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Market Insights, October 24, 2022

Each week, our Investment team shares its market views with you !

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Essentials

The latest economic data from the UK have been surprisingly weak. Retail sales, for instance, were down 1.5% month on month and 6.2% year on year in September. Liz Truss’ successor will have to deal with a very difficult economic situation, at a time when the Tory Party is rife with scandal.

After reaching new highs in September, natural gas prices have dropped more than 60% in Europe, and the decline has gained momentum recently. The winter heating season is approaching, so this is very good news for the eurozone, especially for household budgets.

President Xi further cemented his power at the 20th National Congress of the Chinese Communist Party and appointed some of his closest allies to the Politburo. Although most recent economic data have beaten expectations, they clearly show that growth is slowing. What’s more, the lack of any indication of when the government’s zero-COVID policy will end and fears that the country’s leader will wield even more power have spooked the Hong Kong stock market.

A resilient Swiss economy, with valuations back at reasonable levels

It’s been a tough year for stock markets, but what’s different about 2022 is that the major sell-off has left very few asset classes and regions unscathed. Swiss equities should perhaps have put in a better performance in this environment, since they usually do well during bouts of high volatility and financial market stress. Yet over the first nine months of the year, Swiss stocks posted similar losses to global equities.

What makes this grim performance all the more surprising is that Switzerland’s economic fundamentals are extremely strong. Economic indicators for both manufacturing and services may have lost ground, but they are in better shape than in other parts of the world. There is no chance of a recession in Switzerland over the coming months, and inflation, which is a major source of concern in other developed countries, remains more or less under control and is clearly starting to ease. All these factors mean that the Swiss National Bank can be much less aggressive in its tightening than its European peers.

The Swiss market’s underperformance can be put down to its excessively high valuations. They reached record levels at the end of last year, making Swiss equities particularly vulnerable to a widespread rise in interest rates, since the more expensive a stock is, the more sensitive it is to changes in long-term interest rates. The P/E ratios of small and mid caps had reached particularly excessive levels.

Their premium over large caps was around 45% at the beginning of the year, although it has since dropped back to 10%. The current low premium has only ever been seen during major events such as the 2008 financial crisis and the 2015 global economic downturn – another sign of just how bearish investors have become. Now that valuations have returned to more reasonable levels, we think Swiss equities should pick up between now and the end of the year, especially since the domestic economy is holding up well in the current uncertain macroeconomic climate. We therefore recommend continuing to overweight Swiss equities.

Central banks are driving currency movements

The US Federal Reserve’s decision to quickly and aggressively tighten its monetary policy clearly strengthened the dollar in recent months, bringing in capital from international investors looking for higher returns. Most central banks around the world have been extremely slow to raise interest rates from rock bottom, so investors have been drawn to the very attractive yields offered on the dollar, which are at their highest in more than 10 years. The yield spread will continue to favour the greenback, which should remain strong against the currencies of the USA’s main trading partners.

Among the other major currencies, the yen is still experiencing significant downward pressure. That can be put down to the Bank of Japan’s decision to stick to its zero interest-rate policy, bucking the trend of other major central banks. The European Central Bank has started raising rates, but the euro remains weakened by the war in Ukraine and the threat of an energy shortage. And the UK’s highly unstable political climate forced the Bank of England to take action to calm the markets and shore up the tumbling pound. The Swiss National Bank (SNB) is happy with a strong franc, which is helping to keep a lid on imported inflation. In its latest press release, however, the SNB did indicate that the franc may already have gained enough ground on the euro in the short term.

Central banks have therefore been key drivers of currency market movements in 2022 and everything suggests that this trend will continue into 2023 as well.

 

 

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