A partner of one of the greatest investment advisory firms discourages ordinary people from the Swiss franc; however, portfolio managers and expert investors should consider taking bets on the significant weakening of Swiss franc. In the interview, Felix Brill, responsible for the strategic decisions of Wellershoff and Partners, explains that relatively quickly the franc will become significantly weaker against the dollar, the pound, the Norwegian crown, and mainly against the euro. According to his company’s calculations, the exchange rate of franc to euro is 1.27. As he said – his country will fall into recess if there will be no strong depreciation of the franc. However, he does not see signs of deflation neither in Switzerland, nor in Europe.
He also suggests increasing the European equity ratios in portfolios.
Péter Zentai: So far, the Greek problem is still unsolved; however, the euro still seems stable. Can we conclude from it that the market expects a positive outcome from the Greek situation and is not afraid of that it will bring forward an ‘epidemic’ of radicalization in Spain, Italy, and in Portugal as well?
Felix Brill: The new Greek government would like to present itself as strong, but with time, compromises will have to be made that will not relieve Greece from its debts and the responsibilities coming with them, nor from paying back interests.
Even if the recently elected Athenian government – to demonstrate its power – fulfilled some agreements fairly quickly: by stopping privatizations, and reemploying ten thousands of previously removed employees, such as teachers. However, not the Athenian government, but the ECB, the IMF, and the European Union are in a stronger position. The people of Greece know that if the relation between the Greek governments and the main creditors – states, and international financial institutions – would become radical, it would possibly lead to state bankruptcy. In that case, life in Greece would change dramatically. The consequences would be unforeseeable – and the Greeks know that!
This situation is reflected in the exchange rate of euro, which – despite the Greek difficulties – tends to remain stable, while the yields of Spanish, Portuguese, and Italian government bonds are not increasing. This means, the market is not expecting an ‘epidemic’.
Euro has become remarkably weaker compared to the dollar. Is this tendency going to continue? What do you say to your clients in this regard?
My short answer is that the dollar has to get weaker against the euro.
The fair value of the euro against the dollar is – relating to the American and European purchasing power parities – 1 euro is worth 1.39 dollar.
As if market players would not be bothered by fair value…
Dollar was overvalued by twenty percent, and it can become more severe in the next weeks.
The market is ‘over-favouring’ America against every other area – due to the uncertain situation. Everyone is focusing only on the difference of growth between the United States and Europe. There is no doubt that America is growing faster than Europe. Meanwhile, it is also without doubt that the expected increase of interest rate differential is overestimated: Fed increasing interest rates is seen as unavoidable, while it cannot happen in Europe in the near future.
However, based on history and experience, it can be said that the relation of currency pairs is modified by markets – when they become calm – based only on one factor: inflation, and inflation expectation.
Prices will increase faster in the United States – compared to Europe. The most important has always been the so called Big Mac index: where, and for how much McDonalds can sell their emblematic product, Big Mac in proportion to salaries.
Today, Big Mac index has been replaced by the so called iPad index: how the popular product of Apple relates to people’s income. It does not matter which – since both indices are showing the same: the money of Europe is currently undervalued, and it will inevitably be appreciated – in the foreseeable future. In the last year, prices have been increasing faster in the United States than in Europe.
What do you at Wellershoff think about the franc’s relation to the euro? What does comparison based on purchasing power parity show us – what do the Big Mac or the iPad index tell us?
It shows that the Swiss franc was significantly and unprecedentedly overvalued for a couple of days by the market, right after our central bank separated the franc from the euro.
However, we assure our clients: they should prepare for the stabilisation of a notably lower franc exchange rate – as soon as they can.
We think that the Euro, the dollar, the British pound, and the Norwegian krone will become stronger against the franc, and we also think that this process will start sooner than our esteemed Swiss and foreign colleagues believe. They said the central bank will not intervene in fixing the exchange rate to euro until 2016. As they were wrong about that, we think, they are wrong about fanatically believing that the strong franc, the parity relation with the euro can be maintained until 2016 at least.
We think this is an incorrect presumption. The franc will not be able to remain this strong for one and a half – two years.
What is the fair value currently?
It is 1.27 franc for 1 euro.
The fixed 1.20 exchange rate caused problems for two – three years, because it fixed the overvaluation. It initiated the weakening of export sectors, the decrease of import prices, and resulted in a minus one percent inflation in Switzerland.
Is there a deflationary risk in Switzerland?
No, that’s not the situation. The dropping energy prices and the overvaluation of the franc together would result in that situation. Last year – independently – our economic growth was still higher than the EU average. By the prices remaining the same, wages and salaries have become higher and boosted consumption; officially, there is a minus one percent inflation.
At the same time, real estate market is an exception. There is inflation, which is accelerated by the remarkably cheap, negative interest rate environment.
This negative interest rate, however, endangers the country’s financial stability, causing more and more damage in the significant bank sector. If banks provide at least zero interest rate to their clients, they are going to suffer losses; however, if they charge negative interest rate, which is loss-making for them as well, then banks will take unforeseeable risks.
The point is that the market will notice – rather sooner than later – that this situation is unsustainable, and the franc will start its fall.
If it did not happen, then Switzerland would fall into recess.
Why would it become weaker against the euro? It is not the Swiss central bank what dilutes currency, but the European central bank does it with the euro…
We must not forget that, based on this, the dollar would have to become dramatically weak against the euro, right after Fed started its great QE (qualitative easing) project. But that’s not the case. The dollar is not weakening. And the latter one is getting stronger…
So is it the right time to go indebted in franc? Is getting a loan for a house or shopping worth it? Since – as you said – a continuously weakening foreign currency has to be paid back…
This is exactly what I warn families and people against. Even if – theoretically – you are right: circumstances have never been better to go into debt in Swiss franc. It is better if private households stay out of the game of ‘big ones’. Anything can happen that changes the setup; currency risks can hardly be evaluated.
It is a different issue, which many portfolio managers, who can allow themselves – will definitely try to take advantage of the current situation: the unmaintainable overvaluation of Swiss franc, and the negative interest environment.
Do you recommend buying shares in currencies which can get stronger against the Swiss franc, for example in euro?
We do not recommend it at all to those who believe in the weakening of the Swiss franc against the dollar or the euro. We tell them to buy euro or dollar. And keep it! Keep the currency itself. Foreign exchange speculators should not take the risks in shares!
Which stock markets do you prefer?
We think that the prices of the American market are too high compared to the European. So – indeed – we buy European shares, and this is what we recommend to our clients.
Commodities, energy sources?
It is risky. This is not the right time for enhancing existing commodity portfolios, and opening towards new positions.