Swiss equities: being familiar with quality companies is key

• Some of the anticipated base rate cuts have already been factored into stock prices
• It is likely that companies will only start to see an easing in the second half of 2024
• We expect a soft landing in the US
• There is a heterogeneous economic picture in Europe
• The Chinese economy is expected to gradually pick up in 2024

Given the strong final spurt in stock prices in 2023, we believe the base rate cuts anticipated in the current year are already partially priced in. We do not expect interest rates to ease until the second half of 2024. Until then, companies will continue to face high refinancing costs.

We do not foresee a hard landing for the US economy, which we believe is already in a mild recession. European countries are currently painting a heterogeneous economic picture. The situation is particularly difficult in the construction and automotive industries in Germany, for example, which is Switzerland’s second-most important trade partner. In China, there are delays to the economic recovery that we expected last year following the lengthy pandemic-related shutdowns. Based on our current assessment, the situation there should gradually improve as the year progresses, in part thanks to support measures from the Chinese government.

• War in Ukraine
• Escalation in the Middle East
• Discord between superpowers
• Conflict between China and Taiwan
• Presidential elections in the US

We closely monitor geopolitical uncertainties and always take the possible consequences of these into account when making our investment decisions.

• The current valuation of the Swiss stock market as a whole is in line with its average P/E ratio over the last 15 years
• Swiss small & mid caps currently have a discount of more than 10 percent compared to their long-term average P/E ratio
• Our focus is not on absolute valuations but on relative consideration

The valuation of the Swiss stock market based on the price/earnings ratio (P/E ratio) is currently in line with the average of the last 15 years (Figure 3). In our opinion, Swiss small & mid caps are currently particularly attractively valued compared to the historical average. At the end of 2021, they were still trading at a premium of 35 percent compared to the long-term average, but they are currently trading at a discount of around -13 percent.

Relative consideration is more important to us than absolute valuations. While we contrast Swiss companies’ valuations with those of their direct competitors—many of them based abroad— we also compare the valuation performance of individual companies over the last five or 10 years. We believe that this is relevant, as the current valuations of many Swiss companies are high compared to those of their direct competitors. As an example, this is the case for Ems-Chemie, Lindt & Sprüngli, Straumann and VAT. This is justified in our view, as many Swiss companies from a wide range of sectors achieve by far the highest margins in the world.

• Resilient business model
• Strong balance sheet
• Innovative strength
• Pricing power
• Stable margins
• Corporate culture
• Dividend policy

The quality of the companies is key to our investment process. By “quality,” we mean companies with a leading position in the global market, a strong balance sheet with low levels of debt, the ability to innovate, pricing power, stable margins, exemplary corporate culture, and a sustainable dividend policy. In times of economic uncertainty, as is currently the case, we favor companies that are only slightly dependent on economic trends or interest-rate developments because they have a resilient business model in addition to the quality-related characteristics mentioned above.

We also prioritize expected corporate earnings in our investment process because they have a significant impact on the stock markets. This can be seen in the historical profit performance of the 140 Swiss companies we analyzed—20 large caps and 120 small & mid caps, which together make up around 95 percent of the SPI’s market capitalization (Figure 4). Their earnings fell by 11 percent in 2022 compared to the previous year, and those of small & mid caps even fell by 25 percent, as measured by the SPI Extra. Stock prices also fell accordingly in 2022 (SPI: -16 percent vs. SPI Extra: -24 percent). Based on our estimates for 2023 (as the actual annual results are not yet available for many companies), earnings are likely to have again grown by around 4–5 percent compared to the previous year.

Comparing the most important stock markets over the last three years, the Swiss stock market stands out for having the heaviest downward earnings revisions, especially last year and particularly in the second half of last year. This stands in contrast to the US stock market, for example, which showed significant upward revisions due to the high proportion of technology companies that benefited from the tailwind brought by artificial intelligence (including ChatGPT). As a result, we conclude that the current prices on the Swiss stock exchange are already anticipating some recessionary fears. The magnitude of the earnings currently expected seems realistic to us, i.e., we do not foresee any further substantial downward revisions for the time being.

Our assessment is that 2024 earnings expected for Swiss large caps are likely to fall slightly or stagnate, while those for Swiss small & mid caps are likely to increase by 1.3 percent (Figure 5). This estimate is based on the assumption that many companies will initially face challenges, but that their order numbers will then pick up in the second half of the year. In turn, this will ultimately have a positive impact on their stock price—especially given their valuations, which are considered attractive in historical terms.

The Swiss small & mid caps segment is significantly more cyclical than Swiss large caps because the latter are strongly represented in defensive sectors such as food, healthcare, and telecommunications. In the past, Swiss small & mid caps have performed worse than Swiss large caps when the global economy cooled and purchasing managers’ indices (PMI) have dropped or fallen below the growth threshold of 50 (Figure 6). Once the period of declining PMI was over, it was a good time to shift into small & mid caps. In our view, this is likely to be the case again in the next two to three quarters.