Swiss volatility presents opportunities

For more than three years, the Swiss National Bank (SNB) has had a cap in place to prevent the Swiss franc from appreciating beyond 1.20 francs to the euro. However, with the euro’s depreciation, authorities have had to increasingly intervene in the currency markets, buying euros in order to keep the exchange rate from breaching this level. This has had a significant effect on the central bank’s balance sheet: the latest disclosure, as at the end of November, shows the balance sheet at almost half a trillion francs (compared to GDP of 650 billion francs). Although the SNB would have had other options available to it to manage this huge balance sheet, on 15 January, it decided to abandon the cap. As a result, the exchange rate fell to 0.85 francs to the euro and experienced considerable volatility throughout the day, to recover eventually to around parity. The currency strengthened by a similar extent against other currencies, including the US dollar.

The effect on the stockmarket

The Swiss stock exchange as measured by the Swiss Performance Index (SPI) lost 8.6% on the day of the announcement. The Swiss franc gained about 12% against the US dollar when the Swiss market closed, resulting in approximately a 3.5% gain for the average dollar-denominated investor. Obviously, there was a lot of disparity between individual stocks. Whether the daily move correctly reflected the new exchange rate level needs to be analysed in terms of the transactional impact on the market’s constituents, but in general it could be said that it is unlikely that the appreciation of Swiss franc has been fully reflected in the decline of the stock market on 15 January. As a rule of thumb, and ignoring variations between stocks: if the Swiss franc gains 15% against a bundle of other currencies, the Swiss equity market should be 15% lower on average.

Stockpicking opportunities

We believe that long-term, Swiss equities are a good investment. Many companies are global leaders and over the last several decades, Swiss companies have successfully coped with a strengthening Swiss franc. However, in the short term, we expect exchange rate and equity market volatility to persist. This is both an opportunity and risk. We have started to look into exploiting the volatility by “bottom-fishing” in stocks that fulfil three of the following four conditions: 1) share price loses more than the overall market, 2) an already attractive valuation prior to the share price fall, 3) almost no transactional foreign exchange exposure and 4) pricing power. Any action taken will be gradual as there remain a number of important events that have the potential to have a significant impact on financial markets, such as the European Central Bank meeting on 22 January.