The Swiss Stock Market Plunged: Should You Buy?

The Swiss Market Index (SMI), Switzerland’s blue-chip stock market index has lost 14% of its value over the last two trading days. Should you rush and buy shares of Nestlé (WKN:A0Q4DC) (VTX:NESN) (ETR:NESR), Novartis (WKN:904278) (VTX:NOVN) (ETR:NOT) or The Swatch Group SA (WKN:865126) (VTX:UHR) (ETR:UHR)? The short answer is no — at least, you should not rush into such a decision. Some caution is needed, and you should understand the reasons for — and the implications of — the astonishing drop.

The catalyst for the stock market earthquake was the decision by the Swiss National Bank to eliminate its currency floor of 1.20 Swiss franc to the euro. This move caused the Swiss franc (CHF) to sharply appreciate against the euro (EUR) (and all other currencies): At some point during Thursday, it was trading 28% higher at 0.86 CHF/EUR. By the end of Friday the Swiss franc traded at around 0.99 CHF/EUR, a 17% increase in the value of the Swiss currency compared to two days before.

What are the key implications of this for us, retail investors?

The exchange rate increase can offset the share price drop

Unless you are one of our Swiss readers — or you have been stashing away Swiss francs under your mattress –, you probably use euro funds for your investments. However, Swiss shares are originally valued in Swiss francs. In order to buy them, you need to pay more euros for every franc today compared to only a few days ago. As a result, even though the Swiss franc value of a share may have fallen significantly, the euro value of the same share has dropped much less, or it could have even increased. Let’s look at two examples:

Source: Onvista.de

Swatch saw a huge drop in its Swiss franc share price. It was, in fact, the worst performer on Thursday among the SMI stocks. However, the drop in its euro price was much less, as investors had to pay more euros for each Swiss franc.

Nestlé shares were also hit hard in Swiss francs, albeit less so than Swatch. However, Nestlé share price in euro actually increased by 7%, as the drop of the Swiss franc value was lower than the change in the foreign exchange rate.

Whenever you deal with a company whose shares are denominated in a currency other than the currency you funded your investment with, you will be exposed to foreign exchange fluctuations. As a result, the return on your investment may differ from the performance of the shares in their original currency. This can go both ways: A European investor who owns shares of Apple (WKN:865985) (NASDAQ:AAPL) (FRA:APC) has benefited over the last year not only from an increasing share price, but from a stronger US dollar as well. On the other hand, an American investor who invested in Adidas (WKN:A1EWWW) (ETR:ADS) (FRA:ADS) a year ago would not only be faced with a sharp drop in Adidas’ share price in euros, these euros would also be worth 15% less in dollars as the exchange rate moved from 1.35 USD/EUR to 1.15 USD/EUR.

Changes in currency rates can have significant impact on business performance

Ok, so the share price change in euro may be different from the share price change in Swiss francs due to foreign exchange fluctuations. However, why did Swiss shares lose so much value in Swiss francs in the first place? The answer is simple: Investors believe that a stronger franc will mean worse financial results for Swiss companies.

And they are, in general, right. So what is the reason for this?

Firstly, Swiss exports will become more expensive. For example, German customers will need more euros to buy the same product. Swiss companies will either lose sales or will need to reduce their Swiss franc prices to keep their customers. If they are selling in other currencies, these sales will be worth less Swiss francs. The overall impact is a strong pressure on Swiss franc revenues.

Some of this revenue loss will be offset by reduced costs, as the companies manage to re-negotiate their prices, at least to some extent, with their foreign suppliers. However, these companies also have significant costs based in Swiss francs for their operations at home, so not all costs can be reduced. Since most of the big Swiss companies are very reliant on exports — as an example, Swatch generates 87% of its revenue outside of Switzerland –, the pressure on sales is expected to be much bigger than the possible reduction in costs. As a result, most of these companies are expected to have a negative impact on their future financial results, which explains the big drop in share prices.

Companies that generate most of their sales and profits outside of Switzerland — luxury goods producers such as Compagnie Financiere Richemont AG (WKN:A1W5CV) (VTX:CFR) (ETR:RITN) or big international banks like UBS Group AG (WKN:A12DFH) (VTX:UBSG) (ETR:0UB) — are the worst affected. Chief Investment Officer at UBS Wealth Management Mark Haefele estimates a negative impact of five billion Swiss francs (or 0.7% of Switzerland’s gross domestic product) directly on exporters. However, even domestic industries such as tourism will have a negative impact, as Switzerland will become (even more) expensive to foreign visitors. The only company in the SMI index that didn’t lose value was Swisscom AG (WKN: 916234) (VTX:SCMN) (ETR:SWJ), Switzerland’s main telecoms company, since both its sales and operations have strong domestic focus.

What does all this mean?

There is a fair chance that at least part of the market plunge was overreaction and some companies will have better financial results than today’s share price indicate. In this case, the share price of these companies should rise. I do not know the Swiss market well enough to comment which company may represent such an investment opportunity, but to investigate any company further, I would look at the following questions:

• How much does the company rely on export sales?
• How much pricing power does it have? How price sensitive are its customers?
• How much cost reduction can the company achieve due to the stronger Swiss franc?
• Based on the above, does the expected negative impact on future results justify the drop in the share price?

If the answer to the last question is no, this company may be a potential investment opportunity. However, even in this case, you should not forget the potential foreign exchange exposure: Assuming you invest euros, the success of your investment will depend not only on the share price in Swiss francs, but also on the development of the Swiss francs to euro exchange rate. As the last few days showed, this could be more volatile than people expected.