TRANSCRIPT

Edmund Shing

Hello and welcome to another weekly podcast from BNP Paribas Wealth Management. I'm Edmund Shing, Chief Investment officer, and today I'm joined by my good colleague and friend Guy Ertz from Luxembourg, our deputy CIO. Hello, Guy.  How are you?

Guy Ertz  

Hello. Thanks. I'm fine.

Edmund Shing

So today the subject of this podcast is the Swiss economy and Swiss financial markets. Just to give some context: this is a pretty open economy, historically speaking, dominated by technology, industry and brand name companies. It, of course, has had to cope over time with the strong domestic Swiss franc currency pretty much since 2008. So in this context, Guy, what can you tell us specifically about the characteristics and the growth in the Swiss economy and looking at the FX as well?

Guy Ertz  

Well, the Swiss economy has been quite resilient over the past few years despite the strength of the currency and thus, the impact on exports. The growth rate we're looking for is just above 1% this and next year, more precisely 1.1% this year and 1.3% next year. That's relatively close, and actually, to some extent, even above some of the other eurozone countries.

What is also interesting is, of course, the inflation outlook and the inflation situation. Now, Switzerland has not had such a strong effect on inflation in the years 2021 and 2022, because actually the effect was dampened by the strength of the currency. And what we've seen recently is actually inflation falling well below 2% and closer to 1%. And in particular, the last figure, which was measured month over month, was flat, so no growth in price month on month. So there is an issue here in Switzerland to deal with a strong currency, but also inflation that has fallen below 2% and closer to 1%. So there is an issue here of potentially rising deflation fears.

Edmund Shing

And yes that sort of makes sense. I must admit, from a personal perspective, every time I go to, Switzerland, like, for instance, Geneva, I'm shocked by the price levels. You know, just referring to The Economist Big Mac index. If I go to McDonald's, it's the most expensive McDonald's I've ever been to. So I can certainly confirm that prices are high.  But maybe that's why inflation is not so high. It really, as you said, reflects the very strong historic currency level.

Now, if we turn to the central bank, this of course presents an issue to the central bank. I guess they don't want consistent strengthening of the currency because that in the end presents a problem for the economy. They have already cut rates in response to falling inflation, which you've already mentioned. And we're now looking at interest rates, which are back at approaching zero. Now, I remember that, in the good old days, between 2014 and 2022, the Swiss National Bank actually maintained a negative deposit rate. So the obvious question there is, Guy, what is the impact on the currency? And what does the Swiss National Bank do? Do we go back to negative rates in the end?

Guy Ertz  

That is a very key question now for the central bank because, especially the last few prints on the inflation side, showed growing concerns about inflation falling too low at a level that which could be problematic. So we are looking for at least one more rate cut that would lead the policy rate to zero. But obviously, when we look at the recent data, there is a concern or there is a risk that the Swiss National Bank could be again leading their policy rate into negative territory. So it's not our base-case scenario. But it is obviously a risk.

Now, when we look at the currency side now, we think that actually, despite low levels of rates, the currency will remain strong. We think that the economy is showing signs of resilience, but also, we could see some positive impact from the German recovery that we expect also due to the infrastructure programmes in Germany.

Indeed, what we've seen historically is that the Swiss economy is relatively, strongly correlated to the German economy. So that's on the positive side. The risks on the tariff side are relatively moderate we think. So from an economic growth perspective, we're looking at resilience. And what will of course also support the currency despite low rates is of course the remaining uncertainty, the economic policy uncertainty, globally speaking over the next few months.

So all in all, we'll look for a target on the euro Swiss, which is 0.94, which is not that far from current levels. So that's the value of €1. And when it comes to the value of $1, that would translate into 0.82, 12 months out.

Edmund Shing

Okay. So we've talked about the economy and the currencies. Now let's start talking about financial assets, starting with the bond market in Switzerland, which is quite a particular bond market, because of course, yields in the Swiss bond market are low, reflecting the strong currency and of course, the safe-haven perspective and attractions of Swiss assets. What are market expectations Guy for rates and yields in the coming months. And are there any opportunities in Swiss bonds?

Guy Ertz  

Well, let's start with the outlook for rates that is currently implicit in the pricing of the bond market. There are obviously here some expectations that the Swiss National Bank could be moving back to negative rates. Indeed, when we look at the 2-year yield, it's hovering at around zero and actually has also been temporarily in negative territory. The 10- year yield is actually not much higher. We're looking around 0.40 for the 10-year yield. So as I mentioned earlier, we see our base-case scenario with the Swiss National Bank not going into negative territory on the policy rate. But the market is probably implicitly pricing that they will.

As you said, the opportunities in the bond market in Switzerland are not really present here. We have with such a low level of yields. Even if you take a pick-up linked to a premium, when you invest in high quality corporate bonds, you're still at a very low level in terms of yield. So obviously the bond market side is not really offering opportunities in this environment.

Well, as just discussed, the opportunities are not really to be found on the bond market in Switzerland. So the obvious question now, Edmund. Are there opportunities in the Swiss market and what are the risk return trade-offs here?

Edmund Shing

Yes. It’s interesting, if you look at the Swiss equity market, that's clearly the obvious home for Swiss franc investments given, as you said Guy, that the bond market and cash deposits yield so little.

If you look at the Swiss market the SMI, this trades at a 22% premium to the broader European stock market. So that translates to a 17 times forward PE valuation versus 14 times for the broader European market. And of course, you know, let's not forget, the Swiss market is the second-biggest market outside of the eurozone in Europe. So of course you have the whole eurozone bloc. You then have the UK and then you have Switzerland. So it's still a pretty chunky element within the European stock market.

And of course, as you've just mentioned, it's very high quality. It actually correlates very closely to the European quality factor within the stock market. Again higher valuation but of course higher profitability, better defensive characteristics because of course the Swiss stock market is dominated by companies in the pharmaceutical, food & beverage and branded goods sectors, all of which are high margin, high profitability.

It’s not surprising to see that. But what we have seen over time is a steady outperformance of the Swiss stock market in common currency terms against the broader stock market in Europe, as measured by, for instance STOXX Europe. So it's been a good performing market on the back of its strong quality and obviously helped, to some degree, by the strengthening currency even though, let's be honest, the companies in the SMI are all globally-exposed companies. They're not obviously just operating in Switzerland. They're merely headquartered in Switzerland, with the bulk of their sales and profits generated outside of Switzerland.

I would say in all in all, if you like the quality factor in Europe, then Switzerland is an attractive place to be. And of course, if you want to hold the safe-haven currency, the Swiss franc, then the SMI Swiss stocks is the natural investment vehicle that you would use rather than, let's say, currency or bonds. Thank you very much Guy for today. And thank you to our audience for listening to this podcast. Please like, share and subscribe to our weekly series of podcasts.

Guy Ertz  

And until the next time, goodbye.

Edmund Shing

Goodbye