Investment Thesis
iShares MSCI Switzerland ETF (NYSEARCA:EWL) owns a portfolio of about 50 stocks from Switzerland. The fund has underperformed the S&P 500 index in the past. This underperformance is primarily due to its low exposure to growth sectors. Although its valuation appears to be fair, earnings growth from stocks in its portfolio will likely be inferior to stocks in the S&P 500 index. Therefore, investors seeking higher returns than the S&P 500 index may want to seek funds that cover other countries instead.
Fund Analysis
EWL has rebounded from the low in late 2022, but has yet to surpass the peak in late 2021
Since the market reached the cyclical low in October 2022, EWL has performed well. In fact, the fund has delivered a total return of 38.6%. While this return was quite good, its current fund price of $50.21 per share has yet to surpass the price peak of $52.73 per share reached on December 27, 2021. In contrast, the S&P 500 index has delivered a total return of 53.2% since the cyclical low in October 2022 and the index has already passed the previous peak reached in late 2021.
High exposure to defensive sectors and low exposure to growth sectors
What has caused EWL to underperform the S&P 500 index? Well, we believe one primary reason has to do with EWL’s portfolio composition. Below is a table that shows EWL’s sector allocation. As can be seen from the table, health care and consumer staples sectors are its two largest sectors, representing 32.7% and 19.6% of EWL’s total portfolio respectively. These two sectors are generally referred to as defensive sectors. On the other hand, growth sectors such as consumer discretionary, and information technology sectors only represent about 5.6% and 1.5% of EWL’s total portfolio respectively.
EWL’s low exposure to growth sectors and high exposure to defensive sectors is very different than the sector allocation of the S&P 500 index. Defensive sectors such as health care and consumer staples represent only about 12.0% and 6.0% of the S&P 500 index respectively. Growth sectors such as information technology and consumer discretionary represent about 31.2% and 9.9% of the index, respectively. EWL’s low exposure to growth sectors explains why its total return has lagged the S&P 500 index, and it is likely that this trend will continue in the foreseeable future.
Switzerland’s manufacturing PMI has likely bottomed
Since EWL covers stocks from Switzerland, it will be important to check the strength of the country’s economy. Here, we will look at two indicators, manufacturing and services purchasing managers’ index (PMI). For reader’s information, PMI is an indicator of the direction of economic trends. A value above 50 typically means the economy is heading towards expansion, and a value below 50 means the economy may be heading towards contraction.
We will look at Switzerland’s manufacturing PMI first. As can be seen from the chart below, its latest manufacturing PMI has improved to 46.4 last month. While this is still below 50, we can see the value improving from the bottom reached in mid-2023. Therefore, we think Switzerland’s manufacturing sector is showing signs of strength.
On the other hand, services PMI is a bit confusing. As can be seen from the chart below, services PMI is quite volatile in the past year. Its value of 48.4 in May is 6.9 index points lower than April’s 55.6. It is difficult to see the direction where Switzerland’s services sectors will head.
Valuation not expensive
Since it is arduous to calculate the valuation of each individual stocks in EWL’s portfolio, we think it is fair to simply look at Switzerland’s market valuation as a whole. One indicator that can help investors gauge the valuation of one individual market is to use the Buffett Indicator. This indicator is often used by Warren Buffett to check whether the valuation of a region/country’s stock market as expensive or not. So what exactly is the Buffett Indicator? It is basically an indicator that checks the total market capitalization to GDP ratio. Since Switzerland’s central bank has significantly expanded its balance sheet in the past two decades, it will make more sense to include both GDP and total assets of central bank as a whole. Therefore, the indicator should be revised to total market capitalization to GDP + total assets of central bank.
As can be seen from the chart below, the total market capitalization to GDP + total assets of central bank ratio has been in the range of 100% ~ 150% since 2010. Its current ratio of 122.9% is not low, but also not high. Therefore, we think Switzerland’s market valuation is fair.
Investor Takeaway
EWL’s valuation is not expensive. However, its higher exposure to defensive sectors but lower exposure to growth sectors means that EWL will likely continue to deliver inferior returns to the S&P 500 index. Therefore, we think investors may want to seek funds that focus on other countries that can deliver better returns than the S&P 500 index instead.
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