Leumi Capital Market Review
Our main investment recommendations:
- The global economy keeps improving, while inflation is edging up slowly. If these trends continue, they could set the stage for the gradual transition away from the ultraloose monetary policies of recent years. The Federal Reserve’s rate hike this week marks another milestone in the process. Rising interest rates, it’s worth noting, could lead to changes in the way all assets classes are priced over time.
- Israel’s economy also shows signs of continued improvement against a backdrop of slowly rising inflation and persistent upward pressure on the shekel. These factors should enable the Bank of Israel to keep its policy rate at near-zero levels for the time being and offer continued short-term support to local financial markets.
- For fixed-income portfolios, we advise that investors maintain equal exposure to fixed-rate and CPI-linked bonds. We project that inflation will edge up in coming months, but could do so faster than markets currently expect. This assessment is based on our outlook for a faster pace of wage growth, strong aggregate demand, and slowly rising inflation in overseas economies. That said, the pace of Israel’s rising consumer prices could well be tempered by the strength of the shekel.
- We advise that investors keep their bond portfolios positioned in short to intermediate durations, given our forecast that the trajectory of global interest rates (including those in Israel) will continue trending higher in coming years. 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 recommend that investors maintain an average level of exposure to equities. While stock valuations are undeniably high, so are the valuations of all other assets classes, leading us to recommend that shares remain the core holding in investor portfolios. We advise maintaining significant exposure to Israeli stocks, given that the earnings of Israeli firms are expected to rise, driven by the 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. As an additional plus, valuations on Israeli shares are more attractive than those for their overseas counterparts. However, given the rich valuations, investors should be selective in choosing stocks, and avoid 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 widen in 2017, which could lead to heightened exchange-rate volatility later this year and reduce the underlying pressures for the shekel’s appreciation. We advise that investors gain forex exposure by investing in overseas stocks and corporate bonds, without putting currency hedges in place. This recommendation is 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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