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The hidden beauty of Swiss stocks

For the last year, investing in Swiss stocks has been a pain trade. The country's equities lagged the global markets mainly due to the weak performance of two of its key sectors: Healthcare and financials.

But there's more to the market than meets the eye. There are two simple reasons why this market looks underappreciated. For one, Swiss stocks are often innovation leaders in currently disliked sectors. Their earnings power is understated by the strength of the Swiss franc – something that will not last forever.

Alphorn players perform in Nendaz, Switzerland.
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Alphorn players perform in Nendaz, Switzerland.

Second, Swiss stocks offer a diversifying bet on the euro zone's political calendar. If France was to follow the Dutch example and opt against the populist politics of the National Front for a Europhile president, Swiss stocks could be the unexpected beneficiary. That's because a resulting euro-appreciation would weaken the Swiss franc and reveal exceptional hidden value.

If, however, the FN's Marine le Pen prevails, Swiss equities would offer some relief from the likely market sell-off. Meanwhile the Swiss franc would melt up if the euro melts down.

Strong dollar and reflation should help Swiss equities

Swiss equities, alongside healthcare, tend to do well when the U.S. dollar is strong. Cheap valuations and improvement in European economies also should help Swiss equities continue their recent outperformance. Factors that held back Swiss equities in 2016 are unlikely to repeat themselves in 2017.

One of the reasons Swiss stocks had a bad 2016 was down to troubles in the healthcare industry, which came under fire from both candidates in the run up to the presidential election in the U.S.– by far its biggest end-market. Meanwhile Switzerland's financial sector was exposed to ever lower bond yields and continued legal issues and regulations.

While, these factors impacted Swiss equities and created a disconnect between fundamentals and what the market was pricing in 2016, the healthcare and financial sectors are on a stronger footing for the year ahead .

This year, healthcare looks to outperform as political risks surrounding drug pricing fade away in the U.S. and strong fundamentals, such as the very supportive medium-term pipeline, start getting reflected in prices. At the same time, reflation and higher yields in general should also support financials.

We also expect political risks in Europe to recede, lending further support to financials. More broadly, as those risk premiums slowly normalize, we expect Swiss equities to continue to outperform and close the gap between fundamentals and market prices.

In addition, the Swiss equity market exhibits some of the most attractive relative valuations. While global equities are in an expensive territory, Swiss equities are on the neutral side.

The fundamental backdrop also remains supportive. The Swiss franc has weakened in the past couple of weeks against the euro, but, more importantly, the franc also weakened against the U.S. dollar.

A strong greenback has usually been a positive for Swiss equities as it creates a positive translation effect for Swiss companies earning revenues in dollars . We expect the U.S. currency to continue to strengthen against the franc. In the past few years, when the two currencies were was around parity, and US bond yields were around 2.5 percent, that is, when both the numbers were close to the current levels, Swiss equities were consistently10 percent–15 percent higher relative to global equities.

While we do not expect Swiss equities to necessarily outperform by such an extent, clearly there are upside risks for the Swiss market.

Burkhard Varnholt is Deputy Chief Investment Officer, Credit Suisse and Gérald Moser is Head of Equity Strategy at International Wealth Management, Credit Suisse

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