BearBull Group Research: Positive Outlook for Swiss Stocks
BearBull Global Investments Group (DIFC)
BearBull Global Investments Group is a leading independent Swiss wealth advisory firm based in the DIFC
Key Points:
The Swiss economy is progressing slowly
The growth of Swiss GDP for the first quarter has just been published and once again shows a certain resilience of our national economy in an internationally hesitant context. The Swiss economy has indeed progressed again at the beginning of the year by approximately +0.6% per annum, showing a remarkable consistency in our country’s dynamics. At the end of the year, the three-month growth was already +0.3%, and the slowdown in activity in the United States and the near stagnation in Europe did not significantly affect our economy's performance at the beginning of this year. The GDP growth announced by SECO follows a trend of growth below the average, it is true, but around +0.3% per quarter over the past two years, except for the temporary halt in June 2023, which saw a decrease of -0.3%. The Swiss economy has therefore been able to maintain its growth pace, even though the manufacturing sector seemed logically affected by the strength of the franc. The restrictive monetary policy implemented by the SNB had greatly benefited the franc at the end of 2023, making it certainly more difficult for certain sectors to adapt to this factor, even as domestic and international demand seemed to slow down.
Swiss GDP grew by +1.3% in 2023, but the results of the first quarter suggest that 2024 will likely be more challenging. Since the second quarter of 2020, at the height of the Covid crisis, Switzerland has remained on an upward trend, experiencing only one quarter of decline in June 2023. However, the Swiss economy remains hampered by declining global demand and an overly strong Swiss franc until early 2024. The manufacturing sector is still significantly affected but seems to be recovering slightly and benefiting from developments in the first quarter regarding exchange rates and interest rates. The services sector, along with household consumption, appears to be doing relatively better.
In the manufacturing sector, value creation slightly decreased in the first quarter (-0.2%), primarily due to pressure from the chemical and pharmaceutical sectors (-0.9%), which continued the slight decline observed in recent quarters. In other industrial branches, added value remained generally stable. The construction sector saw a slight improvement (+0.3%) thanks to an increase in revenues from building and civil engineering; however, investment in construction was somewhat less favorable (-0.2%). The energy sector (+2.1%) was the only industrial branch to experience solid growth, with energy exports also increasing. Overall, value creation in the industrial sector stagnated, and the outlook for the second quarter does not suggest a reversal of this trend.
On its part, the services sector performed well and strongly supported GDP growth in the first quarter, albeit with some heterogeneity among branches. Financial services (-0.2%) saw a slight decline, which was also observed in business services (-0.3%). The transport and communication sector remained unchanged, while freight transport, in particular, saw moderate growth due to subdued industry dynamics. Conversely, value creation approached historical averages in hospitality (+1.3%), healthcare and social services (+0.8%), and public administration (+0.2%). It exceeded the average in retail trade (+1.4%), contributing positively to overall trade (+1.3%).
Echoing retail growth, private consumption saw robust progression (+0.4%), driven by expenditures on food, non-food items, housing, and healthcare. Government consumption expenditures also showed a slight increase (+0.2%). Finally, final domestic demand (+0.4%) benefited from positive impulses from equipment investments (+0.8%), which returned to growth after three negative quarters. Investments notably increased in vehicles, information technology, and research and development.
Domestic demand growth also led to a significant rise in imports (+2.0%) of goods and services in the first quarter. However, merchandise exports (-3.3%) declined, largely due to negative trade developments. Service exports (+1.0%) saw a slight increase. Overall, external trade negatively contributed to GDP growth. Not surprisingly, in a particularly strong fourth quarter for the franc, up +8.07% against the US dollar and +4% against the euro, Swiss exporters faced significant challenges. Nonetheless, the economy navigated this difficult context relatively well.
At the beginning of the year, we assessed that the Swiss economic outlook was severely weakened by the strength of the franc and increasing risks of export downturns. Now, with the observed weakening in the first quarter, this factor should become more neutral. While consensus among forecasters suggests GDP growth of +1.2% in 2024, our forecasts are only slightly more optimistic (+1.3%) and depend partly on continued franc weakness and a global economic recovery in the second half of the year. However, recent weeks have not confirmed these two factors, with signs instead pointing to a strengthening Swiss franc and global economic weakness for now.
Swiss exports are declining again
Fortunately, the Swiss franc weakened in the first quarter of 2024 after finishing the previous year particularly strong. In 2023, the Swiss franc, weighted by trade, appreciated by +7.2% for the sixth consecutive year. The correction of approximately +8% against the dollar and +4% against the euro in Q1 helped restore some balance. However, in recent weeks, despite the BNS's first rate cut, the franc has slightly rebounded and is expected to end Q2 with modest gains. These developments are currently insufficient to enhance Swiss industry competitiveness. The situation in foreign trade reflects this, with Swiss exports declining by -3.5% in May after a +7% increase in April following the franc's fall. Consequently, the export sector is struggling, exemplified by international watch sales declining by -2.2% in May. Meanwhile, imports have also sharply contracted (-4.3%), marking their most significant decline since December 2020. The more pronounced drop in imports bodes well for the early-year trade balance outcome.
Leading indicators are more concerning
The leading indicators released for the month of June show further concerning deterioration in the services sector, while the manufacturing sector, which has been struggling for some time, appears to be stabilizing slightly. However, the indicator is still unable to rise above the growth threshold of 50. The situation in the industry remains problematic, but the worsening conditions in services are particularly concerning and partly confirmed by a very low consumer confidence indicator.
Finally, industrial production plunged back into negative territory at the beginning of the year, recording its worst quarterly decline (-3.5%) since Q3 2020. However, in this rather gloomy context, retail sales advanced by +2.7%, marking the strongest increase since February 2022.
Inflation is currently stuck at around +1%
Swiss inflation slightly rebounded in April (+1.4%) from its lowest annual increase in March (+1%). Without changing trend in our view, it has stagnated at this level for two months, recording a modest monthly increase of +0.3% in April, while core inflation remains well controlled at +1.2% annually. These recent developments do not challenge the trend anticipated since July 2022 of a new regime of much more moderate inflation, aiming to swiftly bring inflation down to a reasonable level in our country. We previously suggested that a new regime would likely emerge in the second half of 2022, significantly lower than the preceding six months. We also projected that price increases could be limited to +2.2% annually as early as June 2023 if our expectations of a decline at an average pace of about +0.2% per month persisted. Since June 2023, and for nearly four quarters now, inflation has remained below the SNB's 2% target. The evolution of inflation in Switzerland is following a favorable path, partly due to the strong performance of the franc, which correlates with lower imported inflation.
The SNB lowered its key interest rates for the second time in June and remains the most active among major central banks in managing inflation and growth risks. The SNB no longer seeks to control prices through a strong franc, thus accepting some franc weakness in early 2024, while avoiding rapid depreciation. We anticipate Swiss inflation to continue in this trajectory for several months, potentially leading to a twelve-month inflation rate dipping just below +1%. The decline of the euro and the dollar against the Swiss franc has likely helped mitigate the risk of imported inflation. Import and production prices are now also under control.
The stabilization of producer prices also forecasts a more positive outlook for next year's consumer price index. The anticipated global economic slowdown will alleviate pressures on consumer prices, potentially pushing inflation below the 1% threshold.
The SNB is lowering rates according to our schedule
We expected the Swiss National Bank (SNB) to be the first central bank to change its monetary policy in 2024 by lowering its interest rates for the first time in March. This indeed was its decision, coinciding with the Consumer Price Index (CPI) reaching its yearly low of 1%. After witnessing the sharpest decline in inflation among industrialized countries, the BNS began a phase of monetary policy normalization. Despite the resilience of the Swiss economy to the BNS rate hikes and the strong franc, which increasingly threatened the industrial sector, advanced indicators in manufacturing had already pointed to risks of activity downturn for many months. More recently, weakness observed in other sectors of the economy and services has become a growing concern.
The BNS responded to these economic risks by lowering its benchmark interest rates twice by 0.25% each time, while easing its support policy for the franc. The strategy of reducing its balance sheet gap through decreased foreign exchange reserves, which had peaked at 946 billion francs in January 2022 and had been drastically reduced by -32% over twenty-two months to 641 billion, significantly helped limit inflation in Switzerland. However, recent months have seen a 12.2% increase in foreign exchange reserves, indicating renewed sales of Swiss francs, particularly towards the end of the first quarter.
In June, the BNS acted with a second rate cut to 1.25%, aligning with the adjustments we had anticipated and our timeline. The next decision on rates is scheduled for September 26, where we anticipate the BNS will possibly lower rates again. Over the next three months, the evolution of inflation in Switzerland should reinforce its stance on the validity of recent policy changes. A resumption of the downward inflation trend appears essential for BNS action in September. However, achieving a decline in both the core CPI and overall indices during the summer period may prove challenging, potentially complicating the BNS's decision-making process based on this outlook.
Considering the somewhat fragile Swiss economic outlook, risks of growth slowdown could become the next pivotal factor in the BNS's decision-making process. We estimate that another 0.25% rate cut is likely during the September 26, 2024 meeting.
It is probably not advisable to bet on a too-weak franc
The strength of the Swiss franc likely peaked at the end of December 2023, and the expected phase of weakness materialized as the Swiss National Bank (BNS) announced its policy change. However, it's also probable that the rate cuts in Switzerland will now follow a slower pace compared to international counterparts, particularly with expected rate changes from the ECB and the Fed. While Swiss rate cuts could still be around 50 basis points in the second half of the year, for instance, we estimate that the Fed could easily lower rates by 100 basis points.
In this context, it appears that weakness in the franc remains likely, but we no longer anticipate as significant a decline as initially expected earlier in the year. Nevertheless, the franc is expected to weaken by 5 to 7% against the dollar and the euro.
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Rate target achieved for Confederation long rates
For the past two years, inflation in our country has been deflating and is now hovering just around 1.15% annually as of May 2024. The downward trend predicted by BBGI for Swiss Confederation long-term rates has also largely materialized, dropping from 1.6% to just 0.6% over the past fifteen months. Our forecasts of declining inflation and monetary policy changes have similarly materialized with the expected lag in BNS action. Currently, our projections for ten-year rates are still at 0.4% for the next low point in the current cycle, contingent upon Swiss inflation further declining to around 0.5% annually in the coming months. However, recent movements have closely aligned with our forecast, likely already factoring in the perspective of 0.5% annual inflation. Consequently, prospects for capital gains on Swiss franc-denominated bonds are increasingly diminished, as recent yield developments in Switzerland offer diminishing returns.
Positive outlook for Swiss stocks
Swiss stocks have shown a clear uptrend in 2024, with a rise of +10%. However, they lag behind the performance of American equities (S&P500 +14.5% in local currency), while performing on par with European companies (+9% in local currency). The weakness of the Swiss franc in the first half of the year has supported the Swiss stock market, but the Swiss franc returns from other stock markets have benefited from exchange rate effects. As a result, the Swiss market continues to underperform international stocks in 2024, albeit to a lesser extent.
In the second half of the year, the Swiss stock market is expected to gradually be supported by the impact of the franc's depreciation on Swiss companies' earnings, as well as by reduced financing costs.
The decline in Swiss exports continues to reflect the challenges posed by the relative strength of the franc, particularly affecting Swiss chemical-pharmaceutical and industrial firms. However, this situation could potentially change in the second half of 2024. The strength of the franc has significantly impacted profit estimates when expressed in Swiss francs, but now the outlook appears less negative due to the expected changes in policy by the Swiss National Bank (SNB). Anticipated further cuts in interest rates and the cessation of SNB's franc purchases will weaken the franc, potentially leading to a reassessment of profit prospects and supporting the current upward trend. Therefore, the outlook for the Swiss market remains positive for 2024, especially for mid-cap and smaller companies whose stock performance is expected to outperform that of blue-chip stocks.