Leumi Capital Market Review
Our main investment recommendations:
- The global economy keeps improving against a backdrop of slowly rising inflation. These trends, coupled with interest rates that remain exceptionally low, have generated improved corporate profitability, laying the backdrop for stock market rallies and falling corporate-bond risk premiums, in Israel and abroad. The longer these positive trends continue, the greater the likelihood of their engendering 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 recently recommended that investors increase their exposure to fixed-rate bonds and reduce holdings in CPI-linked bonds by an equal degree. We also advised somewhat lengthening the average duration of bond holdings. These adjustments stem from our assessment that inflation in Israel will remain subdued for the foreseeable future, driven by further actions to lower the cost of living by Israel’s government, as well as the slower pace of housing price increase as reflected in the consumer price index, plus a strong shekel. However, a faster pace of wage growth, in addition to strong consumer demand, and slowly rising inflation overseas, could soften the impact of those factors.
- We recommend positioning bond holdings in short to intermediate durations, based on our outlook that the trajectory of global interest rates will continue rising in coming years. We also advise maintaining a slightly longer duration in Israeli fixed-rate government bonds than in equivalent bonds overseas, based on our projection 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 leading 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 recommend maintaining an average level of exposure to equities. While we recognize that stock valuations are high, so are the valuations on all other assets classes, leading us to conclude that shares should remain the core holding in investor portfolios. Over the past year, the profitability of companies listed on major overseas bourses has grown significantly, and this trend is likely to continue in the current earnings season. The profitability of Israel firms is also expected to continue improving, thanks to 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. 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 over the next 12 months, which lowers the underlying pressures for the shekel’s appreciation and could lead to greater 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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