by The Swiss franc, like gold and U.S. Treasuries, is an asset investors turn to when they need a safe place to hunker down. But what about Swiss equities? While they’re no safe haven themselves, they can, like those of any other country, occasionally trade at levels that promise outsize returns. This is one of those times: Credit Suisse’s Private Banking & Wealth Management (PBWM) division thinks Swiss equities – particularly small- and mid-cap stocks – offer greater potential than global and Swiss large-cap equities over the next 12 months. Earnings growth has been accelerating in Switzerland of late, driven in large part by the ongoing economic recovery in Europe, lower input costs and the weakening Swiss franc against the euro and especially the U.S. dollar. And Credit Suisse expects that recovery to continue gathering steam over the coming year. The composite purchasing manager’s index survey pointed to increasing economic output for the twenty-sixth month in a row in July, and both car and retail sales have been strong in recent months. In August, two sentiment surveys – one for consumer confidence and another, broader, one that tracks sentiment in the construction, consumer, industrial, retail, and services segments of the economy – ticked upward. Although the European economy grew just 0.3 percent in the second quarter, down from 0.
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The Swiss franc, like gold and U.S. Treasuries, is an asset investors turn to when they need a safe place to hunker down. But what about Swiss equities? While they’re no safe haven themselves, they can, like those of any other country, occasionally trade at levels that promise outsize returns. This is one of those times: Credit Suisse’s Private Banking & Wealth Management (PBWM) division thinks Swiss equities – particularly small- and mid-cap stocks – offer greater potential than global and Swiss large-cap equities over the next 12 months.
Earnings growth has been accelerating in Switzerland of late, driven in large part by the ongoing economic recovery in Europe, lower input costs and the weakening Swiss franc against the euro and especially the U.S. dollar. And Credit Suisse expects that recovery to continue gathering steam over the coming year. The composite purchasing manager’s index survey pointed to increasing economic output for the twenty-sixth month in a row in July, and both car and retail sales have been strong in recent months. In August, two sentiment surveys – one for consumer confidence and another, broader, one that tracks sentiment in the construction, consumer, industrial, retail, and services segments of the economy – ticked upward. Although the European economy grew just 0.3 percent in the second quarter, down from 0.4 percent in the first, Credit Suisse’s European economists expect the summer lull to be temporary. They expect full-year GDP growth of 1.5 percent in the Eurozone in 2015, up from 0.9 percent in 2014.
Within the Swiss market itself, Credit Suisse’s PBWM division favors small- and mid-cap stocks due to the fact that they have higher operating leverage than large caps, meaning that a larger share of incremental revenues flow to earnings, so they benefit disproportionately from growing demand. Cyclical businesses such as industrial companies and IT firms also make up a large portion of the small- and mid-cap segment of the market, and by their very nature, cyclical stocks outperform when the business cycle is on an upswing.
While a sharp increase in the value of the Swiss franc proved a liability for the country’s equities at the beginning of the year, Credit Suisse’s PBWM division doesn’t see any similar shocks in the near future. The last one, of course, came on January 15, the day the Swiss National Bank shocked markets by removing the country’s peg to the regional currency, and the franc soared against the euro (17 percent) and the dollar (16 percent) in a single day. Since Switzerland is an economy built on exports—some 208 billion francs ($214 billion) worth in 2014—a strengthening currency naturally hurts the Swiss corporate sector, and investors took the benchmark large-cap Swiss Market Index down 20.6 percent in their dismay.
Fast-forward to today: The franc has weakened significantly against both the dollar (11.9 percent) and the euro (8.4percent) since the worst point in January, and Credit Suisse expects it to continue doing so, particularly against the dollar. This is likely to disproportionately benefit small- and mid-cap companies as those have a higher proportion of products manufactured in a Swiss franc cost base which are sold to buyers paying euros or dollars than large-cap stocks do.
There’s one more argument in support of small- and mid-cap stocks. In the wake of January’s market turbulence, investors have flocked to large-cap, dividend-paying stocks, pushing their valuations higher relative to small caps amid a persistently low interest rate environment. The PBWM division points to that disparity, as well as one more: Small-cap valuations, in particular, suggest that investors are underestimating the degree to which cash flows could improve at those companies as the economy continues to improve. If the European economic recovery continues apace, and the franc continues to weaken, small-cap Swiss equities will lead the stock market pack.