Yields on the long-dated bonds of major overseas governments, and in consequence those in Israel, are likely to continue rising over the medium term (i.e., the next two to three years), if America’s economy continues recovering, and to a lesser extent Europe’s.
We advise avoiding the government bonds of the major developed nations (the US, Germany and Japan).
We recommend maintaining high exposure to Israeli government bonds, focusing on short and intermediate durations, while maintaining a balanced mix between inflation indexed and fixed-rate bonds.
We recommend maintaining limited exposure to foreign corporate debt, focusing on the short- and medium-dated bonds of companies with low credit ratings (hence higher risks and yields). The rise in yields at the middle of the curve, coupled with our assessment that no rapid yield spike is likely in the foreseeable future, provides justification for diverting part of client corporate bond holdings to securities with intermediate durations. We also recommend somewhat reducing credit risk by moving into bonds with higher credit ratings.
In the Israeli corporate bond market, narrow spreads fail to adequately reflect the risks inherent in these securities. Investors are therefore advised to maintain nothing but a low allocation in this asset class, with the bonds they do hold being the short-dated debt (no more than three years out) of companies characterized by positive cash flow and mid-level investment-grade ratings.
We advise maintaining high exposure to foreign equities, based on the assessment that valuations on stocks across the globe are more attractive than those for corporate bonds. It’s worth emphasizing, however, that stock-market risks increase as price earnings multiples rise.
In light of the improved conditions in Europe and Britain, we recommend overweighting the equity indices of those regions, which make up around 25% of the MSCI World Index. We also recommend slightly underweighting US shares (which comprise roughly half of the index), as well as maintaining positions in emerging market index funds in equal proportion to their weighting in the MSCI World Index.
As to Israeli equities, we favor the TA-75 Index over the TA-25, based on our assessment that the companies comprising the former are more likely to benefit, on the whole, from global economic improvement than those that make up the latter.
In recent months, the shekel-dollar exchange rate has stabilized, with the upward pressures on the local currency being offset by the Bank of Israel's intervention in the forex market via the purchase of dollars. In the absence of negative developments in the local economy, we expect this situation to continue.
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