Swiss GDP stalled in the second quarter and the outlook is gloomy
Despite recession and relatively low inflation, the SNB could raise interest rates
The franc will strengthen against the dollar and the euro
Ironically, this challenging environment is positive for Swiss equities
CHART OF THE WEEK: "Stock market performance, in Swiss francs"
FINANCIAL MARKETS ANALYSIS
Throughout the pandemic, the Swiss economy outperformed most of its trading partners. It had nothing to envy either of its close neighbours or the world's leading economy, the United States. At the height of the crisis, Switzerland's Gross Domestic Product (GDP) contracted by just 8%, compared with declines of between 10% and 23% in surrounding countries (see Fig. 2). By mid-2021, Switzerland had returned to its pre-Covid production level. Since then, its growth has been in line with that of other developed countries, enabling it to maintain its leading position on the international stage.
Despite its structural dynamism, Switzerland is not immune to recession. At a time when inflationary shock and rapidly rising interest rates are the order of the day for all countries, the Swiss economy is no exception.Figures for the second quarter, released last week, reveal a sharp contraction in business investment and very weak growth in consumer spending (see Fig. 3). Companies are seeing their order books empty, while house holds are suffering from the erosion of their purchasing power and the worsening job market.
Indeed, surveys show confidence is clearly deteriorating, both among purchasing managers and consumers(see Figs. 4 & 5). Industrial production and retail sales will remain in negative territory. Everything points to negative GDP growth in the third quarter, which officially places Switzerland in recession.
One factor that sets Switzerland apart from the rest of the world is its low inflation rate. Admittedly, it has risen at a high pace in recent years, but nowhere near that of its main trading partners. In Switzerland, inflation peaked at 3.5% year-on-year, compared with 9.1% in the United States and 10.6% in theEurozone. Price growth is already close to the 2% target set by the Swiss National Bank (SNB). It's a long way from concluding that the SNB will not raise its key rates again on September 21. There are several reasons for this :
The SNB meets only half as often as the Fed, the ECB or the BoE, for example. If it does not tighten monetary policy at the next meeting, it will not be able to act until December, unless an extraordinary interim decision is taken.
Interest rates have risen only half as fast in Switzerland as elsewhere (see Fig. 6), admittedly for good reasons, but their inflation-adjusted level (in real terms) is still not very restrictive by historical standards (see Fig. 7).
A resurgence of inflationary pressure over the coming months cannot be ruled out. The producer price index, for example, which is heavily influenced by energy prices, has rebounded slightly recently.
Some strategists argue that the SNB will choose to stand still because a further rate hike would favour the appreciation of the Swiss franc, penalising exporting companies twice over. This argument is correct, but it appears insufficient to alter the SNB's rate hike trajectory :
In surveys, companies do not report that the strong franc is holding back their exports. This is because the franc's appreciation has merely offset the inflation differential between Switzerland (low)and the rest of the world (high). Contrary to popular belief, companies have not lost competitiveness. As long as inflation is lower in Switzerland, the franc will have good reason to appreciate further.
The SNB's directors regularly state in speeches that their priority remains the fight against inflation.With inflation still far from the targeted level, they will seek to dampen the economy by further raising the cost of money. At the same time, they are fine with a gradual appreciation of the franc. It helps to curb inflationary pressures while giving companies time to adapt and make productivity gains if necessary. Proof of their comfort with the interest rate policy being pursued and their tolerance of the level of the Swiss franc, they are still reducing the SNB's balance sheet. Over the last fifteen months, they have sold some 153 billion euros and dollars to buy (and destroy) Swiss francs (see Fig.8). If they had the slightest doubt about the need to tighten monetary policy, they would have slowed the pace of quantitative tightening introduced at the beginning of 2022.
In the short term, therefore, investors could be surprised by the new monetary tightening on 21 September and the resulting appreciation of the Swiss franc. In the long term, analyses point to a structural appreciation of the Swiss currency, against the euro and, even more so, against the greenback(see WIF April 24).
The biggest disappointment for Switzerland is the recent sharp underperformance of its stock market. In the second half of 2022, the situation could be justified by a "return to normal", following the positive trend in the Swiss market over the previous 30 months. In contrast, the lag in performance in 2023 looks not normal given the defensive nature of the Swiss index. Usually, when the global economic cycle slows down, stock market indices fall, but the SMI is more resilient: it outperforms (see Fig. 9). With stock market indices having risen this year, despite the economic slowdown, the relationship appears to have broken down. A return to fundamentals, via a sharp correction in the stock market, would undoubtedly restore colour to the SMI, the SPI and companies that have already performed well this year, such as ABB,Kuehne + Nagel, Straumann and Temenos (see Fig. 10).
Investors who are used to standing back and investing in Swiss francs have nothing to worry about. The performance of the Swiss stock market, adjusted for currency effects, compares very well with the best regional indices, such as the American S&P 500, and remains well above that of Europe's flagship index, the EuroStoxx (see this week's chart). Doing without it in a portfolio would be a mistake.
Switzerland is slipping into recession, but its economic situation remains structurally better than that of its main partners, both in terms of growth and inflation. A further rise in key rates by the SNB could give the Swiss franc a further boost. Swiss equities, meanwhile, will benefit from the next bear market to out perform. Two good reasons for investors to look at them.