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. It’s worth noting that rising interest rates, over time, could lead to changes 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 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 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. While official CPI figures came in lower than expected in June and July and returned the annual rate of inflation to near-zero levels, consumer prices are likely to edge up modestly in the months ahead. 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. That said, the pace of consumer price rises 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 will continue rising in coming years. We also recommend that investors maintain a slightly longer duration on Israeli fixed-rate government bonds than equivalent bonds overseas, given our assessment 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 well prove to be less accommodative in coming months.
- 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 it’s true that stock valuations are high, so are the valuations of all other assets classes, which leads us to recommend that shares remain the core holding in investor portfolios. We advise maintaining significant exposure to Israeli stocks, because the earnings of local 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 those of overseas counterparts. But given the rich valuations, investors are advised to be selective in choosing stocks, and avoid 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 widening slowly in 2017, which lowers the underlying pressures for the shekel’s appreciation and could even spark heightened 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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