Switzerland ETFs Are A Buy

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Includes: EWL, FSZ, HEWL
by: Alan Longbon
Summary

Large, consistent capital flows growing the private sector.

Foreign direct investment very strong showing a vote of confidence from overseas investors.

60B+ CHF per year flowing into the Swiss economy.

This is another in a series of articles that makes a fundamental macroeconomic sectoral flow analysis of the economies of key countries across the globe.

The purpose of the review is to see if the local stock market is worth investing in via exchange traded funds (ETFs). These funds are available to all investors, even for non-residents or those not able to trade in the stock market of that country directly.

In this article, we examine Switzerland from a sectoral flow analysis perspective to see if the private sector, containing the local stock market, is getting the support it needs from the government and external sectors to continue its march upward.

Details of the methodology employed to analyze these opportunities are available in the sectoral analysis section found later in this article.

The magic formula for success is:

P = G + X

And you can read more about that below.

Which Countries Are Doing Well?

The first port of call is the ETF page at Seeking Alpha and a look at country ETFs and how they are performing.


The chart is from early December 2016. In that time positions have changed a little as the table below shows.

Most countries on the list are in the red and are of no further interest, though we could learn from them what to avoid, as could their governments and politicians. But, as investors, we will leave that to them.

Switzerland

Since the start of this series of articles, Switzerland has moved from 32 to 27 on the list and is up 11% over the last 12 months. Switzerland is one of the few countries that has fallen back in the chart since beginning this series of articles. But it has not fallen far and gone from a net loss to a net positive result.

We will start the analysis with the government sector.

Government Sector

The Swiss ministry of finance provides the following summary for 2017:

"A deficit of approximately 220 million is expected in the ordinary budget for 2017. Receipts will be up by 3.1%. This positive development is due to the expected nominal economic growth rate of 2.0%, as well as special factors. However, expenditure will also grow by a hefty 2.7%, driven primarily by migration expenditure and the increase in strictly earmarked expenditure. In order to be able to comply with the debt brake, the Federal Council is requesting that some of the significantly higher migration expenditure be recognized as an extraordinary payment requirement. Including the extraordinary budget, the deficit increases to 619 million. It appears that gross debt will rise by approximately 7 billion to 106.4 billion in 2017, with 5 billion of this due to the application of new valuation principles and 2 billion due to the building of liquidity to redeem a bond issue. "

(Source: Government of Switzerland, Ministry of Finance)

Reading through the past and present Swiss financial papers and budgets reveal that they are obsessed with debt. The government even has a fiscal brake that is applied if expenditure exceeds receipts. It is very fortunate for Switzerland that is has a strong external sector as it can expect little or not support from its government sector.

The chart below shows the government budget picture.

The Swiss government has drained the private sector of funds over the last ten years.

The next chart shows the value of the budget and a measure of how much money is added or drained from the private sector by the government sector.

The chart shows that the government has been withdrawing, on average, about 1500 CHF Million from the private sector each year and plans to keep on doing so.

If the Swiss external sector were in balance, the economy would shrink every year by 1500 CHF Million. The government is a net negative influence on the private sector.

Switzerland has the following tax rates:

(Source: Trading Economics)

The rates of taxation are relatively high and skewed heavily for business with a 17.92% corporate tax while the wage earners are paying a 40% top marginal rate plus a 8% consumption tax on all they buy. The financial misery of the consumer goes on with the likelihood of a very high mortgage with which to afford his overpriced accommodation as the chart below shows.

The chart above shows that the cost of housing has increased four-fold since 1970. Switzerland suffered heavily in the land led financial crisis of 1989/90 known in America as the Savings and Loans crisis. The more recent 2007 GFC was a twenty-year cyclical repeat. In 1989 the Swiss real estate market experienced a boom-bust from which price levels troughed in 1998 and did not regain their 1989 peak high until twenty years later in 2010.

One can see from the government budget chart above that during the 1990 Swiss housing crisis the government run deficit budgets for many years afterward to support the private sector and allow it to deleverage from the huge credit boom-bust. The automatic stabilizers that deploy in recessions in the form of unemployment benefits would have formed part of the deficit spending to help those people whose job disappeared in the recession.

A generation of Swiss people have grown up in the shadow of the 1990 housing crisis and do not see home ownership as a good investment as the chart below shows. Housing is still very expensive in Switzerland as is the cost of living generally.

Despite low home ownership, which is the primary component of household debt, debt to income ratios are quite high as the chart below shows.

Incomes are relatively high so the debt in absolute terms is also high. The chart below shows private debt. what people cannot earn or retain out of their earnings they borrow to maintain their lifestyle or make ends meet. Loan creation was flat from 1992 to 2004 and then accelerated upwards at the same time that the government began running surpluses. The private debt is the government surplus provided at interest by private banks. It flows from one sector to the other penny for penny.

The Swiss government is the sovereign issuer of its currency unit; as the source of all money in the economy it does not need to obtain funding from the private sector via taxation or borrowing. This sort of economic thinking shows that the government is acting as if the gold standard still exists and that its spending needs to be squared off against a fixed quantity of gold; this has not been the case since 1971.

The picture gets worse when one reads that the government has a self-imposed fiscal brake, that it keeps breaking and needing to make exceptions for. If one also has the self-imposed tradition of issuing a government bond to match government spending then of course one will break these self-imposed constraints each time the money supply is expanded to match the number of GDP transactions taking place when GDP grows.

This paints a picture of a government that is not aware of its currency creation powers, is obsessed with debt and driven by a now redundant gold standard budgeting mentality. It is unaware of its role as the provider of the medium of exchange. All this from a nation famous for its banks and financial acumen and

...home of the secret bank vaults, which house treasures stolen from people (particularly the Jewish victims) by the Nazis during WW2 and ill-gotten cash by capitalists who wish to evade scrutiny of prudential and tax authorities of their domiciled nations.

(Source: Professor William Mitchell)

Though given the Swiss banking orientated business culture perhaps it comes as no surprise that fiscal policy is braked while monetary policy is preferred. This is because with monetary policy government spending is done via bonds at interest to private banks. The alternative is simple credit creation by the Treasury marking up the respective bank accounts of the government departments to fund their spending at no cost to anyone.

Taxation that dampens aggregate demand and creates enormous and unnecessary tax collection dead-weight losses could be dropped and that resource more productively allocated.

Fiscal policy that is hemmed in by self-imposed constraints, such as fiscal brakes and bond issuance, expanded by dropping those artificial restrictions.

Expanding the money supply, debt free and not at interest, within the limits of set inflation, employment and currency exchange rates could begin. This is a far more rational basis than the current "old think."

External Sector

The chart below shows the long-term balance of trade position.

The chart shows Switzerland has a good balance of trade position and that it is trending upwards.

The chart below shows the capital flow situation.

The chart shows that capital flows are a net positive, relatively consistent and add to the private sector.

The chart below shows foreign direct investment.


Foreign direct investment is a very positive picture FDI indicates that foreign business people are investing in Switzerland and see future profits and growth there. This is a strong vote of confidence. The chart shows foreigners making deposits into their Swiss bank accounts for safe keeping; there is not a lot of real production of goods and services going on.

The chart below shows the current account situation.


The current account pulls it all together and shows that when one considers the external sector's total impact, it is a net add to the private sector. One notices the interruption to the positive growth trend caused by the GFC in 2007 after which flows resumed but have not grown at the same rate since and indeed appear to have leveled off.

Total Trend

One can see the whole trend when one compares GDP with the amount of money in circulation, shown in the following two charts:

Both charts show an upwards trending growth profile overall, though GDP has fallen and leveled off since 2015. GDP follows the capital account surplus which has also leveled off and begun to fall. To maintain the growth trend, employment and aggregate demand the government sector needs to inject the difference into the private sector otherwise it will shrink.

GDP has fallen of late, and the money supply has not. This should lead to inflation, and the chart below shows that this is indeed the case.


The inflation rate is creeping higher after many years of decline and more recently deflation. At less than 1% it is still ultra low by any standard. This means the Swiss government has fiscal space to create more currency and spend it into being on public health, education, and infrastructure or lower tax rates or both. Lowering tax is a good deal easier than making and building things and can have an immediate impact. This would be popular too as the average consumer is highly taxed and loaded with debt.

The level of unemployment is stubbornly rising as the chart below shows. One has deflation and rising unemployment and a falling GDP indicating that government deficits are too low and jobs are being taxed out of the economy. Aggregate demand is sapped by high taxation and high debt servicing burdens and unemployment.

Economic thinking that says you can have one and not the other is clearly false; you can have both at once. NAIRU, the Phillips curve, and the Laffer curve have no place in Switzerland; in fact, Switzerland debunks them roundly. One can have rising inflation and rising unemployment.

One can achieve inflation in two ways. One is positive in that the government puts too much money into circulation and the other is negative in that the economy shrinks and produces less while the money supply rises or stays the same. Swiss public policy is achieving both by reducing aggregate demand.

Sectoral Analysis Methodology

Each nation state is composed of three essential components:

  • The private sector
  • The government sector
  • The external sector

The private sector comprises the people, business, and community, and most importantly for investors, the stock market. For the stock market to move upward, this sector needs to be growing. This sector by itself is an engine for growth and innovation. However, it needs income from one or both of the other two sectors to grow in value.

The government sector comprises the government with its judicial, legislative and regulatory power. The key for the stock market is that this sector can be both a source of funds to the private sector through spending and also a drain on funds through taxes.

The government through its Treasury also sets the prevailing interest rate and provides the medium of exchange. Too much is inflationary and too little is deflationary. It puts the oil in the economic engine and can put in as much as its target inflation rate allows. It is not financially constrained, for a sovereign government with a freely floating exchange rate any financial constraint such as a matching bond issue is a self-imposed constraint. A debt ceiling is also a self-imposed constraint as is a fiscal brake.

The external sector is trading with other countries. This sector can provide income from a positive trade balance, or it can drain funds from a negative trade balance.

One should note that a negative trade balance also means that a country has traded currency, that is in infinite supply, for real resources that have a finite supply.

For the stock market in the private sector to prosper and keep moving upward, income must enter the flow. Otherwise, the sector can only circulate existing funds or is being drained of funds and is in decline.

The ideal situation is that the private sector has a net inflow of funds and is constantly growing, thus giving the stock market headroom within which to expand in value. For this to happen, one or both of the other sectors have to be adding funds to the circular flow of income.

The following formula expresses this simple relationship.

Private Sector [P] = Government Sector [G]+ External Sector [X]

P = G + X

For the best investing outcome, one looks for countries where the government sector and external sector are both net adding to the private sector and causing the local stock market index to rise with the receipt of additional funds.

Recommendation

Switzerland is a buy. Our assessment criteria are met in that overall there is a net add to the private sector allowing it to grow. The trend is however slowing with the capital account trend. The parsimonious government cannot be relied upon to take up the slack to counter this trend. The government has a debt control obsession coming from a now obsolete gold standard economic management belief system and is more likely to make the situation worse than better. The folly of the pursuit of the golden surplus common to most western governments.

The government sector is a negative influence in the economy, and this appears culturally based and not likely to change despite a high level of financial intelligence, or paradoxically because of it, there is a free lunch for private banks being enjoyed here. The gold standard belief system is too strong to change quickly.

The external sector is adding some 60B CHF per year into the private sector. The government is only draining out about 2B CHF per year and has been known to take out as much as 10B CHF (2009) at its worst, this is bad but is much less than the net inflow. On rare occasions it has contributed.

Investors taking the positive investment view of Switzerland could try the following ETFs:

  • Shares MSCI Switzerland Capped ETF (NYSEARCA:EWL)
  • First Trust Switzerland AlphaDEX Fund (NASDAQ:FSZ)
  • iShares Currency Hedged MSCI Switzerland ETF (NYSEARCA:HEWL)

The next article takes us to Belgium.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.