We expect yields on the long-dated bonds of major overseas governments to climb incrementally over the intermediate term, assuming the economic recovery continues globally and particularly in the US. In consequence, investors are advised to avoid the government bonds of the largest developed nations—America, Germany and Japan.
Equities remain our preferred risk asset, and we recommend significantly overweighting overseas shares, given that Israel's economy is experiencing weak aggregate demand. In foreign equities, we recommend overweighting the emerging markets, while underweighting US stocks. In Europe, despite the increased risks, we recommend slightly overweighting equities (at least, for now), focusing on German and British indices, as well as the Continent's financial sector.
In foreign equities, we favor sectors likely to prove relatively immune to rising interest rates—high-tech, financials, and energy. We recommend avoiding the real estate sector and companies sporting very high dividend yields, since both are likely to be particularly vulnerable to rising interest rates in the US.
We advocate maintaining limited exposure to overseas corporate bonds, focusing on low-rated investment-grade debt with short to intermediate durations. We recommend avoiding speculative-grade bonds, because their spreads are still too narrow relative to the inherent risks.
We recommend maintaining high exposure to Israeli government bonds, focusing on short to intermediate durations of up to 5 years. Rich valuations on long-dated bonds have increased the risk of holding those maturities.
Yield spreads on Israeli corporate bonds remain narrow. We advise maintaining nothing but a limited allocation to this asset class, focusing on the short-dated bonds of companies characterized by positive cash flow and mid- to high-level investment-grade ratings.
While the short-term impact of current military activity on Israel's economy has been limited, the combination of sluggish economic growth (which preceded the outbreak of hostilities) and the potential impact of those hostilities on the local economy's third quarter (on the budget deficit, for example), imply heightened financial-market risk. In consequence, we recommend maintaining nothing but fairly limited exposure to local stocks and bonds.
The shekel's decline against the dollar in recent weeks is a product of the greenback's strength across the globe as well as developments in Israel. Part of the shekel's weakness is attributable to the diverging pace of projected economic growth in the US and Israel in the second half of 2014. Accordingly, there's now less reason to establish foreign currency hedges for investors' overseas allocations.
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