However, the upside potential for Swiss equities remains very high, given their low valuations and the boost they have just received from the rate cut by the Swiss National Bank (SNB).
The Swiss equity indexes have performed in a similar way quarter after quarter. While their performance has been positive, they have struggled to keep pace with other regions. Eurozone equities particularly stood out in the first quarter of 2024, attracting investors' preferences. While the defensive bias of domestic equities is a handicap in the current euphoric environment, it is also the specific problems of the largest companies in the Swiss Performance Index (SPI) that are weighing on performance.
On the one hand, Nestlé, which accounts for over 16% of the SPI, is seeing its income growth melt away, while deflation makes it very difficult for the company to raise prices further. On the other hand, Roche, traditionally regarded as one of the most innovative pharmaceutical groups, is experiencing a series of failures in clinical trials involving new molecules in its pipeline. As a result, the firm is raises doubts amongst investors in relation to its future growth prospects. In addition, there is limited exposure in Switzerland to the theme of artificial intelligence or semiconductors, the primary beneficiaries of this trend.
The defensive nature of large domestic stocks is only attractive in times of risk of recession. However, this scenario is entirely out of the question today, as Swiss GDP growth forecasts point to an increase of 2%, similar to the growth of the US economy. What's more, the objective of price stability has been achieved, while inflation in the country is rapidly falling and approaching 1%.
As a result of this consumer price normalisation, the SNB allowed itself to reduce its base rate of interest at its March meeting, taking traders by surprise. This quantitative easing enabled the BNS to preserve the competitiveness of domestic companies by halting, at least temporarily, the appreciation of the Swiss franc in relation to the US dollar and the euro. Structurally, the franc's strength will probably be maintained in the long term, especially once the European Central Bank and the Federal Reserve have started to lower their interest rates, as they have much more room for manoeuvre than the SNB.
Against this backdrop, it is difficult not to see the appeal of the Swiss equity market, which for once is trading at extremely attractive valuations as compared to global indexes. The premium at which Swiss equities are usually priced has completely evaporated. As a result, there is significant upside potential. In the event of a market consolidation, the risk of a further decline in the value of domestic equities seems relatively low.
As usual, specific positioning on the Swiss market is a key differentiation factor compared with the highly concentrated Swiss Market Index and Swiss Performance Index. As the European and US central banks prepare to follow the SNB's lead in easing monetary policy, all the signs suggest that we are on the cusp of a new economic and stock market expansion cycle. In such an environment, it is advisable to favour cyclical, export-oriented stocks, as these are the ones that will benefit the most from amore accommodative monetary policy and a more affordable Swiss franc. Not surprisingly in these circumstances, we believe that shares in small and mid-cap companies offer the most significant opportunities . Here, too, excessive valuations are a thing of the past, and the potential for outperformance remains substantial.
We therefore recommend maintaining an asset allocation which is overweight in Swiss domestic equities with a generous exposure to small and mid-caps as a vector for outperformance in a context of accelerating growth.