Investment StrategyEconomy and Financial MarketsJuly 2017

Contents

1 Editorial Living with a strong Swiss franc

2 Economy Central bank balance sheets: confidence at risk, but not the economy

4 Interest rates and yields SNB leaves expansionary monetary policy unchanged

5 Equity markets Banking stocks: resurgence or flash in the pan?

6 Currencies Investor sentiment supports euro

7 Commodities OPEC must be patient too

8 Investment Strategy Calmer waters

9 Market overview Economic data and cycles Interest rates and currencies Equity and commodity markets Financial markets and forecasts

Impressum

IssuerSt.Galler Kantonalbank AG St.Leonhardstrasse 25 9001 St.GallenTel. +41 71 227 97 00 info@sgkb.chwww.sgkb.ch

Analysts

Caroline Hilb (Economy, Investment Strategy)Patrick Häfeli, CFA (Interest rates and yields)Tobias Kistler, CFA (Equity markets)Daniel Wachter (Currencies, commodities)

Editorial deadline

June 21, 2017

Release

Monthly

Title Picture

Palau, Sardinien, ItalyPhoto: Roland Gerth

July 2017 Investment Strategy 1

Dear investors,

For Switzerland, the Swiss franc is at once a boon and a curse. On the one hand, its strength and sa-fe-haven status represent a vote of confidence in the country’s po-litical and economic stability, while on the other hand its sur-

ging value puts the Swiss economy under strain. This affects not only exporters, but also dome-stically focused companies forced to compete for the custom of cross-border shoppers. Since the 2008 financial crisis, and more particularly since the euro crisis, the pressure on the Swiss franc has been so great that the Swiss National Bank has had to respond with massive interven-tion on the foreign exchange markets. As a re-sult, its foreign currency holdings have swelled to CHF 710 billion, with no end to the inflow in sight.

However, the franc’s appreciation cannot be blamed solely on the euro crisis and foreigners seeking safety in Switzerland. There are also economic reasons for its inexorable rise. Swit-zerland usually has a lower inflation rate than most other countries. Over the past 20 years the rate has on average been 1.2% lower than in the eurozone and 1.6% lower than in the Uni-ted States. This lower price inflation, which put simply also means lower cost inflation, gives Swiss companies a competitive advantage. Ac-cording to economic theory, this is evened out via an appreciation in the value of the franc against the euro and the dollar. From this point of view, there is nothing abnormal about the Swiss franc appreciating by an average of 1–2% per annum.

What is more, as a successful exporter of goods and services, Switzerland also regularly genera-

tes a current account surplus (CHF 69 billion last year). This surplus is normally balanced out by investments made by Swiss companies and in-vestors abroad. However, since the financial cri-sis this compensatory mechanism has not been working. On the contrary: the repatriation of foreign investments to Switzerland is an impor-tant driver behind the franc’s appreciation.

The absence of any compensatory mechanism to offset the current account surplus has fuelled a sharp appreciation in the value of the franc. To counter this, the Swiss National Bank has jum-ped into the breach and invested abroad via its interventions in the foreign exchange market. How long it will be able, and most importantly willing, to do so is an open question. The franc will not weaken unless the eurozone’s problems are resolved or Switzerland becomes politically and economically unstable. The first of these scenarios appears unlikely, while the second ap-pears both unlikely and undesirable. The SNB will therefore need to continue to stabilize and control the franc. It will, however, be willing to allow the franc to appreciate over time. A rise of 1–2% per year is not a problem. The Swiss eco-nomy can take this in its stride. This is a state of affairs that it has become accustomed to since the introduction of floating exchange rates in 1973. Indeed, it actually makes the economy stronger, since it is forced to be innovative and flexible.

Dr. Thomas Stucki

Chief Investment Officer

EditorialLiving with a strong Swiss franc

Investment Strategy July 20172

EconomyCentral bank balance sheets: confidence at risk, but not the economyThe global financial crisis forced central banks to resort to extraordinary measures, which left them with record-high balance sheets. The big question much debated at present is «Where do we go from here?» In June the answer to this question came from the Fed. What are the im-plications for the ECB and the SNB?

Since the outbreak of the financial crisis the Fed’s balance sheet has quadrupled in size. During the global financial crisis, triggered by a real estate crisis in the United States, the Fed had to move swiftly, with targeted unbureaucratic action to stabilize the US banking sector. This involved ta-king a whole raft of measures. It flooded the in-terbank market with liquidity so that solvent banks had sufficient capital, it quickly cut inte-rest rates and it embarked on what was to be known as «quantitative easing». Under this pro-gramme, the Fed started buying up mortgage-backed securities (MBS) to support the US real estate market and bank mortgage lending. In addition, it expanded its purchasing activities in the US government bond market. The Fed had always been a dominant player in the market for US government bonds, but following its bond-buying programme now owns 16% of outstan-ding paper.

USA: time for a reduction in balance sheet sizeThe US economy still bears the last scars of the deep recession that struck nearly seven years ago. But the big picture for the US economy is rosy. It will therefore soon be time for the Fed to gradually start scaling back its extraordinary measures. After seven years of growth, it is only a matter of time before the momentum of the economic engine starts to slow. The Fed therefo-re now needs to rebuild its panoply of measures if it is to regain greater scope for action should the need arise. In mid-June it let the cat out of the bag by announcing a detailed plan of how it proposes to reduce the size of its balance sheet. According to a paper published to accompany the press release, the Fed will be reducing its re-investment of expiring government bonds and mortgage-backed securities at a fixed rate (by USD 10 billion per month every three months). It would already like to make a start on this pro-

gramme during the course of this year. This is a sound approach, since it is predictable and ensu-res a gradual reduction which the capital mar-kets – notably including the huge US dollar capi-tal market – will have no trouble coping with.

A stroll in the park for the Fed, but a chal-lenging mountain hike for the ECB For the Fed to reduce the size of its balance sheet might be likened to a stroll in the park. The rea-son for the bond-buying programmes, i.e. the banking and economic crisis, is over. The Fed holds all the bonds in its domestic currency, the US dollar, and it is selling them on the world’s lar-gest capital market. The ECB will be starting from a trickier position while the task the SNB is faced with appears virtually impossible. But let us turn first to the ECB. It too launched a bond-buying programme because it needed to save the euro. The latter was already at death’s door because of the high levels of government debt in some euro-zone countries. It was only the ECB’s unflinching intervention at that time that was able to guaran-

Balance sheet total: SNB has intervened the most

Source: Bloomberg

Balance sheet total versus 2008

0

1

2

3

4

5

6

08 09 10 11 12 13 14 15 16 17

EZB SNBFED

Gold 4112

Foreign currency investments

Bank notes

Banks’ sight deposits710 520

76

Liquidity in the economy

TotalOther

76375

TotalOther

92Equity capital/reserves

763

Gold 4112

Foreign currency investments

Bank notes

Banks’ sight deposit

710

76

Liquidity in the economy

TotalOther

76375

TotalOther

92Equity capital/reserves

763

SNB-Bills

Assets AssetsLiabilities and shareholders’ equity

Liabilities and shareholders’ equity

July 2017 Investment Strategy 3

Source: Bloomberg

tee capital market access for Italy and Spain, the-reby buying a future for the euro. The ECB has be-en buying fixed-income securities for some time. One noticeable feature of its purchases is that they are mainly focused on government paper, in-cluding a very high proportion of German govern-ment bonds as the purchasing formula is based on GDP size and not on who might urgently need the ECB’s support. If the ECB ever wants to redu-ce the size of its balance sheet, it will hardly be ab-le to follow a plan as simple as the Fed’s. This is because the ECB’s purchasing programmes have brought about a convergence of credit risk premi-ums in the eurozone, and without the ECB these spreads would very quickly widen again. The ECB would then be back to square one. The euro ca-pital market is also smaller, which means that it will become illiquid more quickly than the US dol-lar market. We can well imagine that, like the Fed, the ECB will keep the size of its balance sheet sta-ble for quite some time yet and will reinvest expi-ring paper. The ECB can increase its benchmark interest rate if inflationary developments so requi-

re – regardless of its plans on the balance sheet front.

SNB in an impasse?A comparison of the three central banks Fed, ECB and SNB reveals that the SNB is starting from the most challenging position. It resorted to extraordinary measures to counter the strength of the franc, buying up euros for francs with targeted foreign exchange interventions in the EUR/CHF foreign exchange market. As a re-sult, the past few years have seen the SNB’s cur-rency reserves swell to CHF 710 billion and it cannot reduce this sum without working against their own objectives. If it were to start buying francs, the franc would immediately increase in value. But is there any need for the SNB to redu-ce the size of its balance sheet? Not necessarily. A possible appreciation in the value of the franc currently poses one of the biggest risks to the Swiss economy. The SNB’s approach of continu-ing to hold these artificially created funds and in-vesting them as effectively as possible therefore makes sense. What matters more for the perfor-mance of the Swiss economy is whether the SNB is able to control the liabilities side of its balance sheet, i.e. the liquidity in the economic system. And this is something that it is able to do. For ex-ample, it can reduce the liquidity in the econo-mic system by issuing what are known as SNB bills as it has already done in the past. It is only if the SNB loses control of the liquidity in the sys-tem that it runs the risk of setting off uncont-rollable inflation with an over-expansionary mo-netary policy. However, we see very little likeli-hood of such a scenario as the inflationary pres-sure remains low. The issue of balance sheet si-ze is primarily a political problem which could culminate in a loss of confidence in the SNB. This would leave it permanently weakened and would represent a major disadvantage for Swit-zerland as a location for business. It is therefore important not to confuse the large fluctuations in the SNB’s profit statements with a destabili-zing monetary policy. After all, in the current si-tuation, in which the main threat to the econo-my lies in the strength of the franc, the SNB has no other option but to stick to its highly expan-sionary policy. And thanks to the low level of in-flation, it has the freedom to do so. n

SNB: Liquidity and balance sheet total are not the same

-1.5%

-1.0%

-0.5%

0.0%

0.5%

1.0%

1.5%

2.0%

2014 2015 2016 2017 2018 2019 2020

Inflation SNB forecast

Inflation and SNB forecast

Investment Strategy July 20174

Interest rates and yieldsSNB leaves expansionary monetary policy unchanged

While the Fed has applied another turn to the interest rate screw, the Swiss National Bank (SNB) is maintaining its ultra-expansionary mon-etary policy. The situation appears virtually un-changed compared to our last assessment in March.

As expected, the Swiss National Bank has left the target range for the three-month Libor at 1.25% to 0.25%. The interest rate on sight de-posits with the SNB has also been left un-changed at 0.75%, as has the exempt amount for commercial banks. To ease the pressure on the Swiss franc, which it still regards as signifi-cantly overvalued, the SNB is continuing to in-tervene actively in the foreign exchange market as and when the need arises. This is intended to stabilize prices and support economic activity.

The global economy has continued to strengthenThe Swiss National Bank expects the global eco-nomy, which has strengthened recently, to con-tinue to make good progress. However, it says that the positive stimuli from abroad in the first quarter of 2017 have only partially filtered through to the Swiss economy. Nevertheless, the SNB still expects 2017 to see the Swiss eco-nomy grow by 1.5%. While there has been a further improvement in the labour market in the industrialized countries recently, inflation re-mains fairly moderate. The SNB therefore ex-pects the trend of Swiss inflation to remain sub-dued. There has therefore been little change in its conditional inflation forecast compared with March. It is still predicting an inflation rate of 0.3% for 2017 and average price rises of 0.3% (March: 0.4%) for 2018. Its forecast for 2019 is 1.0% (March: 1.1%)

Fed heading toward normalizationWhile the SNB’s first rate rise is still a long way off, the US Federal Reserve has, as expected, in-creased its key interest rate by another quarter of a percentage point to 1.00-1.25%. Despite a slightly weaker inflation trend lately, the mone-tary guardians are expecting a further rate mo-ve this year – a view we share. It remains open whether this will already happen in September or only in December. The FOMC members still

predict three rate rises in 2018. The Fed will al-so soon make a start on scaling back the size of its balance sheet to reasonable levels. Its re-in-vestment of expiring bonds is to be reduced at a fixed pace and should therefore be gradual and predictable. Sooner or later this will also lead to a rise in US capital market interest rates. As usual, Swiss interest rates will not be comple-tely unaffected by this. As short-term interest rates will continue to be held down by the Swiss National Bank’s monetary policy for quite some time, the yield curve will steepen again some-what over the coming months. n

Source: Swiss National Bank

Inflation in Switzerland still only modest

59% 46%

8%

7%

23% 36%

10% 11%

0%

20%

40%

60%

80%

100%

Credit Suisse UBS

2006

Investment Banking Trading

Asset Management

Wealth Management

Retail & corporate clients

Less capital-intensive business, more wealth management

ea

n

45%

27%

6%

7%

39%

52%

10% 14%

0%

20%

40%

60%

80%

100%

Credit Suisse UBS

2016

July 2017 Investment Strategy 5

Equity marketsBanking stocks: resurgence or flash in the pan?

favourable position compared with its competi-tors, with a hard core capital ratio of 13.2% and a leverage ratio of 3.8%.

Less toxic assets at UBSWith assets under management totalling CHF 2.8 trillion, UBS is the world’s largest asset ma-nager, and asset management is at the heart of its business strategy. The bank focuses heavily on clients in the high-net-worth and ultra high-net-worth segments (with assets worth up-wards of CHF 50 million). Its business operates globally, but with a strong focus on Asia, whe-re UBS is the leading asset manager. The bank’s portfolio of toxic assets now only accounts for around 2% of its balance sheet total. Compa-red with its competitors, UBS is currently stron-gly positioned, with a hard core capital ratio of 14.1% and a leverage ratio of 3.6%.

Barriers for the big banksUBS and Credit Suisse are well positioned com-pared to most major European banks. We parti-cularly like their focus on wealth management with strong positions in Asia, the concomitant growth in client assets, their strong position in Switzerland and, in the case of UBS, its global diversification with a focus on high-net-worth clients. However, neither Credit Suisse nor UBS, nor indeed the other major banks, are «out of the woods» yet. Since the financial crisis, most of the big banks have been steadily «destroy-ing» shareholder value since their returns on equity have not been higher than their capital costs. In other words, in comparison with other equity investments, shareholders are not being adequately compensated for the risks they have assumed. The few big banks that earn their ca-pital costs are trading at high premiums to their book value. What is more, we are not convinced that added value can be generated over the course of an economic cycle using the current known business models. The economic upturn plus the increase in client activity this has brought about, along with rising interest mar-gins, will undoubtedly continue to boost the banks’ earnings. This is offset by higher costs for increases in equity and hybrid capital and fines. Within the financial sector, we therefore conti-nue to prefer certain insurers and small specia-lized financial stocks. n

Apart from their supposedly low valuations and the economic upturn, the resurgence of bank-ing stocks has mainly been driven by two exter-nal factors.

One of these external factors is the reflationary trend, which is resulting in a steeper yield curve and can therefore be expected to boost revenues. The other is market hopes of weaker US banking regulation under the new US administration.

Credit Suisse restructuresWith assets under management of CHF 1.3 tril-lion, Credit Suisse is the world’s fourth largest asset manager and the number 3 player in Asia. Since October 2015, CS, under new leadership, has been restructuring to become a financial group concentrating more on wealth manage-ment, supported by an investment bank, and with a stronger focus on Asia. The restructuring process is expected to take until the end of 2018. The remaining business areas and posi-tions that do not fit the strategy will be wound up as part of the «Strategic Resolution Unit» (SRU). At USD 83 billion, this unit still accounts for around 9% of the balance sheet total. At the end of 2018, a further reduction in the holdings to USD 40 billion is planned so that the SRU can be closed and the remaining positions distribu-ted around the Group. Following its recent capi-tal increase, Credit Suisse is expected to be in a

Source: Credit Suisse & UBS; our own calculations and graphics

Business model: shift towards wealth management

0.9

1.0

1.1

1.2

1.3

1.4

2012 2013 2014 2015 2016 2017

Euro in CHF Euro in US dollars

Exchange rate EUR/CHF and EUR/USD

Investment Strategy July 20176

CurrenciesInvestor sentiment supports euro

The past year has seen a number of political ques-tion marks hanging over both sides of the Atlan-tic. While US policy remains difficult to predict for now, the biggest political stumbling blocks for the euro were removed in June after the decisive elec-tion result in France and the agreement on a fur-ther credit tranche for Greece. In April, the first round of the French presidenti-al election galvanized the markets. The currency markets took the clearer-than-expected result as a positive sign for the eurozone and the euro du-ly climbed to a seven-month high. By contrast, the French parliamentary elections on 11 and 18 June did not give the euro any fresh boost. High hopes are pinned on Emmanuel Macron and his party «La République en marche!» This puts the spotlight on economic factors.

Eurozone economy in calmer watersThe eurozone’s economy is back in calmer wa-ters. While not spectacular, growth is steady and increasingly broad-based. According to the latest OECD forecast, for the first time in a long while the eurozone should experience growth not only on average across the zone but in all Member States too. Leading indicators such as the purchasing managers index (PMI) are con-sistent with this picture. PMI survey figures for the coming months signal economic optimism, for example. There is still a fly in the ointment, however: a glance at the lower end of the growth table for 2017 reveals that two of the eurozone’s economic heavyweights, Italy and France, are bringing up the rear along with Greece. Although they too are making pro-gress, these three countries are an indication of possible future stumbling blocks.

Not all risks have disappearedThus, with next year’s completion of the current third credit package, the Greek government will at some point be supposed to shoulder its own capital requirements. As Greece heads back to the capital markets, key questions still remain unresolved. Moreover, in the Italian elections (yet to be called), all eyes will be on the Euros-ceptic «Five Star Movement». With the ECB’s bank stress test, the problems in the Italian ban-king sector may also resurface as a hot topic.

ECB in no hurry June’s monetary policy decisions in the US, Eu-rope and Switzerland did not make any big headlines. This is reflected in the unspectacular development of the currency market. The euro trend will be shaped by the ECB’s timetable, and in particular by the debate over any possible ter-mination of the monthly bond-buying program-me. Given the moderate inflationary pressure, the ECB will not be in a hurry to alter its mone-tary policy: at 0.9%, core inflation remains below the targeted level of just under 2%. The Swiss National Bank’s monetary policy assess-ment was also in line with the currency markets’ expectations. The SNB regards the Swiss franc as «significantly overvalued», and thus the CHF exchange rate remains its top priority.

Awaiting new stimuliThe currency market has grown accustomed to the Fed’s tighter monetary policy. The market will now turn its attention to the timing of the change in the ECB’s monetary policy as a new indicator, which will benefit the euro. Once in-vestors jump on the bandwagon of a stronger euro, the single currency will gain support from investor sentiment in the near term. n

Source: Bloomberg

Euro firming up

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00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17

Global oil inventories in OECD countries (left-hand scale)

US oil inventories (right-hand scale)

in million barrels

July 2017 Investment Strategy 7

The gold price stagnated in June as investors evidently found much to please them in central bank decisions and the French election results. By contrast, the Organization of the Petroleum Exporting Countries (OPEC) found the trend in oil prices less to its liking.

Last November’s announcement of a production cap enabled OPEC to push up the oil price from USD 45 to USD 55 per barrel. However, the same effect did not materialize when the agreement was extended. Since the oil cartel’s decision on 25 May, the oil price has slipped back to its No-vember level. Even tensions between Qatar and neighbouring countries in the Gulf region failed to support the oil market. In the past, similar re-ports would invariably have triggered appreciab-le price jumps.

Focus on oil inventoriesThis price trend is at odds with the efforts of the OPEC countries and Russia to achieve some sort of market equilibrium. Although the production cuts in force since January have largely been complied with, the decline in oil stocks has pro-ved modest in the year to date. Both US crude oil inventories and commercial stocks of the OECD countries remain significantly higher than the average of previous years. Consequently, OPEC’s primary objective has not yet been achieved. In this context, the renewal of the pact between the largest oil-producing countries until March 2018 sends out a positive signal in terms of fundamen-tals, but the high levels of stocks worldwide still stand in the way of a substantially higher oil pri-ce. Over the coming months, we shall therefore be focusing on the inventory trend in particular.

US monetary policy dampens gold price The gold price climbed to a new annual high of USD 1,296 per troy ounce at the beginning of Ju-ne, only to slide back to a 5-week low later that month. The price movements are driven by poli-tical and monetary decisions. The round of mo-netary policy decisions ended in June without any significant disruptive background noise. In particular, speculation that the Fed would pro-ceed with greater caution after the publication of weaker inflation data proved unfounded. The Fed is nevertheless pressing ahead with its cau-tious normalization of monetary policy and is not allowing itself to be deterred by a temporary slowdown in growth or inflation. The balance sheet reduction programme was carefully prepa-red and communicated. So far this approach has been very successful. The resulting benign stock market environment has meant that safe havens such as gold have been pushed into the back-ground. The direct political risks in Europe have eased in the wake of the clear election result in France and the agreement on a further credit tranche for Greece. This was another factor that caused the gold rally to lose steam. From an an-nual perspective, though, gold is still holding up well with a 9% gain. In an environment in which US policy is difficult to forecast and global inte-rest rates are only rising moderately, demand for the precious metal is unlikely to dry up any time soon. n

CommoditiesOPEC must be patient too

Source: Bloomberg

Focus on global oil inventories

Investment Strategy July 20178

The French election result was the cue for the storm clouds gathering over the eurozone to dis-perse. The outlook for the economy and earn-ings in the shared currency area has also im-proved recently.

In recent years, the eurozone has mostly drawn attention to itself with negative headlines. The talk was of burgeoning debt mountains, structu-ral weaknesses and a lack of willingness to re-form. The eurozone’s weaknesses were also clearly reflected in the financial markets, with the euro repeatedly coming under selling pressure against the US dollar and with the European stock market lagging behind its US counterpart. However, tangible improvements are now emer-ging in the eurozone and the stock market has al-ready responded with gains.

What dispelled the storm clouds?There has been a marked improvement in senti-ment in business circles. This is clearly reflected in the trend of purchasing managers surveys in the currency union. These sentiment indicators have recently shown further sharp rises, while, for ex-ample, their US and Chinese counterparts have lost ground. This is an advantage for the Euro-pean stock markets in the regional rankings. Eu-rozone companies’ earnings forecasts have also recently climbed well into the positive range – another positive factor for the European stock markets. The French election result was a victory for proponents of the single currency, and this is likewise positive for the stability of the eurozone. Finally, we should also give due credit to the ECB. True, its monetary policy entails risks, and, yes, it is mainly buying time. Yet without risks the eco-nomy just doesn’t work, since risks are simply the flipside of opportunities. And in the case of the eurozone it makes sense to buy time. The ECB did not grant Italy absolution so that it could kick the necessary reforms into the long grass. It was Italy’s politicians that took that decision. The ECB’s actions preserved Italy’s ability to access the capital markets and in doing so saved the euro-zone from an insolvency problem. This was an advantage for the global economy and not least also for the Swiss economy, for which the euro-zone still remains the most important export partner.

Investment StrategyCalmer waters

Investment strategy

Conclusion: The opportunities and risks are evenly balanced. In light of the French election results and the improved economic and earnings outlook, expanding positions in European equi-ties would appear to be a wise move. We expect the ECB’s monetary policy to continue to provide stimulus. Our equity allocation is now balanced. This positioning shows that we take a fundamen-tally positive view of the equity markets. Howe-ver, a balanced allocation also signals that our as-sessment of the situation is still cautious. We re-cognize the opportunities, but in view of the nu-merous uncertainties we still see the potential for choppier market conditions ahead – particularly given the unpredictability of US policy and the high hopes pinned on the future performance of the economy. n

liquidity

bonds

convertible bonds

equities

Switzerland

Eurozone

North America

Asia Pazific (ex. Japan)

Emerging Markets

alternative investments

commodities

others

– – – Neutral + ++

Source: own graph

July 2017 Investment Strategy 9

Market overviewEconomic data and cycles Data as of 20 June 2017; Source: Bloomberg, Graphics: own illustration

Economic trend in industrialized countries

Switzerland USA Eurozone Germany

Switzerland 1.0 % 0.9 % 0.6 % 0.5% 3.3 % 3.2% 57.8 55.6

USA 2.0 % 2.0 % 2.7 % 1.9 % 4.7 % 4.3 % 57.7 54.9

Eurozone 1.8 % 1.9 % 2.0 % 1.4% 9.5 % 9.3 % 55.4 57.0

Germany 1.3% 2.9 % 2.2% 1.5% 5.9 % 5.7 % 56.8 59.5

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Macro scenarion Switzerland: The Swiss economy is in good health. Stabilization of the situation

in Europe and the stronger euro are helping to improve the outlook for Swiss ex-porters.

n USA: The US economy is performing well, but the «recovery» phase is coming to an end. Despite continuing positive sentiment, caution is called for.

n Eurozone: The eurozone economy is continuing to gain momentum. Although there are still structural barriers that need to be resolved.

n Germany: Not a cloud on the horizon for the German economy; the outlook is refreshingly positive.

Economic trend in emerging markets

China India Brazil Russia

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China 6.8 % 6.9 % 0.8 % 1.5 % 4.0 % 4.0% 50.3 49.6

India 6.7% 5.6% 3.7% 2.2 % – – 52.5 51.6

Brazil –2.5 % –0.4% 4.8% 3.6% 7.5 % 8.2 % 50.1 52.0

Russia 0.3% 0.5 % 4.6% 4.1 % 5.6 % 5.2% 55.3 56.0

Macro scenarion China: China’s growth is once again tending to weaken because of state interven-

tion in lending. This autumn’s People’s Congress is expected to produce further im-portant decisions on the future direction of policy.

n India: India is well on track. The recent tax reform is providing an additional boost and is simplifying the structural barriers which still exist.

n Brazil: We have recently seen the occasional sign of an improvement, but President Temer’s position has been badly dented. This is weakening the government and slowing down important reforms.

n Russia: Russia has bottomed out. The economic situation is showing signs of a signi-ficant improvement.

positive assessment neutral assessment negative assessment

positive assessment neutral assessment negative assessment

Recovery

Recession

Boom

Downturn

Recovery

Recession

Boom

Downturn

Investment Strategy July 201710

Interest rates and currenciesData as of 20 June 2017; Source: Bloomberg, Graphics: own illustration

Switzerland: Low inflation, focus remains on franc stability. Outlook: Expansionary, SNB is sticking to negative interest rates and will actively intervene in the currency market.

Eurozone: Inflation is rising but is still low; major imbalances.Outlook: QE programme extended until end-2017.

USA: The domestic economy clearly favours further interest rate hikes, and inflationary pressure is slowly rising.Outlook: Two further interest rate moves by the end of the ye-ar. Balance sheet reduction is becoming the dominant issue.

Switzerland: Negative interest rates, low inflation and de-mand for bonds are keeping interest rates low.Outlook: Interest rates to rise slightly in medium term in step with eurozone.

Eurozone: Economic recovery is becoming noticeable. Initial signs of inflation. Extended ECB QE keeping long-term inte-rest rates low for the time being.Outlook: Slightly higher interest rates in medium term.

USA: Positive economic prospects. Wage pressure firming slowly. Other interest rate hikes will follow.Outlook: Rising medium-term yields due to rate-hiking cycle and reduction in the size of the Fed’s balance sheet.

EUR/USD: With the French presidential election now out of the way, a major stumbling block for the euro has been put be-hind us. Speculation over an exit from the QE programme is becoming more important.

USD/CHF: The dollar is benefiting from Fed rate hikes, but its potential for surprises is limited. The US administration’s unc-lear policies are clipping the dollar’s wings.

EUR/CHF: EUR/USD exchange rate and the SNB’s interventions are the dominant drivers. The SNB will therefore welcome the weaker franc.

Key interest rates for selected central banks

Capital markets: yields on individual 10-year government bonds

Currencies: rates for selected currency pairs

-1.0%

-0.5%

0.0%

0.5%

1.0%

1.5%

2012 2013 2014 2015 2016 2017

SNB ECB FED

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

2012 2013 2014 2015 2016 2017

Switzerland Germany USA

0.8

0.9

1.0

1.1

1.2

1.3

1.4

2012 2013 2014 2015 2016 2017

Euro in CHF US dollar in CHF Euro in US dollar

July 2017 Investment Strategy 11

Equity and commodity marketsData as of 20 June 2017; Source: Bloomberg, Graphics: own illustration

Outlook: n The stock markets are still looking robust and are showing

few if any signs of weakness. The outlook for earnings is positive.

n Uncertainties arising from political events are receding into the background again.

n The solid underlying trend looks set to be punctuated by high share price volatility and negative phases.

In general:n Valuation ratios have increased during the course of the year.n Valuations are above the average for the last 10 years.

Outlook: n Earnings growth estimates are positive in North America,

Europe and the emerging markets.

Oil price: OPEC will also be reducing its production quota in the second half of the year. This news is not sufficient to push up the oil price.Outlook: High global inventories and a rebound in US oil production will prevent any substantial price rise for now.

Gold price: After a sluggish phase at the turn of the year, gold has found its feet again.Outlook: The headwind on the foreign exchange front (dollar strength) is easing. Higher US interest rates coupled with a moderate rise in inflation limit the potential for the gold price.

Equity markets for selected regions (indexed)

Valuations: estimated P/E ratio for selected regions and markets

Commodity markets: Price trend for oil and gold

75

100

125

150

175

200

225

2012 2013 2014 2015 2016 2017

SPI DAX S&P 500 Emerging Markets index

7

9

11

13

15

17

19

21

2012 2013 2014 2015 2016 2017

SPI P/Est DAX P/Est S&P 500 P/Est Emerging Markets P/Est

20

40

60

80

100

120

1'000

1'200

1'400

1'600

1'800

2'000

2012 2013 2014 2015 2016 2017

Gold (USD per oz) Oil (WTI, USD per barrel)

Investment Strategy July 201712

Financial markets and forecastsClosing prices as of 20 June 2017; Source: Bloomberg; Forecast: SGKB

Key interest rates 12 Months ago 3 Months ago Current Forecast 3 Months

Forecast 12 Months

SNB –0.75 % –0.75 % –0.75 % –0.75 % –0.75 %

ECB 0.00 % 0.00 % 0.00 % 0.00 % 0.00 %

FED 0.25 % – 0.50 % 0.75 % – 1.00 % 1.00 % – 1.25 % 1.00 % – 1.25 % 1.75 % – 2.00 %

Capital market yields 12 Months ago 3 Months ago Current Forecast band 3 Months

Forecast band12 Months

10-year Conf. –0.42% 0.00 % –0.15% –0.10 % – 0.10 % 0.10 % – 0.30 %

10-year German Bund 0.05% 0.46% 0.26% 0.50 % – 0.70 % 0.80 % – 1.00 %

10-year Treasury 1.71% 2.42 % 2.16% 2.40 % – 2.70 % 2.70 % – 3.00 %

Currencies 12 Months ago 3 Months ago Current Forecast band 3 Months

Forecast band12 Months

EUR/CHF 1.0817 1.0744 1.0857 1.06 – 1.11 1.04 – 1.09

USD/CHF 0.9622 0.9939 0.9751 0.94 – 0.99 0.95 – 1.00

EUR/USD 1.1242 1.0811 1.1134 1.10 – 1.15 1.07 – 1.12

Commodities 12 Months ago 3 Months ago Current Forecast band 3 Months

Forecast band12 Months

Oil (WTI, USD per barrel) 49 47 44 45 – 55 50 – 60

Gold (USD per oz) 1268 1245 1243 1200 – 1300 1200 – 1300

Equity markets YTD Valuation(est. P/E) Current Index Trend

last 3 MonthsTrend

last 12 Months

S&P500 (local currency) 9.9% 18.8 2437

EuroStoxx50 (local currency) 10.6% 15.0 3561

SMI (local currency) 12.7% 17.9 9024

MSCI Emerging Markets in USD 17.9% 12.8 1009

Disclaimer: The information contained on this Recommendation List and specifically the descriptions of individual securities constitute neither an offer to purchase the securities nor an invitation to engage in any other transactions. All of the information contained in this document has been carefully selected and obtained from sources that the Invest-ment Center of the St.Galler Cantonal Bank AG fundamentally believes to be reliable. Opinions or other representations conveyed in this document are subject to change without notice. No guarantee is assumed as to the accuracy or completeness of the information. St.Galler Cantonal Bank AG is regulated and supervised by Swiss Financial Market Super vision Authority FINMA, Einsteinstrasse 2, 3003 Berne, Switzerland, www.finma.ch.