The Swiss economy “High levels of fluctuation the new normal”

The current stock market turbulence is now the norm, says Chief Economist UBS Switzerland Daniel Kalt. He recommends equities.

by Stephan Lehmann-Maldonado 07 Jun 2016

"Switzerland can play in the big league – if it keeps the conditions attractive for companies,” says Daniel Kalt, Chief Economist at UBS Switzerland. Image: iStock

Mr. Kalt, are you happy with how the Swiss economy is performing?

In the circumstances, yes. On January 15, 2015, the Swiss National Bank scrapped the minimum exchange rate of 1.20 francs per euro. This has slowed the Swiss economy considerably in the last four to five quarters. It was primarily the export sector, tourism and in some cases the retail trade that were hit hardest by the strength of the franc. Fortunately we did not experience a recession, as certain factors bolstered the domestic economy, such as the construction industry. For long periods, the Swiss economy was carried by the real estate market and consumption. Our economy is currently growing at about one percent – about the half the rate we were seeing when the minimum exchange rate was in place.

But the real estate market cannot sustain the economy forever...

Correct. We have experienced a veritable real estate boom in recent years, but the end is in sight. Vacancy rates are gradually starting to rise again. In some areas, it is no longer possible to quickly find buyers for all the new houses being built. Another factor is that the immigration of foreign workers who can afford an apartment – as opposed to that of refugees – is decreasing slightly. The construction cycle is on the wane overall, so this growth driver is likely to weaken.

How do you believe the Swiss economy will fare in the long term, e.g. in 20 years?

Our economy is still one of the most competitive on the planet, as numerous international rankings testify. Switzerland is invariably in the top five and sometimes even in the top three, such as in the new IMD competitiveness indicator. There are some political uncertainties, however. These include the implementation of the mass immigration initiative, the fate of the corporate tax reform and the increasing levels of regulation. What is more, our pension schemes are in need of reform. It is absolutely imperative for us to ensure that the economic conditions in Switzerland remain attractive. The challenges are considerable, but we can overcome them. If we make the right decisions, our economy will still be able to hold its own at the top in 20 years’ time.

Many people fear, however, that we will lose jobs in the wake of Industry 4.0.

In recent years we have already seen many jobs in industry being moved abroad, in part due to the strength of the franc. Now the process of structural change is being further accelerated by automation. Simple production processes are being rationalized out of existence. That is why our education system is becoming more and more important. We need to ensure that our people get a broad basic education and are able to think flexibly. What we need is people with entrepreneurial skills. They are able to discover new areas of activity, potentially in the service sector.

To stimulate the economy, central banks around the world flooded the markets with money. This trick no longer seems be having much of an effect.

Until now, the central banks have used the freshly printed money to invest in the financial markets, primarily by buying up government and corporate bonds. The Japanese central bank even purchased equities and real estate in order to bolster the market. Signs have now started to emerge all around the world, however, that the effects of this “medicine” are declining. If all these mechanisms including negative interest rates cease to have an impact on the economy, some observers already see things moving to the next level – the use of helicopter money. This would involve central banks distributing money directly to the consumers – as if they were flying around in a helicopter dropping parcels of money. It would be a very dramatic mechanism. I hope things don’t go that far.

Let’s take a look at the stock markets. Are we headed for a crash?

We have been seeing increased price fluctuations on the stock markets since the summer of 2015. These levels of fluctuation are likely to be the new normal. At the moment, if you’re looking for decent returns over the long term, you need to invest in equities or corporate bonds. You cannot expect any returns from supposedly safe investments such as government bonds. Of course there is a chance that the equity markets might fall temporarily by 10 or 20 percent, but in the past they have always recovered over the long term. In situations like this, however, you need a great deal of patience in order to sit out the slumps.

So risk-averse investors will have the hardest time.

This is why conservative investors need to structure their portfolios well, which means diversifying them by asset class and internationally. In some cases it may also be advisable to hedge currency risk. A broadly diversified portfolio can absorb a great deal of fluctuation.

Which investments are particularly promising at the moment?

Equities from companies that consistently distribute high dividends – such as solid, medium-sized Swiss companies (mid caps) – are particularly exciting in our view.

The key facts in brief for Swiss investors

  • Equities. Despite the high valuation of equities, the dividend yields are attractive. For that reason, preference should be given to high-quality dividend payers and medium-sized companies (mid caps).
  • Bonds. The nominal returns are low or negative. Reasonable risk premiums with positive returns can be found in corporate bonds rated A and BBB.
  • Real estate. After a good start to the year, the price potential is limited.
  • Currencies. In the short term, the franc is likely strengthen slightly against the euro and remain stable against the US dollar.
  • The economy. Growth is likely to accelerate over the course of the year before consolidating in 2017.