#Market Strategy — 15.01.2018

Switzerland: the 2018 financial market outlook

Roger Keller

In our last article on the economic outlook for Switzerland we concluded that prospects are promising. In a nutshell:

- Real GDP growth will rise from 0.9% in 2017 to 1.8% in 2018, before it decelerates marginally in 2019.

- Inflation will strengthen further: after reaching 0.5% in 2017, it should rise further to 0.6% and 0.9% in 2018 and 2019 respectively.

- The Swiss National Bank will be in no hurry to change its policies. We expect interest rates to remain unchanged over the whole of 2018.

Today, we will comment on our forecasts for the franc, the Swiss bond market and the Swiss stock market.

Some marginal weakening of the franc against the euro over 2018

We do not see room for a significant weakening of the franc in the foreseeable future. The main reason is that a lot of Swiss investors have suffered from the “Frankenschock” in January 2015. They are likely to take advantage of a return of the EUR/CHF parity close to 1.20 to reduce their holdings of foreign currencies. In addition, 2018 is likely to be the year in which the world economy reaches “peak growth”, which means that investors will increasingly think about the risk of the next recession coming before the year 2020. A current account surplus of 10% of GDP and a fiscal balance in equilibrium support a fundamentally strong franc. Based on all these factors, our 2018 year-end target for the EUR/CHF parity is 1.18. Against the US dollar, we see the parity staying around the current level of 0.98.

Poor outlook for bonds

Although the Swiss National Bank is expected to keep its interest rates unchanged over 2018, the outlook for bonds is very poor. Bond yields are expected to move directionally in concert with their trend in the global bond market. On short maturities, they will logically rise marginally. We see the two-year government bond yield rising from -1% to -0.90%. Hence, short maturity bonds will offer negative returns, unless one contemplates bonds with ratings below BBB. Bonds with longer maturities will depreciate more significantly. We expect the yield on the 10-year government bond to rise from -0.20% to +0.20%. In comparison, our expectation for the 10-year Bund yield (German government bond) is a rise of 60 basis points, from 0.40% to 1%. Obtaining positive returns on CHF bonds will therefore prove to be very difficult.

Attractive prospects for Swiss equities

With approximately 15%, Swiss stocks have the best earnings growth potential in 2018 among the countries we follow, after India. An important contributor to this growth rate is the 6% weakening of the franc on a trade-weighted basis since the middle of 2017. A more significant factor is the impact on Swiss companies coming from a healthy world economy, given that a high proportion of companies have revenues generated outside of Switzerland that make up at least 90% of total revenues. With such bright earnings prospects, Swiss stocks are positioned to deliver attractive returns in 2018. Because of their high valuations however, the price performance over 2018 is unlikely to surpass the rate of expansion of earnings; we expect capital gains to approximate 10%. Looking at the PE of Swiss stocks relative to the rest of the world, it is the highest since 1990 at least and their price-to-book relative stands at a 20% premium to the world equity market, in the upper part of the range seen in the last quarter century. The upshot is that the upside for Swiss stocks is likely to be not as good as the one we expect from the euro area and Japanese stock markets but they are well placed to perform at least as well as US stocks. Investors should keep in mind that Swiss stocks offer an attractive dividend yield: it is above 3%.

With regards to small and mid-cap stocks, their expensiveness leads us to favour large cap stocks.

Given our expectation that growth will accelerate in 2018 and that inflation is also in a moderate uptrend, Swiss bonds have poor prospects but Swiss stocks offer an attractive upside potential, not the least thanks to the weakening of the franc. The latter is likely to end the year around 1.18 against the euro.