Leumi Capital Market Review
For the week of:
Jan 11-18, 2018
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 enhanced corporate earnings, laying the backdrop for stock-market rallies and falling risk premiums on corporate bonds in Israel and overseas. The longer these trends continue, the greater the likelihood of their spawning the gradual transition away from the ultraloose monetary policies of recent years. And it’s worth noting in this context that rising rates 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 potentially offer continued short-term support to Israeli financial markets.
We expect local inflation to remain subdued for the foreseeable future, driven by further actions by the government to bring down the cost of living, the slower rise in housing prices (as reflected in the consumer price index), and a strong shekel. But a faster pace of wage growth, in addition to strong consumer demand, and slowly rising inflation in overseas economies, could mitigate the impact of the aforementioned factors.
We recommend positioning bond portfolios in short to intermediate durations, given that interest rates are expected to rise across the globe in coming years. We also advise maintaining a slightly longer duration in Israeli fixed-rate sovereign bonds than in equivalent bonds overseas, based on projections 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, because even while stock valuations are high, so are the valuations of all other assets classes, which leads us to conclude that shares should remain the core holding in investor portfolios. Corporations that make up the world’s major equity indices have experienced improved profitability over the past year, which is likely to be reflected in their full-year 2017 results. The earnings of Israel firms are also expected to keep rising, thanks to 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 given rich equity valuations, investors are advised to be selective in their choice of stocks, avoiding general index-linked products, both in Israel and abroad.
The gap between the Federal Reserve’s benchmark interest rate and that of the Bank of Israel is expected to continue growing in 2018. The widening gap in the two countries’ policy rates lowers the underlying pressures for the shekel’s appreciation and could spark 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. The shekel’s appreciation against the dollar in 2017 and outset of 2018 is almost entirely attributable to the greenback’s depreciation worldwide, as well as positive financial market sentiment.
- It’s critical that investors find the right balance between risk assets, on the one hand (shares, commodities, and corporate bonds), and highly liquid assets and government bonds, on the other. The aim is to create a safety cushion that maintains portfolio risks at reasonable levels.
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