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Leumi Capital Markets Report

Weekly Capital Market Review
October 7- October 23, 2014

 Our main investment recommendations:



  • The heightened volatility seen in global financial markets in recent weeks, accompanied by falling prices of risk assets (equities and low-rated corporate bonds), diminished somewhat this week. While we view the share-price falls as a correction, not the onset of a crash, we don't expect volatility to revert to the low levels seen in May and June.


  • Equities remain our preferred risk asset. Most of the dangers hanging over shares revolve around negative developments in the European economy. We recommend significantly overweighting overseas shares, given the weakness in aggregate demand in Israel. In foreign equities, we have a market-weight rating on the US and European markets, and recommend overweighting emerging-market shares and underweighting Japan.


  • Yields are extremely low across the curve in major overseas bond markets. Given that we expect yields to gradually rise—assuming the global economic recovery stays on track, particularly in the US—investors are advised to avoid the government bonds of the largest developed nations: America, Germany and Japan.


  • We recommend maintaining high exposure to Israeli government bonds, focusing on 5-year durations. With yields on short-dated bonds approaching zero, the short end of the yield curve is no longer attractive. At the long end of the curve, bond prices are overvalued, increasing the risk of holding those maturities.


  • Over the past few months, spreads on Israeli corporate bonds have widened modestly against the backdrop of hefty corporate bond issuance, and reflect the slowdown in the local economy, which is liable to continue over the short term. Given the low yields in the local market, the wider spreads now make corporate bonds attractive. We recently recommended modestly expanding exposure to these securities, particularly intermediate durations with high credit ratings (A+ and above), while simultaneously reducing allocations to inflation-indexed government debt. It's worth noting that even after making these adjustments, the corporate bond exposure in our recommended portfolio is still relatively modest.


  • We advocate maintaining nothing but limited exposure to overseas corporate bonds, focusing on low-rated investment-grade debt with intermediate durations. The widening of spreads on short-dated speculative-grade US bonds, offers a short-term trading opportunity (one that involves considerable risk), owing to the low interest-rate backdrop, and based on the assumption that default rates won't significantly increase in coming months.


  • The shekel continues losing ground against the dollar. If the local currency's exchange rate holds at current levels, it could nudge up inflation in coming months, supporting our recommendation that investors maintain around half their bond holdings in inflation-indexed securities.


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