The underperformance of Swiss small caps compared with large caps over the last 2 years has been particularly marked (see chart below).
This was logical, given the weak business growth in Switzerland (as in Europe), a rather unfavourable exchange rate and the defensive nature of Swiss large caps. We should also bear in mind that Swiss small caps are highly sensitive to interest rates, due to the high weighting of property companies.
As we know, the economy is picking up and inflation is gradually coming down. The KOF index is in line with GDP growth of 1.5% (currently 0.8%); see chart below.
As for inflation, it is well below that of the eurozone, although above the historical Swiss norm (see chart below).
Swiss small caps are a good vector for indexing to the upturn in the Swiss economic cycle.
Swiss small caps are much more cyclical and much less defensive than the SMI, with a much greater bias towards industrials and property companies.
The beta for Swiss large caps has historically been close to 1, but it has fallen recently, suggesting a rebound is imminent (see chart below).
What about the valuation of Swiss small caps?
They are not very expensive given their track record. Historically, they have traded at a premium of just over 20% to Swiss large caps. However, the premium is currently just 15% (see chart below).
On the other hand, Swiss small caps are expensive relative to their European counterparts, with a premium that has increased in recent years (see chart below) and is not justified by stronger growth.
The EPS momentum of Swiss small caps has recently picked up in absolute terms. It is in line with that of Swiss large caps. Nevertheless, it remains fairly average by European standards (see charts below).
In addition, the fall in the Swiss franc in real terms (over the last 12 months) is good news for Swiss small caps.
Small caps export less than large caps. Nevertheless, their sensitivity to exchange rates is high: a negative correlation of 45% between the real CHF and Small EPS since 2012 (vs. a negative correlation of 58% between the real CHF and Large EPS); see chart below.
