The International Monetary Fund (IMF) is banking on Swiss economic growth hitting 2.5% in 2018 – the strongest upturn since the country dropped its euro exchange-rate ceiling in January 2015. If you add to that unemployment at 2.9%, low inflation and a flexible monetary policy, the environment is looking good for Swiss companies. That said, it is not good macroeconomic news that will boost Swiss equities, rather it is global growth, which the IMF expects to come in at 3.9%. According to Eleanor Taylor Jolidon, Co-Head Swiss & Global Equity Portfolio Management at Union Bancaire Privée (UBP),
"Swiss macroeconomic numbers only have a passing effect on Swiss companies’ results, as 90% of their revenues are foreign-exposed."
Swiss exporters, having suffered from adverse currency conditions for three years, have had to fight to remain competitive. “Swiss firms had the agility they needed to deploy those parts of their businesses with lower added value abroad,” Eleanor Taylor Jolidon explains. China’s emergence has given rise to intense competition across a wide range of sectors. However, she stresses Swiss companies’ adaptability, “Rieter makes textile machinery in China. The Chinese are not just buying up Swiss companies – ChemChina, for example, bought Syngenta last year – but they are also competition in the same way as everyone else is.”
Swiss firms’ dynamism can be seen in the latest microeconomic data, which showed that order books were full and one Swiss purchasing managers’ index (PMI) stood at 62.4. For Eleanor Taylor Jolidon, these indicators reflect a solid global economy. “As long as there’s global growth, Swiss firms’ numbers will remain good,” she tells us. The Swiss franc’s recent weakening has reinforced this positive climate, but there is something more important than the exchange rate: global markets are picking up and Europe in particular is enjoying a positive trend. With this in mind, Swiss industry has benefited particularly from the rise in global GDP in Q1, and this sector remains closely correlated to global macroeconomic indicators.
UBP has upped its company earnings growth target to 15% and expects dividend yields to come in at 3%. “For 2018, we expect Swiss equities to put in a performance of 15–20%,” Taylor Jolidon tells us. They are in a better position in terms of cash-flow return on investment (CFROI), which UBP’s Swiss & Global Equity team view as the best indicator of firms’ ability to generate value for shareholders. “Firms’ management teams use CFROI to make investment decisions,” she explains.
Small and mid caps standing out
Despite the positive global environment and upward earnings revisions, the SMI has not had a great year so far and is still moving in negative territory. The Swiss large-cap index has not managed to keep up with its peers in the US and Europe since the correction at the end of January. It is down over 1,000 points since its historic high of 9,611.61.
For Taylor Jolidon, this underperformance is clearly linked to the significant overweighting of the three big names in the index: Novartis, Roche and Nestlé. “Nestlé has suffered from a shift in consumer habits, as branding is a less important factor for online shoppers. As for Novartis, its restructuring and disappointing sales figures for some of its products have held its shares’ performance back.
Roche risks suffering from biosimilars coming to market and competing with its flagship products, and the company has not yet managed to make inroads into immuno-oncology,” Eleanor Taylor Jolidon adds. SMEs, in contrast, have held up well, as shown by the SPI Extra (the index of the SPI’s small and mid caps), which is up 3% since the beginning of the year.
Faced with increased tariffs on steel and aluminium imports being imposed by the United States, Switzerland is finding ingenious ways to minimise the impact.
“Swiss firms tend to use commodities produced in the countries in which they are sold.”
For example, products sold across the pond are made using US steel; the same is true in Europe with European steel. The only cloud on the horizon is that a trade war could cause a slowdown in the global economy. “Generally, import tariffs are not a smart choice in the majority of cases; they act as a brake on international trade and consequently on global economic growth,” Taylor Jolidon points out.
Innovation is in Switzerland’s DNA
In comparison with US companies, Swiss companies spend more on innovation as a percentage of earnings. Research & development (R&D) spending not only comes from the healthcare sector, but also from industry. For example, VAT Group has an R&D budget whose ratio to its earnings is six times higher than those of its competitors. Some observers claim that the Swiss franc’s strength had forced companies to trim their R&D costs. For Taylor Jolidon, these claims are false; in contrast, she estimates that this constraint has made Swiss companies more disciplined, spurring them to redouble their efforts. “We’re used to having an overvalued currency. Swiss firms are therefore forced to compete with foreign businesses at R&D level.”
Digitalisation is becoming a powerful engine for innovation. Switzerland looks ideally placed to be one of the big winners from digital transformation. “There isn’t a single Swiss business without a digital project. Even insurers, which, in certain cases, have collected risk data for 150 years, are able to monetise that data,” she explains.
For all that, Switzerland must not rest on its laurels. According to the annual global innovation rankings published by the IMD, the country has slipped from second to fifth place.
“We have to make sure that we stay at the cutting edge of innovation so we can continue to lead the industrial sector,”
concludes Taylor Jolidon.
Eleanor Taylor Jolidon
Co-Head Swiss & Global Equity Portfolio Management