Leumi Capital Market Review
Our main investment recommendations:
- The global economy keeps improving against a backdrop of slowly rising inflation. Should 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 slowly rising inflation and a strong shekel relative to 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 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. June’s consumer price index came in lower than expected, returning the CPI’s annual rate to zero; but in coming months, consumer prices are likely to edge up faster than the markets currently expect. This assessment is based on our outlook for a stronger pace of wage growth, healthy local aggregate demand, and slowly rising inflation in overseas economies. But 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 outlook that the trajectory of global interest rates (including those in Israel) will continue trending higher in coming years. That said, we recommend somewhat lengthening the average duration of local fixed-rate government bond holdings, given our assessment that the Bank of Israel will leave its policy rate unchanged for a longer period than previously expected.
- As to corporate bonds in Israel and abroad, we recommend high rather than low rated issues, given the narrow credit spreads available on the latter.
- We recommend maintaining 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, because the earnings of Israeli firms are expected to rise, fueled 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 their overseas counterparts. But given the rich valuations, investors are advised to 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 continue slowly widening in 2017, which could reduce the underlying pressures for the shekel’s appreciation and lead to heightened exchange-rate volatility. 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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