Lessons from the Swiss investment case

I have already previously written about my relatively positive medium term economic outlook for Switzerland (see Switzerland 2 - 0 UK dated July 13). I suggested that the combination of higher tax rates in other countries coupled with a weakening banking secrecy for non-residents renders moving to Switzerland for wealthy and/or high-earning indviduals as well as corporates attractive. This in turn helps to fuel domestic consumption, raise real estate prices (especially in the high-end areas) and supports the tax intake of the Swiss government amid a larger tax base.
This Evening Standard article (Darling's 50% tax sends tycoons to Switzerland) supports my argumentation. It states that: "The advent of the 50% tax rate appears to be the final straw for many hedge funds and other money firms who are being actively lobbied by the Swiss authorities to decamp to Zug, Zurich or Geneva. They are being promised that in Switzerland they can hide from increasing European Union regulation or the intervention of watchdog agencies like Britain's Financial Services Authority."
However, besides this investment case, Switzerland also provides an interesting basket case in terms of rebalancing an export-dependent economy as well as insights into a likely outlook for government bond markets elsewhere.
Firstly, even more so than Japan and Germany, Switzerland is overly dependent on export (accounting for roughly 50% of GDP with the current account surplus standing at 10% of GDP in 2008). Otherwise it does not have significant internal imbalances (no overvalued housing market, no overindebted/undersaving consumers, no weak fiscal position). Therefore, fiscal easing in combination with ultra-low interest rates promises to be able to support domestic consumption to a significant extent. Finally, given that neither households nor corporates and also not the state are overly indebted, a debt-deleveraging spiral is not on the cards. Rather to the contrary, low and even slightly negative inflation rates help to maintain purchasing power and keep bond yields at ultra-low levels.
Secondly, as the chart below shows 10y Swiss government bond yields are at an interesting crossroad. Even though the global economy has stabilised and risky assets could recover significantly, 10y Swiss govie yields are back to the lows prevailing early this year. Technically, they are in a so-called triangle, with a strong support at current levels given that it has been tested several times this year. On the other side, there is a clear downward trend prevaling since June. Which one will win out is not clear from a technical perspective. However, fundamentally, the prospects for ongoing low nominal GDP growth (amid non-existent inflation and subdued export growth) as well as the fact that the fiscal situation of Switzerland remains healthy (relatively low indebtedness and a roughly balanced budget) would suggest that longer-dated Swiss government bond yields can stay low for longer and even fall further amid a flatter yield curve.

Swiss government bond yields back to their lows

Source: Bloomberg

The low yields clearly help to rebalance the economy away from exports and more towards domestic consumption and investment with low inflation not standing in its way. This could as well be the case for Germany where there is no significant debt overhang which would be accompanied by the risk of a debt-deflation spiral. Again, growth is likely to be muted over the medium term amid subdued growth in exports. However, low inflation would help to maintain purchasing power while low yields would support domestic investment and the housing market.
Within Europe, I remain more optimistic for Switzerland and Germany than the overly indebted countries such as the UK, Spain or Ireland from an asset allocation perspective. Furthermore, the Swiss example supports the notion that government bond yields can fall further, especially in export-dependent countries with limited inflation pressures such as Germany.