Leumi Capital Market Review
Our main investment recommendations:
- The global economy keeps improving against a backdrop of slowly rising inflation. If these trends continue, they could set the stage for the gradual transition away from the ultraloose monetary policies of recent years. Rising interest rates, it’s worth noting, could lead to changes over time in the way all assets classes are priced.
- Israel’s economy also shows signs of ongoing improvement against a backdrop of low inflation and a strong shekel compared with its 2-year average—factors that should enable the Bank of Israel to keep its policy rate at near-zero levels for the time being and could offer continued support to local financial markets over the short term.
- For fixed-income portfolios, we advise that investors maintain equal exposure to fixed-rate and CPI-linked bonds. While official CPI figures for June and July came in lower than expected and pushed the annual rate of inflation into negative territory, consumer prices are likely to edge up in the months ahead—an assessment based on our outlook for a stronger pace of wage growth, healthy local aggregate demand, and slowly rising inflation in overseas economies.
- We advise that investors keep their bond portfolios positioned in short to intermediate durations, given our outlook that the trajectory of global interest rates will continue rising in coming years. We also recommend maintaining a slightly longer duration in Israeli fixed-rate government bonds than in equivalent bonds overseas, based on our view that the Bank of Israel is likely to leave its policy rate unchanged for an extended period, while monetary policy in some of the world’s major economies may prove to be less accommodative in the months ahead.
- As to corporate bonds in Israel and abroad, we recommend high rather than low rated issues, given the narrow spreads available on the latter. We recently advised investors to shorten the average duration of their overseas bond holdings, given flattening yield curves in foreign markets, and our assessment that the Federal Reserve will raise its policy rate in the year ahead more quickly than the markets are currently expecting.
- We recommend maintaining an average level of exposure to equities. While stock valuations are high, so are the valuations on all other assets classes, which leads us to conclude that shares should remain the core holding in investor portfolios. Over the past six months, the profitability of companies listed on major overseas stock markets has markedly improved. The profitability of Israel firms is also projected to continue improving, driven by the local economy’s faster pace of growth, its healthier composition, the strong labor market, and expectations that the Bank of Israel is unlikely to raise its policy rate in coming months. But in light of the rich valuations, investors are advised to be selective in their choice of stocks, avoiding general index-linked products either in Israel or abroad.
- The gap between the Federal Reserve’s benchmark interest rate and that of the Bank of Israel is expected to continue widening slowly in 2017, which lowers the underlying pressures for the shekel’s appreciation and could lead to higher volatility in the currency’s exchange rate. We advise that investors gain forex exposure by investing in overseas stocks and corporate bonds, without putting currency hedges in place—a recommendation based, in part, on the potential for forex exposure to reduce the overall volatility of investment portfolios.
- It’s critical that investors find the right balance between risk assets (shares, commodities, and corporate bonds) and highly liquid assets and government bonds, with the aim of creating a safety cushion, thereby maintaining portfolio risks at reasonable levels.
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